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Abe-nomics: The case against austerity

Kathleen Brooks, Director of Research UK

Another month, another Bank of England meeting where interest rates remained on hold.

Since the Bank’s Monetary Policy Committee is meant to be looking after our economic security, the fact it’s done nothing since July last year is a bit of a sore point. More than four years on from the crash our economy is still weak and we are inches away from an unprecedented triple-dip recession.

Perhaps the Bank should look East for inspiration.

Japan has spent the best part of two decades in the dark ages, but a re-elected prime minister and a new governor at the Bank of Japan are ripping up the rule book and taking things into their own hands to try and get the economy moving again. And Abe-nomics – named after Japan’s Prime Minister Shinzo Abe - seems to be working.

Time to spend, spend, spend!

In the fourth quarter of 2012 Japan’s economy excited recession. Although growth was a very moderate 0.2%, it was a huge improvement compared to the 3.7% economic decline in the third quarter.

Abe, who took office in December for the second time (his first spell as prime minister was in 2006-2007), is basking in the glory of creating a mini-recovery and his popularity ratings are surging.  Added to this, growth signals have been strengthening since the start of 2013, giving hope for a strong economic performance in Q1.

So what is Abe-nomics and could it work here in the UK? It is essentially based on stimulus, stimulus and more stimulus. The first thing the new government did when it took office was announce a large stimulus programme to fund investment in infrastructure.

The exact size is unknown, but it is expected to be huge as the government has stated it wants to boost the economy by 2 percentage points. Added to that, Abe’s choice of new governor for the Bank of Japan, Haruhiko Kuroda, believes in encouraging growth at any expense and an advocate of unconventional monetary policy.

Japan’s plan

The Abe-nomics strategy is two pronged:

  • Implement large-scale fiscal stimulus that will hopefully create jobs and boost domestic growth
  • Increase the monetary base through asset purchases by the central bank in an attempt to weaken the yen.

The second point is important for Japan because its economy is very export-orientated (it makes up roughly 1/3rd of GDP). A weaker yen makes Japanese products abroad more attractive and helps it to compete against other Asian export power houses like China.

The yen has weakened nearly 20% on a broad-based basis since the second half of 2012, and it is already boosting exports. After contracting for most of Q2 and Q3 last year, exports grew at a 6.4% annual rate in January.

[Related feature: The great currency war of 2013 explained]

Why it's working

Abe-nomics is working while other plans have failed. How? Firstly, the central bank and the government are on the same path and working together – both are providing stimulus to the wider economy in an attempt to get growth moving again.

Secondly, by targeting the exchange rate the government/ BOJ initiative can focus on one of Japan’s economic strengths: Its export sector.

Lastly, this focus on exports should reap benefits as Japan has a well-developed export base, with globally recognised brands that people want to buy.

Could it work in the UK?

Lord knows we could do with a recipe for growth here in the UK, so what can Abe-nomics teach us?

Firstly, to kick-start an economy you need the government and the central bank moving in the same direction. Right now that is not the case in the UK. Our government is intent on tightening fiscal policy, while the Bank of England is adopting extremely accommodative monetary policy.

Essentially they are pulling in opposite directions and the net effect is bad for the economy. So even if the Bank of England under incoming governor Mark Carney does embark on an aggressive form of unorthodox monetary policy in the coming months, it is unlikely to work if fiscal policy is moving in the opposite direction.

With Osborne intent on sticking to his policy of fiscal consolidation, Carney is unlikely to get any help from the fiscal side any time soon.

Now onto the second point. Like the yen, the pound has also weakened significantly in recent months. On a broad-based basis the pound has fallen nearly 7% since the start of the year. Although export data is released with a lag, the signs are not good: in Q4 2012 UK exports declined by 1.5%.

The problem is that our export sector is not strong enough to overcome the economic drag caused by fiscal consolidation at home, thus the weak pound can be more of an economic hindrance than a benefit. For a start a weak pound makes our imports more expensive like foreign food, clothes and energy, and this erodes consumer spending and hurts exporters as their inputs like oil and other materials can get more expensive.

So, rather than try to invest in an export sector that could take years to improve, our biggest export destination – the eurozone – is also mired in recession, Abe’s investment programme could bear more fruit for the UK economy.

But before this can happen Osborne needs to start working on lesson one of Abe-nomics – work with the Bank of England, not against it.