Few people now doubt the Bank of Japan’s ability to reflate the economy, after five months of surging share prices, a weakening yen and dwindling bond yields. But Shinzo Abe, the prime minister, won the election in December promising more than that.
Abenomics was sold as a three-pillar deal that would deliver monetary easing, fiscal stimulus and private-sector reforms. So far, only the monetary pillar is in play, with the central bank aiming to achieve 2% inflation by doubling its monetary base and total assets by the end of 2014.
The lack of momentum on the other pillars could mean that Japan will generate inflation and not much else, warns Standard & Poor’s analyst Takahira Ogawa.
“So far, our assessment of economic indicators offers little clear evidence of improved economic performance in Japan,” writes Ogawa in a report published on Monday. “[Abenomics] could potentially worsen the country's already weak finances. For example, if the policies don't generate the intended results or are cut short before full implementation, the country is likely to endure inflation without significant improvement in economic growth.”
The government’s policies are certainly having an effect. Japanese stock market indices are at an almost five-year high, while the yield on 10-year Japanese government bonds fell to 0.315% on April 5 and the yen is close to 100 against the dollar, a psychologically important mark.
But S&P complains that this market euphoria “is mostly based on expectation”, which seems to point out the obvious. After all, the stock market has been rising since Abe became the favourite to win in November, long before the BoJ even declared its plan to buy back bonds. Expectations are precisely the channel the central bank is targeting.
The question is whether this translates into real economic improvement. The rating agency concedes that “a virtuous cycle of positive expectations could improve conditions and thus become self-fulfilling”, but also worries that a widening of the gap between expectations and progress in the economy would be damaging: “At some point, the expectation bubble will burst and the positive wealth effect will end,” writes Ogawa.
Milton Friedman, who prescribed quantitative easing for the “inept” BoJ way back in 1997, was more optimistic about the effects.
“There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so,” he wrote in the Wall Street Journal. “Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly, output will grow and, after another delay, inflation will increase moderately.”
Friedman noted that this growth in real output would make it far easier to achieve much-needed financial and economic reforms. That may still prove accurate, but with elections for the upper house due in the summer, Abe and the Liberal Democratic Party could do with a decent majority to actually get anything done.
S&P continues to keep Japan on watch for a downgrade, which it says is a one-third probability. A bad result at the election may be the trigger for further action.
