Japan has made lots of mistakes and it is time that Europe learnt from them
We can all learn from watching others make mistakes and the experiences of Japan continue to provide valuable lessons. Japan has stumbled into another recession following a hike in taxes to fix the government’s finances. The other key policy doing the rounds in Japan, using expansive monetary policy to put an end to deflation, also seems to be flagging. It is Europe that has most to learn from the unfortunate trials and tribulations in Japan since many of the same problems are shared by both. What should Europe do to avoid making the same mistakes and decades of stagnation?
Following in the same footsteps
Japan has been hit first with many of the same problems that are increasingly expected to plague Europe and other Western countries. For starters, new-borns in Japan are increasingly outnumbered by pensioners which have pushed the population into decline in recent years with an aversion to immigration further accentuating this trend. This translates to fewer workers to provide the taxes needed for the rising costs involved with taking care of old people. The situation is made worse by government debt which is already more than double GDP due to years of inefficient government spending.
Japanese consumer prices have been falling for years as a reflection of the weak demand. There are few opportunities to profit from in Japan due to the falling population and even Japanese firms are looking elsewhere to invest. Weak global demand means that even one of Japan’s strengths, exporting, offers only limited respite even with a weaker yen due to its loose monetary policy. All of this means that the Japanese economy itself is like a tottery pensioner - even a small rise of sales tax from 5% to 8% was enough to push Japan back into recession. This does not bode well for Europe where the economy is sputtering along due to many of the same problems while the governments there are also trying to get a grip on their finances.
Trying different directions
Having been stuck with these problems for longer, policy makers in Japan are increasingly more aggressive in coming up with solutions. The current prime minister, Shinzo Abe, launched a raft of new measures dominated by a massive expansion of the money supply to target falling prices. This new aggressive approach to monetary policy was facilitated by the government installing a new governor to the Bank of Japan who was willing to give up its independence and toe the line.
This is the complete opposite to the situation in Europe. The head of the European Central Bank is eager to do more with monetary policy but is prevented from doing so by the German government. German politicians want to reforms to come first due to an expectation that their neighbours will not implement the necessary policies. Whereas, in Japan, the aim was to use the loose monetary policy to help build momentum that will allow the government to implement reforms.
Yet, the Abe government has been disappointing in its reform efforts (as Your Neighbourhood Economist predicted) and this will bolster the stance taken by Germany. With the Bank of Japan finding it tough to generate sufficient inflation despite a rapidly expanding money supply through quantitative easing, many will question about the reasons behind using a similar policy in Europe. Central banks are struggling to have much influence in a world that is already awash with surplus cash.
Time for Plan C
It seems like the key lesson from Japan is that monetary policy cannot do much by itself. Japan still languishes despite the best efforts of the central bank as the Abe government shirks the much needed measures to free up the economy. Yet, bullying countries in Europe to reform by withholding the full extent of monetary policy is not helpful either. A grand bargain marrying reforms with looser monetary policy, as was supposed to be the case in Japan, seems the obvious solution.
This takes more political willpower when the many countries of Europe are involved but is not something beyond the realms of possibility. Ironically, the chances for such a deal may be improving as deflation becomes more of a concerns and the economic stagnation in Europe also spreads to Germany. Japan has already paid the price for years of economic mismanagement – there is no reason for Europe to do the same.