Japan: The quest for growth and inflation

By Michael Hasenstab, CIO of Franklin Templeton Global Macro

China may have dominated headlines in recent months as the efforts of its financial and political leaders to stem the fear of a slowdown have caused ripples through the global economy, but across the East China Sea in Japan another potentially equally important story is playing out.

It too has profound implications for global investors. Michael Hasenstab, CIO of Templeton Global Macro, explores the dynamics currently taking place in Japan—and whether its unprecedented policy approach to boosting growth and inflation is working.

Our latest edition of Global Macro Shifts focuses on Japan, the world’s third-largest economy. Japan has embarked on an unprecedented economic policy shift to finally break out of nearly two decades of low growth and deflation.

Whether or not the new strategy succeeds will have substantial implications for the global economic outlook.

An understanding of why this policy shift was needed requires an understanding of how Japan arrived at its current economic condition; the genesis, nature and magnitude of the challenges that Japan faces today.

The first stages of Japan’s lost economic momentum began in the 1970s as the economy moderated after a prolonged period of extremely strong growth that was sustained by the quick and successful adaptation of imported technologies.

Then, in the late 1980s, thanks in part to easy monetary policy, Japan again enjoyed a spurt of strong growth: Real GDP expanded by an average of 5.5% between 1987–1990.

The renewed rapid growth of the late 1980s fuelled unrealistic expectations of sustained strong economic expansion; together with easy monetary conditions, this helped set the stage for a massive asset price bubble in stocks and real estate.

The bubble then burst, and stocks and land values collapsed. Japan entered a period that is now commonly referred to as its lost decade(s).

The arrival of Abenomics
About three years ago, at the end of 2012, Japan’s recently elected Prime Minister, Shinzo Abe, launched a regime change in economic policy dubbed “Abenomics,” to address the country’s decades of low growth and entrenched deflation. The policy was articulated in three policy “arrows.”

The first arrow targets a far more extensive and aggressive monetary easing than previous monetary expansions.

With this new quantitative and qualitative easing (QQE) program, the Bank of Japan (BOJ) has more than doubled the monetary base since the start of 2013, it has significantly extended the residual maturity of the Japanese government bonds (JGBs) in its portfolio, and it has undertaken important direct purchases of riskier assets.

This strategy has triggered important portfolio reallocations in Japanese financial institutions and has sent an unambiguous signal of the BOJ’s determination to maintain a powerful monetary stimulus until inflation rises to about 2% on a sustainable basis.

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