First elected in 2006, Mr. Abe, at age 52, was Japan’s youngest Prime Minister since 1941, but he faced a plethora of troubles during his initial tenure. His Agricultural Minister, Toshikatsu Matsuoka, committed suicide after he was connected to the misappropriation of government funds. Matsuoka’s replacement, Norihiko Akagi, resigned two months later due to similar suspicions. A fervent nationalist, Mr. Abe received criticism for denying the abduction of “comfort women” by Japanese troops in WWII and for pushing public schools to teach “patriotism” in class. As his approval ratings plummeted below 30 percent, he announced his resignation in September 2007, after just 366 days in office.
However, Mr. Abe did not let this unsuccessful first attempt end his career. On September 26, 2012, he once again became the President of the Liberal Democratic Party, Japan’s major conservative political party. Less than two months later, he was elected Prime Minister. In a masterful reversal away from his first term, Prime Minister Abe redirected attention from his social and cultural views to his plans for economic recovery and international hegemony. Such a refocusing made political sense for a nation that was growing increasingly worried about economic woes such as deflation, fiscal overextension, foreign energy dependency, low levels of consumption, and a rapidly aging population.
And compared to his first term, Mr. Abe’s current term has been squeaky-clean in terms of scandal. He has maintained constructive relations with both Western and non-Western press, often adding character to his interviews by moving away from prepared notes. This relative calm has afforded Mr. Abe a clean slate with which to pursue his far-reaching economic reforms along with his central bank governor, Haruhiko Kuroda. However, despite both men’s preference for monetary expansion, clashes between them have become more frequent, pointing to further conflicts between the Bank of Japan and the government that could hinder future policymaking.
Big Problems and Bigger Solutions
Mr. Abe entered office facing widespread economic challenges. As a result of Japan’s real-estate crisis in the early 1990s, Japan has fought steep falls in consumption propensity that ultimately precipitated years of deflation. Since May 1995, prices have fallen or stayed constant in two months out of every three. As the money supply contracted, businesses saw rising real wage costs and decreasing profits, debtors paid debts with appreciated currency, and consumption and investment stagnated as individuals held out for lower prices in the future. The recessions that followed were devastating; it took 15 years for the economy to recover to 1995 levels. Fittingly, this period is often referred to as Japan’s Lost Two Decades.
Exacerbating the fallout from the 1990s’ economic turmoil, Japan’s rapidly aging population has squeezed its supply of labor and placed additional burdens on social welfare systems. With a median age of 44.6 years, Japan has the second oldest population in the world; this compares with 36.9 for the United States and 35.2 for China. Furthermore, after the Fukushima Nuclear Disaster in March 2011, Japan moved away from nuclear energy, which supplied 30 percent of the country’s electricity before the crisis. Without this energy source, Japan has been forced to import more of its energy, widening its trade deficit.
As increasing imports, extensive government stimulus, and insufficient tax revenues have plagued the Japanese fiscal structure, Japanese debt has soared to 2.27 times its annual GDP—the highest ratio in the world. Although low interest rates and domestic debt holdings have eased the burden of such obligations (a stark contrast to U.S. debt), this extensive overhang nevertheless poses significant risks to the long-term health of the Japanese economy.
In response, Mr. Abe set the tone for his second term by adopting a radical economic plan for bringing Japan out of its stagnation. With a set of initiatives commonly known as “Abenomics,” Mr. Abe pledged to use three “arrows” to revitalize the economy: aggressive fiscal stimulus, sweeping structural reforms, and rapid monetary expansion.
With concrete policy aims such as a materially weaker yen, extensive quantitative easing (buying long-term government debt), lower corporate taxes, the reinstitution of nuclear reactors, the expansion of fiscal spending by two percent of GDP, and a goal of two percent inflation, Mr. Abe’s administration brought confidence to the Japanese economy. Within weeks of taking office, Mr. Abe made good on his promise for fiscal stimulus by organizing a ¥10.3 trillion stimulus bill. For structural reforms, Mr. Abe put pressure on regional governments, which were responsible for much of Japan’s bureaucratic red tape. Crucially, in pursuit of his two percent inflation goal, Mr. Abe appointed Haruhiko Kuroda as the Governor of the Bank of Japan (BOJ), the nation’s central bank, in February 2013 to rapidly expand the monetary base.
Friends in High Places
After Mr. Abe took office, unemployment continued to fall, exporters cheered a rapidly depreciating currency, and inflation gradually moved out of negative territory. However, as Mr. Abe’s honeymoon period has passed, his political influence with which to reform has dwindled. With Japan’s massive public debt, additional fiscal stimulus has been politically and economically difficult. Similarly, the streamlining of regulations has been slower than desired because such reforms require the cooperation of local governments.
In contrast, Japanese monetary policy is free from political influences. Accordingly, the Governor of the Bank of Japan enjoys a prestigious and powerful position. A long-time advocate of looser monetary policy, Haruhiko Kuroda was as radical in monetary thought as Mr. Abe was in governmental thought. Feeling no qualms about breaking with conventional boundaries of central banking, Mr. Kuroda wanted large-scale government purchases but also said that the BOJ could potentially purchase corporate bonds “or even stocks.” Such statements marked a 180 degree turn from his predecessor, Masaaki Shirakawa, who mitigated the effects of loose monetary policy by frequently warning of the dangers of excess liquidity. Moreover, Mr. Shirakawa desired central bank independence from the government, pushing back against Shinzo Abe’s calls for unlimited easing to end deflation.
In contrast, Mr. Kuroda seemed much more in sync with Mr. Abe’s administration. He quickly delivered a plan to double the monetary base within two years, a move that could flood global markets with up to $2 trillion. Furthermore, Mr. Kuroda gave the assurance that such measures would continue for “as long as it takes” to reverse Japan’s deflationary cycle. Although it may be difficult to prove that Mr. Abe removed the BOJ’s independence with Mr. Kuroda’s appointment, it is clear that the Japanese government and its central bank were on the same page. With Kuroda at the head of the BOJ, Mr. Abe appeared to have secured the one “Arrow” that could fly forever.
To date, Mr. Kuroda has been true to Mr. Abe’s policy initiative. The Bank of Japan has pledged to increase the monetary base by 60-70 trillion yen annually, the current BOJ balance sheet is near $3 trillion, and it has maintained its base interest rate at 0 percent. These measures have helped to speed the Japanese economy along, albeit modestly. According to figures provided by the Wall Street Journal. for the fiscal year ending March 2014, Japan’s GDP grew 2.3 percent, inflation increased to 1.3 percent, and the unemployment rate fell to 3.6 percent.
The April 1 sales tax increase from five to eight percent threatened to reverse this progress. A previous sales tax hike in April 1997 led to a 1.5-year recession, and Mr. Abe shared concerns that Japan’s fragile economic recovery would be undone by this austerity measure, which he had inherited from his predecessor, Yoshihiko Noda. He feared that a stronger yen, less competitive exporters, and deflationary pressures would reverse the early progress of “Abenomics,” but he could do little to remove it through democratic processes. Thus, Mr. Abe urged Mr. Kuroda to increase the Bank of Japan’s monetary accommodation before the April 1 deadline in order to offset the effects of the tax hike.
However, Mr. Kuroda and the Bank of Japan held steady. In an April statement, the BOJ noted that Japan continues “to recover moderately as a trend, albeit with some fluctuations due to the consumption tax hike.” Furthermore, the BOJ believed that “the pullback (in economic activity) after the tax hike will decrease in the summer onward,” implying that the Bank did not intend to increase its monetary stimulus; instead, the BOJ would stick to “our 2 percent price stability goal”. Although these guarded words seem to lack substance, they are clear by the standards of tight-lipped central bankers. With this nuanced dissension, the Bank of Japan ultimately declined to bend to Mr. Abe’s wishes, refortifying its insulation from political influences and leaving Mr. Abe out to dry.
The April Bullet Dodged
As consumers and businesses front-loaded their purchases in the months prior to the tax increase, economists and investors alike expected a severe economic slowdown in April. However, as forecasted by the Bank of Japan, Japan’s economy proved to be surprisingly resilient. International trade strengthened as both exports and imports increased, businesses signaled confidence as they ramped up machine tool orders, and inflation continued to gather momentum even when correcting for tax-induced price increases.
Regardless, tensions between the Prime Minister and the Bank of Japan Governor remain. Although April vindicated Mr. Kuroda, there are still questions surrounding the subsequent months. While the Bank of Japan forecasts an inflation rate of 1.9 percent for 2014, the consensus estimate of 42 private forecasts cited by the Wall Street Journal expect an inflation rate of 1.0 percent. This discrepancy testifies to the uncertainty in Japan’s economic future, and it suggests that Mr. Abe and Mr. Kuroda will continue to cross paths on this issue while searching for an exceedingly elusive solution to Japan’s economic slack. As past and future ideological differences surface, these two leaders’ relationship and resolve will be again tested.
In a set of interviews with the Wall Street Journal on May 23, Haruhiko Kuroda contradicted his April comments by emphasizing risks for Japan’s “real growth rate”. Most importantly, Mr. Kuroda made direct comments against the nation’s currency, stating, “I don’t think it’s reasonable to expect the yen to appreciate against the dollar.” In the world of self-censored central bankers, this was shockingly explicit: Kuroda wants and will act for a weaker yen, and he has once again aligned himself with Mr. Abe in terms of general policy goals.
However, in rationalizing his change in opinion, Mr. Kuroda extensively discussed Japan’s structural issues and critiqued the Abe administration. Positioning Japan’s suboptimal business environment as an evil as destructive as Japan’s persistent deflation, Mr. Kuroda said that the “government and the private sector” have lacked initiative in reducing bureaucratic red tape and incentivizing private-sector business activity. Specifically, Mr. Kuroda cited continued immigration restriction, the low retention rates of female workers post-pregnancy, and the country’s swelling debt. Even though the Abe administration has moved in the direction of economic liberalization by freeing the retail electricity market from government intervention and removing a “40-year-old subsidy to cut rice planting,” Mr. Kuroda and the international community generally agree that reforms have been too small and too slow.
The Arrow Reversed
Although Mr. Kuroda’s discussion with the Wall Street Journal was normal when compared with American and European academics, it was uncommon for the Governor of the Bank of Japan—especially one that had been perceived to be moving in lockstep with Prime Minister Abe for more than a year. Discreetly, Mr. Kuroda had reprimanded the sluggishness of the Prime Minister and his government. Furthermore, Kuroda insinuated that because the Japanese government was not fulfilling its responsibilities to liberalize the structural roadblocks of Japan’s laws, the Bank of Japan may be forced to pick up the economic slack in the future.
Thus, even though Mr. Kuroda has taken a monetary policy stance consistent with Mr. Abe’s agenda, he has done so in a way that scrutinizes and undermines the Abe administration. Although it seems that Mr. Abe will take this negatively, there remains a possibility that he will embrace Mr. Kuroda’s words and find a way to put additional pressure on anti-reform voices within the Japanese government. Surely, this would be the more constructive of the two outcomes.
Image sources: Wikipedia, South China Morning Post, and the Wall Street Journal.