Japan is back. When the world’s financial markets were stopped in their relentless advance on 23 May, it was not the result of shock data from the US or yet another debacle in the eurozone, but because Japan’s stock market had suffered a 7 per cent fall after rising 50 per cent in the previous five months. Not for 20 years has the world’s third-largest economy demonstrated such vigour and such power over global sentiment. Where has this turnaround come from? What does it mean? And does it hold any lessons for the UK?
In 1993 the idea that Japan was about to disappear into two decades of economic irrelevance would have seemed preposterous. Sure, 1990 had been the year when the country’s mammoth stock-market bubble burst. But County Hall in London had just been snapped up by Japanese investors, and Michael Crichton’s latest bestseller, Rising Sun, summed up the widespread feeling that Japan was taking over the world.
It turned out that the hangover from the bubble years was far more damaging than expected. The 1990s and 2000s brought a string of stop-go policy responses. As a result, the Japanese economy barely grew, deflation set in, and Japan’s policymakers seemed to give up on trying to fix the problem.
All this changed in December 2012 with the election of the nationalist government of Shinzo Abe. Abe promised to take bold measures to reinvigorate the economy. He promised a strategy with three “arrows”: an aggressive loosening of monetary policy; a generous application of fiscal stimulus; and structural reforms to increase Japan’s productivity and competitiveness.
Dramatic reforms had been promised before – so the world, and the Japanese, waited to see whether the new doctrine of “Abenomics” would live up to its exciting prospectus. The immediate test came with the appointment of a new governor of the Bank of Japan in April this year.
Abe did not disappoint. In place of Masaaki Shirakawa – a graduate of that inner sanctum of anti-interventionism, the University of Chicago – arrived Haruhiko Kuroda, who learned his economics at Oxford from Sir John Hicks, the man who formalised the bible of activist policymaking, John Maynard Keynes’s General Theory.
On 4 April, Kuroda announced a programme of money-printing unprecedented even in this era of quantitative easing. The Bank of Japan will aim to double the money supply within two years by buying up the government’s debt with freshly issued yen.
This sudden conversion to policy activism came as a surprise after so many years of fatalism. Yet there is a historical precedent for the Japanese experiment. Abenomics is closely modelled on Japan’s economic programme of 1931-36, which succeeded in lifting the country out of the global depression of that era.
Faced with persistent deflation, an overvalued currency and export markets in the doldrums following the US crash of 1929, Korekiyo Takahashi, the then finance minister, took Japan off the gold standard, ramped up government spending and ordered the central bank to finance it. The effect was the fastest recovery of any major economy. The fiscal stimulus kick-started demand. Low interest rates and the devalued yen fed privatesector investment and exports. Japan’s GDP grew more than 50 per cent in four years. No wonder Abenomics has adopted the Takahashi plan.
Japan was not the only major economy to depart from the interwar economic orthodoxy and execute a bold policy experiment. So did the UK. In September 1931, a decade of slump conditions forced Britain off the gold standard. In 1932, the new chancellor, Neville Chamberlain, announced that sterling would be devalued and the primary aim of monetary policy revised to return the price level to that of 1929 by any means necessary.
There was one important difference from the Takahashi plan. In the British case, fiscal pump-priming was unnecessary. Low interest rates and an explicit commitment to higher inflation proved a powerful enough tonic for the private sector on their own. The key was an unprecedented boom in housebuilding which bequeathed to Britain’s suburbs the thousands of 1930s semis that line their streets today and made British GDP grow at 4.5 per cent a year between 1932 and 1936.
There was also a crucial common factor, however. Takahashi and Chamberlain were elected ministers of finance, not appointed central bank governors. Under their programmes, monetary policy ceased to be a matter for the bankers and became an explicit tool of government. This transfer of responsibility was critically important. For the same reason as an independent central bank can more credibly promise to hit a low inflation target, an elected politician is better able to commit to a high one. After all, it is in the government’s interests to inflate away the value of its debts. In both Japan and the UK, it was the public’s expectation that the government was finally serious about defeating the deflationary bust that prompted the recovery in private investment.
It is no surprise, therefore, that since the launch of Abe’s contemporary version of the Takahashi plan, monetary policy has been explicitly subordinated to the government’s plans for pubic spending and growth. In the new world of Abenomics, the Bank of Japan is independent in name alone.
The contrast with the UK could not be starker. Unlike the Japanese, we soldier on with a policy mix fit for a boom, not a slump: fiscal austerity combined with a low inflation target overseen by an independent central bank. Future generations will be astonished that we not only ignored the lessons we learned eight decades previously – but did so at the very moment when Japan was finally showing the way back to the future.
Felix Martin’s book “Money: the Unauthorised Biography” will be published by the Bodley Head on 6 June