The three arrows of Abenomics -- fiscal policy, monetary policy and structural reform -- continue to present a road map for Japan to end deflation, balance fiscal consolidation and growth, and raise medium- and long-run prospects for the economy. But the political capital won by Prime Minister Shinzo Abe will be required for the programme's success.
In my view, criticisms of Abenomics as a policy failure miss the mark. Monetary policy has made progress in arresting deflation. The attempt to revive "animal spirits" has brought forth some success. It is for fiscal policy and structural reforms that much harder work remains, but neither is beyond the government's grasp. To see the way forward, it is useful to compare challenges and opportunities for revitalizing economic growth faced by Japan and the US
The world's eyes are on the Japanese economy and related policies given the importance of the three-pronged reforms for growth in the globe's third-largest economy. At least three questions of concern will appear in 2015. First, will the Bank of Japan's boldness manage to raise expected inflation to 2 per cent? Second, can the economic impact of a future increase in the consumption tax rate be cushioned by other elements of taxation reform? And third, will Prime Minister Abe's policies retain a commanding leadership position within the Liberal Democratic Party?
Monetary policy is likely carrying too large a burden in both economies. Central bank policy played an important role in the US recovery from the global financial crisis of 2007-2009. Post crisis, the Federal Reserve's aggressive expansion averted a deflationary spiral. By contrast, fiscal policy played a much less constructive role, with a poorly designed fiscal stimulus and uneven support for aggregate demand in the aftermath of the recession. The Fed must now confront lessening labour market slack, which has led to calls for faster withdrawal from its ultra-accommodative monetary stimulus than some officials at the central bank would like.
In Japan, under Gov. Haruhiko Kuroda's leadership, the Bank of Japan has been successful so far in increasing inflation expectations without disrupting the bond market. Indeed, one recent study by the Brookings Institution credited monetary policy's role in Abenomics with the bulk of Japan's growth since 2013. But just as the Fed must recognise that monetary policy cannot by itself fix structural problems in the labour market, monetary policy actions by the Bank of Japan alone cannot and do not address the nation's need for broader structural reforms.
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