Following the Japanese general election in December 2012, newly appointed Prime Minister Shinzo Abe implemented a three-part plan to boost the Japanese economy. Commonly referred to as Abenomics, Abe’s plan tackles decades’ worth of economic struggles by using massive monetary stimulus, fiscal policy and structural reform to decrease stagnation, deflation and public debt. However, to date, any beneficial economic progress has not met forecasted goals. Due to the lack of legitimate structural reforms, the Japanese economy has been unable to create medium- to long-term sustainable growth.
European Central Bank (ECB) President Mario Draghi intends to address the European Union’s economic turmoil in a similar fashion. The eurozone has been plagued by near-zero growth, high unemployment and deflation in the wake of the Great Recession. Draghi’s three-part economic program, nicknamed Draghinomics, targets aggressive structural reforms, fiscal policy and massive monetary policy through quantitative and credit easing. After six months of Draghinomics, initial reports suggest that unemployment has decreased and inflation has risen within the eurozone. Despite initial optimism, the viability of long-term sustainable growth cannot be assessed without multiple years of progress.
The Great Recession caused long-lasting economic turmoil that devastated Europe, Japan and the United States. The eurozone crisis, in particular, resulted in debt crises in several EU member states, and several countries faced the collapse of financial institutions, increasing unemployment rates and high government debt. According to EU rules, member countries that use the euro aren’t allowed to run annual deficits of more than 3 percent of GDP; Spain, Italy and France all ran deficits above the ceiling. The persistence of these problems in the years after the recession prompted Draghi to implement his economic program in 2014.
Along with increases in government borrowing, rising labor costs and trade deficits have resulted in economic distress for EU nations. In order to repay debts, banks, lenders and consumers cut spending at the expense of investor confidence. Notably, Greece’s financial collapse required International Monetary Fund (IMF) and ECB bailouts of $147 billion and $173 billion in 2010 and 2012, respectively. However, even with economic bailouts, growth in the eurozone continues to stagnate due to high unemployment and deflation.
Draghinomics is based on three core principles, the first being the adoption of rapid structural reforms to promote output growth across the eurozone. The ECB can only directly control monetary policies, so EU members must implement structural reforms in order to stimulate economic activity. Labor markets have been a key area of focus for reforms. Like Japan, the eurozone is creating more flexible labor markets and encouraging women’s labor force participation.
While monetary and fiscal policy intend to boost short-term growth, sound structural reforms aim to create long-term growth on the supply side. Despite Draghi’s intentions, several EU governments have been reluctant to implement these policies, as they perceive them to be contrary to domestic interests. As a result, progress remains slow in countries such as France and Italy.
The second element, fiscal policy, aims to maintain long-term growth and debt sustainability. In September, Draghi asserted the need for positive fiscal policy through the use of tax cuts rather than increased spending. In economics, expansionary policy theoretically increases income and the propensity to consume. The economic multiplier effect suggests that an injection of extra income with greater use of aggregate fiscal policy – such as a common EU budget with tax breaks – will lead to improved spending.
In addition to tax relief, Draghinomics suggests that lowering expenditures in unproductive areas can create growth opportunities. Like Japan, austerity and fiscal consolidation must be established through policymaking in order to restore investor confidence. However, in the EU, implementing widespread fiscal policy requires the coordination of 18 member states and budgets.
As Japan, the U.K. and U.S. have shown, monetary policy is crucial in the recovery process following a recession. Quantitative easing (QE), which creates money for buying financial assets without central banks printing any.and other unconventional monetary policies have been implemented to boost economic activity during periods of economic turmoil.
In early 2015, the ECB introduced a QE program to purchase $70 billion in sovereign debt monthly for at least one year. The expansion of ECB balance sheets drives down interest rates and the euro, subsequently creating available credit for investments and exports. However, the results of the ECB’s QE have been unsuccessful. At least $1.7 trillion in European sovereign bonds have reached negative yields: 5-year government bonds from Germany, Sweden and Denmark currently yield less than zero. This means that prior to adjusting for inflation, investors are paying to own the bonds.
Draghinomics vs. Abenomics
Draghi drew largely from Abe’s reforms in the development of his threefold plan, which, like Abenomics, intends to boost economic recovery through monetary policy, fiscal policy and structural reforms. Both the ECB and Bank of Japan have used quantitative and credit easing to battle deflation and rebuild investor confidence as part of their monetary policies. Likewise, fiscal consolidation has been a focal point for sustainable growth and job creation; however, unlike Draghi’s planned tax cuts, Japan has increased the national sales tax in order to create sustainable debt. The third element, structural reform, has plagued progress in both Japan and the Eurozone. Draghi insists that QE and fiscal consolidation would be ineffective unless governments implement supply side structural reforms; whereas the Japanese government has neglected to address structural changes.
The Bottom Line
Like Abenomics, Draghinomics aims to drag EU economies out of recession with a three-step program. As in Japan, structural reform, fiscal policy and monetary policy must coexist in order to increase growth, job creation and debt sustainability. The lack of coordination and implementation of key aspects of Draghinomics by Eurozone governments has largely slowed progress to reinvigorate economies.