On July 27, 2016, Japanese Prime Minister Shinzo Abe announced a JPY 28 trillion stimulus package, the largest ever in the modern history of the Japanese economy. The fiscal stimulus includes spending on infrastructure, such as the maglev train from Tokyo to Osaka, the reconstruction of disaster zones, wage increases for child and elder care workers, and direct cash payments to low-income households. Of the total package, 7.5 trillion Yen will be fresh spending out of the pockets of the central and local governments. The Abe administration intends to use the stimulus to contain the negative shock of Brexit and inject desperately needed blood to the sluggish Japanese economy. It is estimated that the stimulus would boost the gross domestic product (GDP) of Japan by 1.3 percent.
In the same week, after the Bank of Japan concluded its regular policy meeting, it stated that it would maintain its base money target as well as the pace of purchases of other assets including Japanese government bonds. It also left interest rates unchanged at 0.1 percent. The statement disappointed financial markets, which speculated that the Bank of Japan would adopt “helicopter money” to coordinate the fiscal stimulus.
Less than three months ago, worried about the detrimental effect of the sales tax increase on struggling household consumption, the Abe administration postponed the sales tax hike, which was set to be lifted from 8 percent to 10 percent in April 2017, to late 2019. It was the second time that the Abe administration delayed the planned tax increase. Japan’s public debt, at more than twice the size of the economy, is the highest among advanced economies. A steady increase in the sales tax is crucial for Japan to avoid a sovereign debt crisis and achieve fiscal sustainability in the future. A flexible fiscal policy is the second arrow of Abenomics. “Flexibility” means fiscal policy should emphasize both the sustainability of debt and economic growth. Under certain circumstances, enhancing growth may be given a higher priority over reducing public debt as robust economic growth is essential to reducing government debt. The delay of the sales tax hike is consistent with the principle of the flexible fiscal policy.
The paradigm shift of Japanese macroeconomic policy — the introduction of the fiscal stimulus, the delay of the sales tax, and the decision of no helicopter money by the Bank of Japan — implies that the Japanese government is steering away from further expansion of the quantitative easing program and is turning to fiscal instruments.
After Prime Minister Abe won his election in December 2012, the Bank of Japan acceded to Abe’s demand and announced a 2 percent inflation target. In April 2013, Haruhiko Kuroda, the former president of the Asian Development Bank and a strong supporter of Abenomics, was appointed as the new governor of the Bank of Japan. Under the leadership of Governor Kuroda, the Bank of Japan introduced quantitative and qualitative easing (QQE) and committed to doubling the monetary base in two years through open market operations — purchasing Japanese government bonds, exchange-traded funds, commercial papers, and corporate bonds. With QQE, Japan’s monetary base in December 2014 rose to JPY 267 trillion, almost double that in December 2012. By April 2016, Japan’s monetary base further surged to JPY 386 trillion, more than 75 percent of Japan’s nominal GDP. In terms of GDP, the monetary easing by the Bank of Japan has been the most aggressive compared with that of the US Federal Reserve and the European Central Bank.
Despite of the massive amount of money injected into the economy, Japanese inflation remains far below the 2 percent target. Even worse, Japanese consumer prices excluding fresh food fell 0.3 percent in April 2016 from a year earlier, after dropping by the same amount in March. It seems that QQE alone is not sufficient to lift the price level and revive the Japanese economy. Moreover, the 2 percent inflation target failed to alter the inflation expectation of Japanese households. In all his public speeches, governor Kuroda repeatedly committed to the inflation target. Unfortunately, Japanese households ignored the message. Instead of withdrawing their bank saving to spend more, they held their wallets tighter. Household consumption dropped 0.8 percent and 1.3 percent respectively in 2014 and 2015. In the first quarter of 2016, it rose by a mere 0.6 percent.
The absence of significant wage increases in the last few decades is another factor dragging down Japanese private consumption.
In order to boost consumption and investment, the Bank of Japan surprised the market in February 2016 by introducing a negative interest rate of -0.1 percent, which is charged on excess reserves held by Japanese commercial banks. The Bank of Japan expected the negative interest rate to force commercial banks to lend rather than park their money at the central bank to earn easy risk-free interest. But the negative interest rate triggered confusion in the Japanese bond market and caused a lot of anxiety among Japan’s thrifty savers, who are deeply concerned that commercial banks would eventually pass the cost of the negative interest rate to them. So far, there is little evidence that the negative interest rate has facilitated either investment or consumption.
The failure of QQE and the negative interest rate imply that the fundamental problem of the Japanese economy is not the lack of liquidity but of real demand. The Japanese economy has been suffering shrinking aggregated demand because of drastic demographic changes in the last two decades. From 1995 to 2015, its working-age population (15-64) dropped by 10 million; on the other hand, people older than 65 rose from 14.6 percent to 26 percent of the population. Japan’s total population has already started to contract and the decline will accelerate in the coming decades. It peaked at 128.1 million in 2010 and decreased to 126.1 million in 2015.
We do not need a sophisticated econometric model to gauge how damaging the declining and aging population has been for the growth of the Japanese economy. Just look at a few facts. From 2003-2014, more than 5,800 public schools were shut down because of the dwindling young population aged from 0-14, which decreased by 2.36 million during the period of 2010-2015. The closures of the public schools mean less demand for school teachers, student uniforms, textbooks, stationary and other necessities. Additionally, due to population decline and aging, there are more than 8.2 million homes, about 13.5 percent of all residential units in Japan, which are uninhabited. Unambiguously, the demographic changes have significantly undermined domestic demand. The detrimental effects of the declining and aging population could counterbalance any positive effects of monetary policy. In other words, sluggish economic growth and low inflation are rooted in the structural change of the Japanese population.
Moreover, the absence of significant wage increases in the last few decades is another factor dragging down Japanese private consumption. Trickling down the economic benefits of Abenomics through wage increases is crucial to establish the “virtuous cycle” of rising corporate earnings, wages hikes, and consumer spending growth. For many years, nominal basic wages in Japan have been declining despite the tight labor market. Labor’s share of national income has dwindled from around 66 percent at the turn of the millennium to around 58 percent now. Actually, the nominal monthly wage in fiscal year 2015 was JPY 299,600, which is 2 percent lower than the basic salary of 14 years ago, despite the 20 percent labor productivity growth during the same period.
Corporate Japan, especially large Japanese enterprises which earn a substantial amount of revenue from overseas markets, have benefited significantly from Abenomics. In the last three years, the cash holdings of Japanese non-financial companies rose 18 percent and amounted to JPY 247 trillion, more than half of Japan’s GDP. However, Japanese companies are reluctant to share the profits with their workers by raising base salaries.
Globalization has weakened the collective bargaining power of labor unions. Japan is no exception. Japanese labor unions are too weak to negotiate a decent slice of the rising profits for their members in annual wage negotiations — the so-called “spring fights” — with Japanese corporate management. For instance, Toyota, the most profitable auto-maker in the world, made a record profit of JPY 2.14 trillion in 2015, of which JPY 560 billion was attributed to the depreciation of the Japanese yen, thanks to the aggressive monetary easing of Abenomics. It agreed from fiscal year 2016 to increase the basic monthly salary of their workers by only JPY 1,500, which can only buy a lunch plus a cup of coffee. Frustrated by the slow wage growth, the Abe administration decided to raise the minimum wage 3 percent this year, the largest annual increase since Japan adopted the minimum wage. It is expected that the hike of the minimum wage will pressure Japanese companies to increase the base salary of their employees.
Various spending programs financed by the stimulus will boost Japanese aggregate demand and revive the Japanese economy in the short run. The stimulus is a one-time expenditure, not a permanent increase. Whether it can revive the growth in the long-run remains a question. The demographic change of Japan will continue to be a hard constraint for the Japanese economy in the foreseeable future and challenge the effectiveness of monetary and fiscal policies.