All significant events seem to become ‘great’ events in financial lexicon. Not great as in something that is wonderful, but as in something that is immense – there was the great depression, the great recession, and now, in Japan, a ‘great’ experiment in monetary policy.
This experiment uses vast amounts of freshly minted money to stimulate demand as the “second arrow” of prime minister Shinzo Abe’s plan to restart the Japanese economy. (The other two arrows are fiscal stimulus and economic reform.)So far, so good for Abe’s experiment, although the latest print of Japanese GDP growth showed a slowdown and there are still many questions over that final arrow of economic reform.
The Japanese economy expanded at an annualised rate of 1.9 per cent in the three months to September, much slower than the near 4 per cent growth in the first half of the year. Domestic consumption and net exports were the biggest drags on growth, but business investment was also weaker than expected. However, economic releases for October and survey data suggest that this was just a dip and that the fourth quarter should see a return to higher rates of growth. The closely followed Tankan survey of business confidence, for example, was at its highest level in September since the end of 2007.
Despite the third-quarter dip, the Japanese economy should continue to expand over the medium term. Consumer spending should rebound as households bring forward purchases to beat the consumption tax rise planned for April next year, while building momentum in the global economy should see increased demand for Japanese exports. Meanwhile, public investment will support broader economic activity as the country prepares to host the 2019 Rugby World Cup and the 2020 summer Olympic Games. (Fascinating fact: Japan holds the record for conceding the most points in a Rugby World Cup game, losing 145-17 to New Zealand). Longer term, however, the picture is less clear. Stronger wage growth is needed to ensure higher rates of inflation, while details on the third arrow of structural reform are light.
The second arrow of Abe’s plan was to create 2 per cent inflation over two years by doubling the monetary base. This certainly appears to be working, and Japan has moved back into inflationary territory. Some of this inflation is the result of increasing levels of domestic demand, but it’s also being driven by a weak yen, which makes imports, particularly energy, more expensive. This positive inflation environment may come undone, though, without a commensurate rise in wages. Wage growth has been sluggish as companies are perhaps not yet convinced that profits will continue to rise and that higher wages will be affordable. In the absence of positive nominal wage growth, a rise in inflation driven by a weaker yen will push down real wages and depress consumer demand. The increase in the consumption tax next year will further erode household purchasing power. The failure of wages to increase and the potential for a weaker inflation outlook in the coming year have led to speculation that the Bank of Japan may introduce further monetary easing in the new year to ensure that the 2 per cent inflation target is achieved by the middle of 2015.