Why Japan's Abenomics Won't Work

"Quantitative and qualitative monetary easing is expected not only to work through such transmission channels as long-term interest rates and asset prices, but also to lower real interest rates through a pickup in inflation expectations."
--Bank of Japan, semi-annual report

In September, Japan voted the LDP, led by Shinzo Abe, into power. Abe and his LDP colleagues ran for office on a platform of reflation, promising to impose a 2% inflation target on the BoJ. This may sound like a modest goal to us gaijin, but 2% inflation for Japan is like Mount Everest. Japan’s CPI has remained flat for twenty years. In fact, Japan has never had a sustained 2% inflation rate; 2% has been a level experienced during transitions between higher inflation and deflation.

Japanese CPI has been flat for 20 years not because the BoJ desired it, but despite the BoJ’s efforts to fight deflation over that period. The BoJ has sought to fight deflation by following a zero interest rate policy or ZIRP for the past 12 years. The BOJ has been unsuccessfully fighting deflation at the zero-bound for over a decade. When criticized for deflation and stagnant GDP growth, the BoJ has said that it is doing all it can. In saying this, the BoJ has ignored a great body of academic literature by western economists such as Ben Bernanke, Paul Krugman, Ronald McKinnon, Barry Eichengreen, Scott Sumner and David Beckworth.

Eleven years ago, Ben Bernanke gave a speech in Tokyo in which explained to the BoJ in detail how to target inflation or, better yet, price levels. The BoJ studiously ignored Bernanke’s advice until the Abe government finally ordered it to adopt inflation targeting, or else. Abe appointed a compliant governor, Haruhiko Kuroda, and the BoJ’s board has duly voted to implement a 2% inflation target. The BoJ has pledged to grow the monetary base by Y60-70 trillion per annum until 2016 in order to achieve 2% inflation. That would represent monetary base growth of about 40% this year, equivalent to the Fed’s QE3.