Meanwhile, In Japan

Source: Reuters

Japan is undertaking an economic experiment with heavy implications for the rest of the world.

George Osborne has declared time and time again that there is no Plan B. Ed Miliband and Ed Balls’ have also been talking tough on borrowing over the last few weeks. However, if growth hasn’t picked up after the next election a return to stimulus spending may look irresistible to some. Before turning the tap, though, they may want to let Abenomics run its course.

Earlier this year the Japanese Prime Minister Shinzo Abe announced his ‘three arrows’ policy to revitalise an economy which has been stagnating on and off for over 20 years. What was announced was one of the largest most ambitious stimulus packages since WWII. If it succeeds Mr Abe will have succeeded where Japanese leaders (including himself, in his first stint as PM) have failed. If it fails though the knock on effects to the world economy could be gigantic.

Big in Japan

The “three arrows” (a reference to Japanese folklore) consist of the combining expansionary monetary and fiscal policy with structural reforms to encourage growth. Promises were made to liberalise public services and employment law while bringing in spending cuts which, combined with the hoped-for growth, would reduce the deficit and reassure investors the Japan would not default on can pay its debts. You may recognise this model as a fairly robotic Keynesian response to a disappointing economy. What is different here is the scale.

The Bank of Japan is keeping interest rates at 0.1% while pumping $1.4 trillion (£907 billion) worth of quantitative easing into the economy to reverse historical deflation. Britain on the other hand has a QE programme around £375 billion. Meanwhile the government unveiled a fiscal stimulus package worth $119 billion (£73 billion).

Abenomical with the truth

However last week when the structural reforms were revealed they were met with disappointment. In the run up to recent elections Abe’s Liberal Democratic Party dodged tough decisions and announced only a few modest reforms.

The UK Government has been under huge pressure to adopt a “Plan B” and turn on the fiscal and monetary fire hose to boost growth. Abenomics is even being cited as a model the Government should be following. The Guardian’s Simon Jenkins wrote last month that our leaders would look “like monkeys” if Abenomics worked. He admitted it was a gamble, but may have underestimated how big of a gamble it may turn out to be.

Land of the rising debt

Japan was only able to afford its current level of debt (to the extent that it could actually afford it) because of its reputation for caution and fiscal discipline. Japan’s Bond yield, the amount it pays to borrow money, has become increasingly volatile. This is not the first time Japan has turned to deficit funded stimulus either, and the result has been a debt to GDP ratio of over 230%.

The new Bank of Japan Governor, Haruhiko Kuroda, helpfully called this situation “not sustainable”. That is a giant understatement. Betting the farm like this and coming up short could lead to a confidence meltdown and potentially put the world’s third largest economy in IMF territory.

A crisis in the worlds’ third largest economy would send shockwaves across the globe and pose a serious threat to the recovery. It would also leave a ‘new deal’ giant style peacetime spending spree, the nuclear option of interventionists, looking broken beyond repair.

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