The Great Recession not only devastated the U.S. economy but had long lasting effects on a global scale, severely impacting both Europe and Japan. Japan had dealt with economic turmoil for the majority of the decade leading up to the recession; as a result, in 2008, the country witnessed a 42 percent decline in the Nikkei 225 Stock Exchange and negative real GDP growth rates. These developments, combined with deflation and minimal nominal GDP growth through the 2000s, signaled that Japan’s economy required reform.  

Following the December 2012 Japanese general election, newly appointed Prime Minister Shinzo Abe introduced a new set of economic policies. His three arrow strategy, commonly referred to as Abenomics, aimed to fight deflation, which has plagued Japan for over two decades, and stimulate economic activity.

Abenomics implements aggressive monetary policy, fiscal stimulus and structural reforms to ensure short- and long-term sustainable growth. Japan’s initial optimism following the introduction of Abenomics resulted in greater consumer confidence and gains in financial markets. However, with below forecasted GDP growth in 2014, Abenomics’ initial success has waned with risk factors of the program becoming more apparent.

Monetary Policy

Abenomics proposes aggressive changes based on three core principles: monetary policy, fiscal policy and structural reforms. Traditional monetary policy has been unsuccessful in boosting economic activity during an economic recession due to deflation and already low interest rates. Thus, unconventional monetary policy, such as quantitative easing, can be implemented to fight deflation, maintain low interest rates and increase lending.

Quantitative easing was first introduced in Japan in the early 2000s, and the policy was used again as a part of Abe’s economic program. In 2013, the Bank of Japan unveiled a massive stimulus package increasing purchases of government bonds by 50 trillion yen per year in order to reach its target inflation of 2 percent.

Fiscal Policy

The second part of the Abenomics program involves short-term fiscal policy: using government spending or taxation to improve economic conditions. The Japanese government spent an extra $114 billion from January to April 2013 in effort to spur economic growth. The increase in government spending funded infrastructure changes in schools, roads and earthquake defense.

As a result of Shinzo Abe’s expansionary fiscal policy, Japanese public debt ballooned to $10.5 trillion in August 2013.  Amongst developed nations, Japan has the highest debt-to-GDP ratio with over 240 percent more public debt than GDP. A high debt-to-GDP ratio increases risks of default and may lead creditor countries to seek higher interest rates.

Structural Reform

The third pillar of Abenomics incorporates a structural overhaul of key sectors including agriculture, healthcare and energy. While monetary and fiscal policies in Abenomics target short-term growth, structural reforms undertaken in Japan are expected to carry medium- to long-term effects. In particular, Japan has focused its attention on increasing competition, productivity and mobility in the labor force and various sectors.

Japan is tackling its aging population problem by urging women and youth to join the labor force. The adoption of progressive childcare policies encourages women’s participation while increasing labor mobility. As for agriculture, policies and trade agreements, along with efforts to increase agricultural exports, are expected to boost competitiveness and decrease prices in the sector.

Risks

While intended to stimulate economic activity, a massive overhaul of monetary and fiscal policies has inherent risks. Using quantitative easing to promote inflation can lead to hyperinflation in some cases. As prices start to rise, interest rates will too eventually, effectively rendering zero interest rate policies useless.

Furthermore, quantitative easing weakens currency in order to promote exports; however, a weaker yen leads to higher costs for imports, and Japan is a large importer of energy and reactors. Likewise, side effects of expansionary fiscal policy can undermine Japan’s finances. With Japan’s increasing debt and high debt-to-GDP ratio, Abenomics failure to trigger economic growth will make it difficult for the nation to reconcile its public debt.

Progress

Abenomics hasn’t been as successful as initially intended In the two years following Abe’s December 2012 victory. Quantitative easing has resulted in a weaker yen, but exports only grew by 4.9 percent in 2014, much slower than the forecasted 7 percent increase. Prices also climbed due to quantitative easing, but wages have risen at a slower rate, causing Japanese consumers to recover more slowly than expected.

In early 2014, Abe implemented a consumption tax hike and increased the nationwide sales tax to 8 percent from 5 percent. A second consumption tax increase has been set to lift the sales tax from 8 percent to 10 percent in October 2015. Japan’s tax increases, while aiming to stabilize a high debt to GDP ratio, offset economic benefits from Abenomics.

The Bottom Line

Following a decade-long recession, a massive overhaul of economic programs and policies was intended to stimulate economic activity in Japan. The three pillar system, called Abenomics, restructures monetary policy, fiscal policy and structural reform.

Despite aggressive reform, any economic benefits of Abenomics have fallen short of forecasts. In particular, the third arrow of structural reforms has little evidence of any positive change. For Abenomics to create long-term sustainable growth, comprehensive structural reform must be effectively managed to stimulate economic activity.