The Bank of Japan

When economic historians look back at the Great Recession of 2007/09, the greatest criticism they will make is that policy makers put too much reliance on monetary policy and not enough on fiscal policy. They will argue that the fears over the rise of public debt to GDP were overdone and too much emphasis was put on the numerator, public debt, and not enough on the denominator, nominal GDP. It is much easier to control the ratio if the denominator is rising than when it is falling. This point has been completely missed by the authorities in Europe, particularly in Germany. They have decided to completely ignore the lessons of the 1930s when too many countries tried to adhere to the gold standard and failed miserably. Today’s ‘gold standard’ is of course EMU and the fiscal austerity imposed by Germany on the periphery economies is having the same disastrous results. If there is any doubt about this, simply compare European unemployment and retail sales to those of the US. European unemployment is now 12% and rising whereas that in the US is 7.7% and falling. European retail sales have fallen by 1.5% over the last 12 months whereas those in America have risen by 4.5%. One country that has changed course in recent months has been Japan, where Prime Minister Abe has insisted that the Bank of Japan adopt an inflation target of 2% and do everything possible to ensure it is reached. In addition, there has been a sea change within the Bank of Japan with a new Governor and a Board prepared to support him. Gone is the traditional timidity where the attitude has been ‘we have done all we can’ to be replaced by ‘let’s go for it’. To this end, the Bank of Japan has announced that it will double Japan’s monetary base and formally adopt the 2% inflation target. QE will now be the centre of what the BoJ does. This is a significant shift, not just for Japan but also for Asia and even possibly globally. If only policy makers in Europe would take notice! If one wants to temper one’s enthusiasm for Japan, it would be the need for the change in monetary policy to be accompanied by structural reform. PM Abe has talked about this need but in the obscure world of Japanese politics, do not hold your breath.