Japan’s quantitative easing (QE) program may be in trouble. The main plank of the program is large-scale asset purchases designed to boost money supply growth, asset prices and inflation expectations while holding down interest rates.
Economic activity has indeed picked up since the QE program began early last year, but there are now serious warning signs that this progress may not be maintained.
First, broad money supply growth has not been sustained. A slowdown in real broad money growth was a lead indicator of the downturns in 1998, 2005, 2009 and 2012.
This may reflect a continued aversion on the part of Japanese firms and households to taking on new debt. Even more than two decades after the bursting of the ‘bubble economy’ deleveraging pressures in the private sector still linger.
Since the 1990s, Japan has seen generally high savings by the private sector offset by large government deficits and a foreign sector deficit.
One of the big hopes for ‘Abenomics’ was that it would deliver a shock to expectations in the private sector that would alter this pattern; no longer fearing long-term deflation pressures, the private sector (especially the corporate sector) would become less defensive, investing more and paying higherwages and dividends instead of prioritising debt reduction.
So far, the evidence seems to be that relatively little has changed.
A closer look at the behavior of the household and corporate sectors reveals more scope for optimism – but not much more.
Both sectors have actually begun to take on new debt, whereas a year ago they were still reducing their debt stocks in absolute terms. But the pace at which new debt has been taken on has lagged behind the growth of income and GDP.
So while we have seen a shift from what is sometimes termed ‘active’ deleveraging (paying down debt) to ‘passive’ deleveraging (allowing the debt ratio to fall as income rises, but not actually cutting debt), deleveraging is still occurring – and this despite a big decline in real interest rates. This suggests that debt aversion is blunting the effectiveness of the credit channel aspect of QE in Japan.
QE also aimed to boost the economy by creating wealth effects through higher asset prices and boosting exports through a weaker yen.
As a result of the QE program, stocks are indeed up and the exchange rate down. But the big moves were a year ago or more, so the impact is starting to wane. The stock market is little changed on the levels of a year ago, and Japanese households may also recall that there have been other stock market surges that have not been maintained in recent years – notably in 2000 and 2006/7.
Meanwhile the yen is also at more or less the same level against the dollar as it was a year ago. And although this is a much weaker level than in 2011-12, it has failed to create the strong surge in exports hoped for. Export volume growth has been very modest and the current account position has actually deteriorated into a small deficit.
Overall, recent evidence gives us considerable cause for concern about near-term growth prospects in Japan, bearing in mind a doubling of the consumption tax in two steps this year and next.
Unless the second phase of consumption tax hike is postponed or Bank of Japan steps up its monetary stimulus, Japan now risks a slump in economic growth. Such a slump would be likely to be particularly bad news for Japanese equities.
The writer is senior economist at Oxford Economics.
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