In what would significantly enhance global liquidity, potentially impacting asset prices across emerging markets, Japan will embark on a major expansion of its central bank balance sheet in order to reflate the economy. After suffering years of deflation Japan is now aggressively targeting an inflation rate of 2% and the central bank will pump in fresh money into the system to achieve this.
Heizo Takenaka, economic adviser to Japanese Prime Minister Shinzo Abe, admitted that Japan had made a mistake by not expanding the central bank?s balance sheet the way the US had done after the 2008 global economic meltdown. ?While the Federal Reserve expanded its balance sheet by more than double, Japan had only increased the balance sheet size of its central Bank by about 12%,” Takenaka said.
Therefore, the new government under Abe will correct past mistakes by aggressive monetary expansion to overcome persistent deflation of the past 15 years. Takenaka admitted that the Bank of Japan had not been active in recent years in attacking deflation through monetary easing. ?For some reason the BoJ had stopped monetary easing in the past decade to attack persistent deflation. Now the prime minister is determined to launch his new economic policy called Abenomics. There is an accord between the government and Bank of Japan to do strong monetary easing so that the economy could come back to a GDP growth rate of close to 3%, interest rate of 3.5% and an inflation rate of up to 2%?.
Takenaka said the new prime minister will follow a three-pronged approach. The first element is strong monetary easing so that persistent deflation is attacked. This has already been started and the effect is there for all to see. Japanese stocks have been up in recent weeks and the yen is also becoming weaker, giving a strong stimulus to Japanese exports.
The second element of the strategy is a flexible fiscal policy which will expand in the short run and consolidate in the medium term. Japan?s fiscal deficit is 8% of GDP today, and this needs to be brought down over the medium term even while there is strong monetary expansion to achieve up to 2% inflation rate.
Takenaka expressed confidence with regard to Japan?s capacity to pare government debt, which is over 200 % of GDP, because ?Japan has a lot of assets in the form of shares in public companies. Net of that, the actual government debt may not be that high.?
Takenaka said the first two elements will be supplemented by a third component ? to support an ambitious growth strategy by introducing much greater competitiveness in the industry. He said traditionally the Japanese industrial growth strategy was based on special government grants to the private sector. However, under Abenomics the idea is to eschew the past policy of government supporting the private sector through special grants. Instead, there must be more competitiveness introduced through better corporate governance and practices, Takenaka said. Greater consolidation will be encouraged in the private sector so that uncompetitive players exit the industry.
However, Takenaka also admitted that fiscal consolidation and adopting a new approach to bring competitiveness in the private sector would require political support. To push these reforms, it was important that Prime Minister Abe wins the crucial elections in the upper house, which is scheduled in mid 2013.
Takenaka is also a member of the Japanese Industrial Competitiveness Council, which will drive the new industrial policy in Japan under Abe.
Takenaka was also very clear that all the three elements of Abenomics ? strong monetary easing, fiscal consolidation and industrial competitiveness ? will have to work together to pull Japan out of deflation and bring economic growth back on the agenda.
He conceded that Japan will have to look at other critical elements like opening up its immigration policy so that young, skilled workers from around the world can drive productivity in Japan. Japan is an ageing society and will need an open immigration policy to drive future economic growth, he added.
Takenaka, however, stressed that the Japanese currency was a major factor responsible for the continuing deflation. ?In the last 6 years or so, the yen has appreciated by 50% against the US dollar. Therefore, we have to depreciate the yen through strong monetary easing so that our global competitiveness is back,? he said.
Asked whether he was certain that monetary easing would weaken the yen because in an uncertain world major currencies tend to appreciate simply because they are seen as a safe haven, Takenaka said, ?I don?t think the yen is seen as a safe haven in the way US dollar is.? Takenaka said even a massive injection of liquidity would not encourage carry trade in the yen once Japan recovered.
He said there was a great scope for economic cooperation between Japan and India because ?Japan was surplus in capital and India needed massive capital to drive its infrastructure projects. There was a synergy there.?