Japan probes the limits of economic policy
Including loan guarantees, fiscal support this year will amount to 40% of GDP
IN THE 1990S Japan seemed to offer a cautionary tale, an example of how feckless macroeconomic management could lead to troubles that other governments had long ago learnt to avoid.
By the 2000s many economists came to see it as a harbinger. The path its leaders took in their efforts to lift weak growth, chronically low inflation and near-zero interest rates has been followed, repeatedly, by others in the rich world.
Japan’s trailblazing has helped reveal that the limits to extreme policy are much farther away than economists had thought at first. This path-finding may well continue. At the end of May the government announced spending plans that will take total fiscal support for the economy this year to 40% of GDP. (Because the measures include loan guarantees, the budget deficit will probably amount to less than half of that.)
The colossal figure might bolster queasy politicians elsewhere. But even as it does so, Japan’s fiscal radicalism exposes the limits to what government borrowing can achieve.
Japan’s experience of covid-19 has been remarkably mild. Despite its older population, a rash of cases early in the epidemic and a reluctance to impose strict lockdowns, its recorded infection rate is among the lowest in the rich world: just 134 per million, less even than in widely touted success stories like South Korea and New Zealand. It began its battle against the economic effects of the pandemic from an especially weak position, though.
In most countries the coronavirus interrupted an economic boom, but Japan’s downturn began last year. An increase in consumption tax last autumn, part of an effort to repair the government’s finances, was followed by a drastic pullback in spending.
Output shrank at an annual rate of 7.1% in the last quarter of 2019, compared with the previous three months, and by 3.4% in the first quarter of 2020. As in much of the rest of the world, the pace of contraction is likely to have been far more dramatic in the second quarter.
In the face of this bleak outlook, the Bank of Japan has continued to provide extraordinary monetary support. It has led efforts to revive the Japanese economy since Abe Shinzo, the prime minister, entered office in 2012. Its policy of yield-curve control, introduced in 2016, caps ten-year government-bond yields at 0% (the idea is gathering some support in America). Bonds with longer maturities yield less than 1%.
Like many other central banks, the Bank of Japan has made emergency loans to vulnerable firms. Furthermore, it has bought about ¥62trn ($600bn) in assets, taking its already swollen balance-sheet to more than 110% of GDP.
More remarkable, though, has been the extent of fiscal support. In April Mr Abe’s government unveiled spending and guarantees worth ¥117trn, or roughly 20% of GDP, one of the most extreme responses to the pandemic. Perhaps feeling the pressure from a public that has become increasingly frustrated with the government’s handling of the crisis, Mr Abe announced another package in late May, which is roughly the same size as the first.
As a consequence, the flow of red ink this year tests the limits of comprehension. Japan will issue government bonds worth roughly 40% of the size of its economy. All else being equal, borrowing could account for nearly 60% of the government’s revenue in 2020. A third spending programme cannot be ruled out. Soaring borrowing and falling output together promise to push Japan’s level of gross government debt well above the already vast level of about 240% of GDP.
Markets have yawned in response. Share prices in Japan have risen steadily from their lows in March—no doubt influenced by the central bank’s large-scale purchases of exchange-traded funds—but so have stock indexes in most of the rest of the rich world. Government-bond yields have barely stirred.
The Bank of Japan’s yield cap partly explains that. But the central bank’s pace of government-bond purchases has slowed since March and April, amounting to just ¥5trn between May 20th and 31st. The yen has been surprisingly well behaved. At the moment, punters do not seem to have become more worried about Japan’s fiscal sustainability or the risk of inflation.
Investors’ indifference to such borrowing may come as a relief to other rich-world governments seeking to breathe life back into their economies. Since the global financial crisis of 2007-09, economists have become more comfortable with the notion that large-scale government borrowing is needed to fight economic weakness. But the awesome scale of debt issuance created by the response to the pandemic risked deterring some governments from borrowing as much as needed. Japan’s benign experience should provide some reassurance.
The Abe shoe drops
There is a risk of over-interpreting the lessons of Japan’s trailblazing, though.
Debt issuance of 40% of GDP, tacitly financed, in large part, by central-bank easing, will probably influence debates around the world about the extent to which sustained borrowing can be used to fund generous social programmes.
But all its stimulus notwithstanding, Japan’s economy is hardly roaring ahead. Its output per person, in real terms, is unexceptional by the standards of the rich world.
In fact, Japan has been able to borrow so much, now and in more placid times, because the rest of its economy spends so little.
High levels of net saving by households and firms—that is, savings less investment—are a persistent problem, and represent forgone consumption and unused economic capacity.
Demography is partly to blame. People approaching retirement save more, and that surely discourages companies from making large investments at home.
But corporate thrift also represents a failure of reform, and of ambition; an inability to take full advantage of the country’s capabilities and its attractiveness to would-be immigrants, for instance.
Japan has shown the rest of the world a policymaking route that is seemingly sustainable. That does not mean it is worth following.
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