This article will be explaining everything about Abenomics and the circumstances that led to its creation. For twenty years the nominal GDP growth rate of Japan was negative and the real GDP growth rate was just above zero, despite the much higher growth in the European advanced countries and the United States. That was a problem for Japan because it caused deflation for Japan. Deflation is the persistent decline in the prices of goods and services. Some might argue and say low prices of goods and services are good for the people. Unfortunately, deflation is accompanied by a persistent decline in wages, and that is the negative aspect of deflation. Japan had suffered from deflation for 15 years in terms of the core producer price index.
Immediately after the consumption tax hike in 1997 from three percent to five percent, the East Asian currency crisis, and the Japanese financial crisis of 1997, the Japanese economy dipped into deflation and continue to fail to get out of it. The government and the bank of Japan have been fully aware of the seriousness of the problem, but their commitment was not enough to drive Japan out of the deflationary environment. When the commodity prices depreciated, the value of money and fixed-income instruments like government bonds, their value continued to rise. The best action under the deflation scenario would be to save money and buy government bonds instead of investing in stocks. Therefore, the savings rate went high and companies started hoarding as much money as possible.
Note that the Japanese economy had been inactive for fifteen years. Before Shinzo Abe took office, he declared that Japan should take a bold step to get out of the deflationary environment and the markets reacted quickly. The yen depreciated, and the stock market appreciated. After he took office, he appointed Mr. Kuroda as the new governor of the Bank of Japan, and in March 2013 the Abenomics started. Abenomics consists of three arrows. The first arrow is the aggressive bold monetary easing policy, the second arrow is the timely fiscal stimulus, and the third is the supply-side policy for economic growth. The basic idea behind Abenomics is to get the economy out of deflation using the first arrow. Without getting out of deflation, all the policy measures would fail because under deflation spending is suppressed.
The consumption tax was increased from five percent to eight percent in terms of the second arrow. Although there are some limits to fiscal stimulus, even though it's a one-time operation, it's effective. The third arrow contains a lot of policy measures and covers a wide range of supply capacity building, regulatory reforms, and restructuring of the workforce. The most significant part of Abenomics is the monetary policy shift because, under the former governor Shirakawa, the mantra of the bank of Japan was that monetary policy on its own was incapable of overcoming deflation. Mr. Kuroda took a much more orthodox view. He believed that monetary policy could be used to overcome deflation and launched a very aggressive quantitative program. The shift was highly significant, it was a battle of ideas.
The fable of the three arrows is a bit ironic because the whole point of the three arrows was that the three objectives had to be implemented together, to have policy strengthened. That was more consistent with the policy under the previous government it was saying that monetary policy and structural reform had to be executed together. Whereas, the economic philosophy under Abenomics is that, ending inflation is a good thing, doing structural reform to lift real growth is also a good thing, but you don't need to do one to achieve another aim. Abenomics as a policy idea and as a policy direction preceded Mr. Abe because the idea of having a policy mix in Japan that serves to end deflation and raise real growth was written in the government consumption tax legislation that was passed in August of 2012.
Policymakers said Japan has got a very bad fiscal position and the sovereign debt crisis in Europe had just taken place. they agreed that they couldn't wait anymore longer and they had to change the consumption tax from eight percent to ten percent that legislation was passed in 2012, but there was a policy debate at the time. Many people pushed back and said the consumption tax would not be changed because it would cause a major fiscal consolidation. In the legislation, it was written as a condition that to proceed with the consumption tax hikes, policies had to be put in place to achieve three percent GDP growth over that decade, comprising of two percent real growth and one percent positive deflator. All of that preceded Mr. Abe. That's not an attempt to undermine the concept of Abenomics but to point out the complexity of things happening in Japan. The second arrow is a bit more ambiguous.
The second arrow says flexible fiscal policy for two to three years is necessary to support recovery and the revitalization of the economy, and yet one year into the three-year program support, Japan has pushed ahead to raise the consumption tax. This was somewhat of a risky move because they were putting their foot on the monetary accelerator and at the same time starting to tap into fiscal consolidation brake. We have seen in previous administrations, are very similar kinds of policy thrust in Japan, trying to end deflation by using monetary policy on the other hand and prematurely moving to fiscal consolidation on the other hand. In terms of the Nikkei, it rose and got ahead of itself. During the time, American hedge funds were putting their money into the Japanese equity markets.
Retail investors In Japan have a culture of saving and once the retail money started to move, it pushed stock prices higher. This showed the increase in confidence in the policies that were imposed by prime minister Abe. Government pension funds lifted constraints on how much equity could be bought, and that exacerbated the rally in the Nikkei. This shows that Abenomics caused more money to flow into the country's equity markets, and both domestic and international investors were attracted to the nikkei. The backdrop of Abenomics is the pressure it put on poor households in terms of tax increases. Abenomics is one of the historical policies implemented, which will be looked at as a guideline for future policy making and implementation.
Current central banks will utilize the lessons that were learned from that era and it will continue to be discussed in the economic conversation of the future. Thanks for reading and good luck.