A Setback For Abenomics

Japan slips into recession, with second straight quarter of GDP contraction. (-1.6% in Q3)
http://t.co/CJlnuO1FU2 pic.twitter.com/IYLjmXbPJ0

— Matt Phillips (@MatthewPhillips) November 17, 2014

Japan’s economy is officially in a recession again, after its GDP shrank for two consecutive quarters. An increase in the country’s sales tax in April is believed to have been the tipping point:

“No part of Japan’s economy looks encouraging,” said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute, who had the weakest forecast in a Bloomberg News survey, with a 0.8% growth estimate for real GDP. “Today’s data will leave another traumatic memory for Japanese politicians about sales tax hikes.” For Prime Minister Shinzo Abe, the report probably guarantees he will put off the tax increase scheduled for October 2015, a move that people familiar with the matter have said will trigger a snap election next month. Japan also tipped into a recession after a 1997 consumption-levy rise, leading to the fall of the government of the day.

Sure enough, Abe called a snap election today to secure a popular mandate for delaying the next planned tax hike. Matt O’Brien faults the prime minister for putting the brakes on fiscal stimulus and turning toward austerity while the economy was still too weak:

The problem … is that the government has started working at cross purposes with the central bank.

See, at first, the government was spending money to jumpstart growth, and the Bank of Japan (BOJ) was buying bonds with newly-printed money to do the same. It was enough to send unemployment down to 3.6 percent now, and inflation finally up into positive territory. But then, six months ago, the government became more worried about its debt of 230 percent of GDP than it was about the recovery. It raised the sales tax from 5 to 8 percent, and the economy promptly tanked. The BOJ has responded by buying even more bonds with even more newly-printed money, but not before domestic prices, as measured by the GDP deflator, began falling again, this time at a -0.3 percent pace.

Abenomics, in other words, has gone from being fiscal and monetary stimulus to fiscal austerity and even more monetary stimulus—and that, at least for now, has brought back deflation.

The Bloomberg View editors also blame a lack of fiscal stimulus … twenty years ago, that is:

[M]ost economists agree it would have been much better if Japan had done two things after its asset-price bubble burst in the early 1990s: pursued a much more ambitious fiscal stimulus program, and moved quickly to force banks to recognize losses and recapitalize.

Instead, Japan’s ill-timed effort to balance its budget with a consumption-tax increase in 1997 sent the economy into recession, and a paralyzed banking sector contributed to an extended period of stagnation that has done much more to worsen the debt burden than well-targeted government spending would have. From 1993 through 2013, gross government debt grew at an average annualized rate of 5.3 percent — a pace that normal economic growth would have largely neutralized. In the absence of that growth, the gross-debt-to-GDP ratio went from 80 percent to more than 240 percent. That’s by far the highest among 179 countries tracked by the International Monetary Fund.

Danny Vinik hopes the US doesn’t make the same mistakes:

[I]it’s very easy for policymakers to cut off the growth if they implement dumb policies, as Japan did with the VAT increase. In particular, this means that the Federal Reserve should not raise interest rates from zero until workers actually see significant wage growth. So far, Fed Chair Janet Yellen has demonstrated a commitment to ignoring inflation hawks inside and outside the central bank. She must continue to do so. It also means that Congress cannot raise taxes on broad swaths of Americans or make significant cuts to government spending

Tyler Cowen is surprised that anyone is surprised:

Unemployment in Japan already had fallen to about three and a half percent. So how much of a miracle could Abenomics accomplish in the first place? Not much, not even for committed Keynesians. Commentators have grown to expect so much of the Phillips curve these days, but still a mechanism for the output boost is required and the Phillips curve (at best) holds only in some contexts. Japan simply hasn’t had that many laborers to put back to work. Getting more women in the workforce, as Abe has tried to do, is a positive development, but that is not mainly about macro policy nor is it mainly about the short run.

In the same vein, McArdle extracts a lesson about the limited powers of policy:

Despite a really good package of reforms, Japan’s economy is still so fragile that a 3 percent hike in the sales tax (even one accompanied by a $51 billion stimulus program) is enough to push it back into recession. …

What this suggests to me is that there may simply be limits on what good economic policy can achieve. This is not a very useful thing for an economics columnist to write, because then what are we supposed to suggest week after week? But there it is: Japan’s economic problems, particularly its long demographic shift, may simply not be very amenable to better policy. Japan’s exports have a lot more competition than they used to, and the country is heading for the demographics of an Assisted Living facility. Better monetary policy won’t change either of those facts.

Ben Casselman adds that Japan’s unexpected slide into recession “should also give pause to economists in the U.S.”:

When the Bureau of Economic Analysis said the U.S. economy contracted at a 2.1 percent rate earlier this year, most economists shrugged it off as a one-off fluke driven by bad weather. They appear to have been correct: The U.S. went on to post its best consecutive quarters of growth since the recession. But that outcome was far from guaranteed. As I noted at the time, negative quarters are rare outside of recessions. Economists are notoriously terrible at forecasting downturns: Most economists failed to “predict” the last U.S. recession even after it had already begun. (They also miss in the other direction, forecasting recessions that never took place.)