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Tuesday 22 July 2014

Tough lessons to be learned from Japan's 20-year stretch of economic struggles

James Saft

Published 15/11/2012|05:00

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JAPAN is shrinking again and its government thinks the answer lies in more of the same policy the Bank of Japan (BOJ) has been unsuccessfully implementing for 17 years.

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Japan's economy contracted by 0.9pc in the third quarter, data showed on Monday, reversing earlier quarters of growth and taking the country into a nosedive equating to a 3.5pc annual decline.

Inevitably, this has economists and policy-makers fretting over whether Japan is sinking into a recession, technically defined as two successive quarters of economic contraction.

"I cannot deny the possibility that Japan has fallen into a recession phase," Japan's economy minister Seiji Maehara said.

As if there could be a more beside-the-point question: this is akin to an alcoholic thinking their big problem is whether they will lose their job.

Japan's issue isn't whether it is sinking into its fifth recession in 15 years – as if recessions were somehow discrete phenomena like colds – but why it is now 20 years into an economic malaise.

There are, to be sure, extenuating circumstances. A territorial dispute with China has led to a sharp drop-off in trade, and the recession in the eurozone is also hurting exports and demand.

Looking at the situation, Mr Maehara called for more, in essence, of the same, asking the BOJ for powerful easing and suggesting it might want to buy foreign debt, a move that presumably would weaken the yen and increase export competitiveness.

Independence

It might be best to be a bit cautious of that last idea: governments piling pressure on their central banks could lead onlookers to conclude the central bank is losing independence, a notion that could weaken the yen rapidly and disastrously.

Japan's government has become increasingly bold in pressuring the BOJ, with both Mr Maehara and Finance Minister Koriki Jojima outspokenly jawboning the bank ahead of its October policy meeting. That led to new easing measures, as the bank increased its asset-buying programme and unveiled a new plan to give banks cheap, long-term funds in potentially unlimited amounts.

It also led to an unprecedented joint statement from the BOJ and government, in which each called on the other to do more. It is unclear if this is the BOJ defending its independence or evidence it is being co-opted. Investors and economists both stoutly defend the importance of central bank independence, lest monetary policy become overly easy, which may aid in re-election but undermine a currency and lead to inflation.

Thus far, deflationary forces have been Japan's signature problem, with the BOJ unable to hit its quite modest 1pc target for annual inflation.

In nominal terms, Japan's economy is now the smallest it has been since 1993, hardly a ringing endorsement of campaign after campaign of quantitative easing and other extraordinary measures.

"The most important lesson of the last 20 years in Japan and of the last four years in western economies is that monetary policy is ineffective when there is no private demand for funds," Nomura economist Richard Koo wrote in a note to clients before the data was released.

Loan demand

"In Japan, there has been little or no private loan demand since 1995, when the BOJ brought interest rates down to near-zero levels. And neither the economy nor asset prices have recovered, even though, as BOJ governor Masaaki Shirakawa has noted, the BOJ embarked on quantitative easing fully eight years before its counterparts in Europe and the US."

Mr Koo coined the phrase 'balance-sheet recession' to describe a contraction driven and reinforced by the paying back of debt.

That idea has taken hold, and an appreciation of the limits of monetary policy has spread. Mr Koo's prescription, for large and decisive amounts of government stimulus and for investment and tax incentives, is less widely accepted.

With Japan's government debt at a huge 230pc of GDP, there is not sufficient political consensus there for a large new round of stimulus, and amid debate over the timing of elections the opposition has refused to give Prime Minister Yoshihiko Noda's government the right to borrow to fund this year's deficit.

There seem to be two easy lessons from Japan, both of which sadly it may be too late for the West to follow.

The first is don't allow massive amounts of debt to build up, and the second is don't confuse a period of growth while debt is shrinking with a recovery.

The harder lesson, at least for Japan, is that if you find yourself in that position, for pity's sake don't do anything to give the impression you are diminishing your central bank's independence.

A long, slow slide could turn into a rather more rapid one. (Reuters)

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