Will Japan hit the economic alarm or snooze?

The good news is the ruling Liberal Democratic Party now has its ‘super majority’ in both the upper and lower houses so it is in a strong position to go harder on reform. The blockers in the past, the ‘silver democracy’ which has thwarted social security reform and the trade unions who have impeded labour market reform have lost much of their ability to block.

"I think a form of helicopter money could quite credibly be used and perhaps help mitigate multiple issues."
Grant Knuckey, Chief Executive Officer, ANZ Japan

Certainly Prime Minister Shinzo Abe’s post-election behaviour would suggest we may see some swift action on both the fiscal and structural reform side.

Moreover, the market seems to have a degree of belief in this latest reform mandate, manifest in the reversal of recent yen strength (counter-intuitive I know but that strength was to some extent the market expressing a lack of confidence in reflation). The next few weeks will be telling but I sense we may be at an inflection point. 

GET TO THE CHOPPER

And what of ‘helicopter money’? Recently Japanese government officials have raised the idea – while then quickly denying it is on the cards. Central bank governor Haruhiko Kuroda was on the record some months ago stating it was not in the plan (for those wondering what exactly helicopter money is, here is a good target="_blank" href="https://www.weforum.org/agenda/2015/08/what-is-helicopter-money/">explanatory link).

I won’t second-guess the Japanese government on this one but I will say I think a form of helicopter money could quite credibly be used and perhaps help mitigate multiple issues.

The key in my view is helicopter money should be (i) targeted in terms of its end-use; (ii) impossible to be saved. Imagine for example if (via creation of money by the Bank of Japan) the Japan government issued ‘vouchers’ (these could be tax rebates) to working mothers that must be redeemed against child-care.

Money is spent and expenditure may also assist reform goals (in the case of women in the workforce). 

There are other possibilities being floated, the most interesting of which is the possibility of the government issuing a zero-coupon, perpetual bond which is purchased and held by the BoJ. Bingo, money creation.

There is a genuine barrier to this idea though in the form of Article 5 of Japan’s Fiscal Law, which prohibits the BoJ from directly financing the government’s fiscal deficit.

WHATEVER IT TAKES

On the BoJ’s part, there will be continued action to expand Quantitative and Qualitative Monetary Easing (QQE). Some commentators are suggesting central bank reserve rates may be set further in the negative but I am more sceptical on this point.

There is little evidence to date the negative rate policy has in itself had substantial impact. Moreover a further move is likely to accelerate the Japanese Government Bond (JGB) curve flattening around and under zero percent which may render the monetary policy transmission mechanism fairly impotent.

I believe it is more likely the BOJ will simply go harder still on asset purchases. I could be wrong but what I am confident of is they will do whatever it takes to reflate. (During periods of inflation the interest rate curve rises – short term rates are have lower yields [rates] and the curve rises [yields rise] over time to reflect inflation. This is what the BoJ wants but at the moment rates are so low and inflation expectations so low the curve is ‘flat’ – the expectation for longer term rates is no higher than shorter term ones.)

One other area of credit creation the BoJ appears to be seriously examining offering banks negative rate financing through its ‘Stimulating Bank Lending Facility’. I feel this would be a mistake. Financial institutions will still make lending decisions to customers based on credit assessment – as well as demand for that credit – and the negative rate financing won’t impact this at all.

If it was synchronised with some government fiscal or reform package that stimulated demand for credit then I would give it much more chance of success - but arguably in that case it wouldn’t be needed anyway.

But let’s step back from the alchemy. The real opportunity here is the synchronisation of the three arrows of Abenomics – fiscal policy, monetary policy and economic restructuring. The ability to get complementarity of both policy timing and targeting cannot be understated and it has been a clear weakness to date.

To the extent reflation is a function of confidence, and confidence in turn a function of momentum, I see a real chance here for Japan that hasn’t existed since Abenomics was launched two years ago.

Yes there are barriers. In addition to those already mentioned, any aggressive fiscal action may draw some negative attention from rating agencies. And households will need to come out of a deep funk to resuscitate those animal spirits of spending. Conditions are not perfect – but then again, the perfect is the enemy of the good as they say. And conditions are good.

There have already been some small scale reforms undertaken, such as the plan starting March 2017 to allow limited numbers of foreign domestic workers to enter Japan to work in ‘special strategic zones’ in a very limited area of the country (in other words experimental and non-commital). Change needs to go much further than this, and more quickly.

And Japan will need to confront the social security monster, which in its current form threatens the fiscal position of the country and prevents other much-needed expenditure. These costs are increasing by ¥ 1 trillion per year due to the aging population. Reforms such as raising the pensionable age or cutting some benefits are a necessity.

CONTEXT

This reform debate will take place in the context of an expectation the Abe government will soon announce a stimulus package of up to ¥10 trillion. If this is not to create a threat of a ratings downgrade then it will need to occur alongside some signs social security costs will be brought under control.

Then of course there remains the question of whether stimulus will in some part be funded by ‘helicopter money’.

Will Mrs Watanabe, the archetypal small Japanese investor and household finance officer hear the hum of helicopter rotors over the horizon soon? It’s still guesswork.

I believe regardless, she will see a more synchronised policy response from the government and BoJ over coming months and that is a good thing for Japan.

Grant Knuckey is Chief Executive Officer, ANZ Japan