Japan Shows Keynes Is Right and Austerity Is Wrong
In the fall of 2012, Shinzo Abe, Japan’s new prime minister, committed the country to a policy of aggressive Keynesian stimulus. This took the form of both additional Infrastructure spending intended to directly boost the economy and also monetary stimulus from the Bank of Japan. In a sharp break with practices of other central banks, the Bank of Japan committed itself to a target of 2.0 percent inflation. Since the country had been experiencing mild deflation for more than a decade, this amounted to an explicit commitment to raise the inflation rate, an unprecedented step for a central bank.
While it is still early, to date the results are overwhelmingly positive. The employment to population ratio (EPOP) in Japan has risen by 1.6 percentage points since the fall of 2012. This would be the equivalent of 4 million new jobs in the United States. That’s twice the pace of job growth that President Obama is anxious to tout.
Japan now stands with Germany as the only wealthy countries to have higher EPOPs than before the downturn. By contrast, the EPOP in the United States is still more than four percentage points e below its pre-recession level.
The gains for women have been especially striking. The EPOP for prime age women in Japan (ages 25-54) now stands 3.6 percentage points above its pre-recession level. At 71.5 percent Japan’s EPOP for prime age women is now more than two full percentage points higher than in the United States. This is in spite of longstanding sexism in the Japanese workplace that continues to impose major barriers to women in their careers.
Abe’s policies have also managed to reverse the deflation that Japan had been experiencing. From February 2013 to February 2014 prices rose by 1.5 percent. This is still below the 2.0 percent target set by the Bank of Japan, but it is a considerable turnaround from the 0.6 percent decline consumer prices over the prior twelve months.
The overall growth number also turned around with the economy growing 2.5 percent in calendar year 2013. This compares to a fall of 0.3 percent in 2012.
The bad things predicted by the skeptics also have not occurred. While inflation has increased modestly, as intended, no one seriously believes that hyperinflation is on the horizon. There has been a drop in the value of the yen relative to other currencies, but this was part of the plan. It is certainly not in a panic-driven free fall.
And investors have not fled Japan’s debt. The yield on its 10-year government bonds is just 0.6 percent, almost a full percentage point below the interest rate paid by austerity minded Germany.
In short, Japan’s recovery has followed the Keynesian textbook closely. This is not to say that everything is perfect. The country still has a long way to go to eliminate the barriers to women in the labor force as well as other structural barriers that slow growth.
Workers also have seen limited wage gains to date. The immediate effect of higher inflation is to reduce real wages, however tighter labor markets should increase workers’ bargaining power and allow them to achieve real wage gains over time, with wages rising in excess of inflation. There is some evidence that this is starting to happen, but it will take somewhat longer to be clear on the impact of this Abenomics on real wages.
The Abe government also is not entirely comfortable with a Keynesian approach. It put in place a large increase in the national sales tax in April, apparently feeling a need to reduce the size of its deficit. This will undoubtedly slow growth in the current quarter and probably through the rest of the year.
But if we needed further proof that Keynesian economics works, Abe’s government has provided it. When an economy has large amounts of unemployed labor and underutilized resources, government spending can increase demand and employment. Ideally this spending will be devoted to areas like infrastructure, research and education which will provide long-term benefits and not just a temporary boost to employment.
The traditional story of crowding out of private sector spending simply does not make sense in this context. With short-term interest rates near zero and long-term rates very low, there is little risk of any substantial hike in interest rates to reduce investment.
Furthermore, central banks that issue their own currency have the freedom to buy up government debt to keep interest rates down. This can be done as long as high inflation does not become a problem. And, in a context of an economy with considerable unemployment and idle capital, too much inflation will not be a problem, as Japan has so well demonstrated.
This means that Japan really does not face any limits on its ability to issue debt as long as its economy is operating well below its potential. The concerns of the Abe government to limit its deficits by raising taxes are really not warranted, at least not until the economy has recovered further to the point where supply constraints actually become a problem.
In short, we have the tools needed to turn around the economies of Europe, the United States, and the rest of the developed world. The only question is whether governments are prepared to use them. The answer most places is no, as politics is dominated by balanced budget cultists. But for those who would like to see policy driven by evidence, Abe’s policies show the way forward.
Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.