The president of the European Central Bank (ECB), Mario Draghi, has recently announced the 60 billion-euro-a-month program which is intended for stimulating growth in the EU. The program, announced in March, is all about giving loans to the private sector in the euro area in the form of selling bonds of countries from the eurozone. What it all means? Put simply, Draghi is printing money. A lot of money.
By introducing his program, Draghi hopes to bring back economic growth to the EU. It is a very noble and ambitious intention, but how is he going to achieve it? Well, he wants to increase the inflation levels, decrease unemployment and increase consumer spending. Sounds like a dream, right? Well, Draghi intends for the program to last until September 2016, and during those past two months we have already seen some positive reactions. However, with programs of this magnitude, it is too early to judge.
But wait, didn’t we see it already?
Of course, Draghi is not a pioneer in the field of quantitative easing (QE). This policy was used before by the US, the UK, and the eurozone. However, in this article I will focus on the quite recent QE imposed by the Japanese government, under the leadership of Shinzo Abe. This economic policy was even named after him by the title ‘Abenomics’.
Although Japan and the eurozone are completely different markets, I reckon that the results of Abenomics can still be fruitful for the ECB and worth considering in the future. Since 1992, the Japanese economy has faced severe stagnation, characterised by low economic growth averaging 0,8% on a yearly basis and a downward pressure on prices. Furthermore, the catastrophic earthquake and tsunami of 2011 were the cause of increasing the budget deficit, which was already significant due to a high share of pension fund payments in governmental spending, to 200% of GDP. Policymakers could not come up with an adequate solution for the economic malaise until Shinzo Abe was appointed as the prime minister in December 2012. A political consensus stood at the base of an economic program to end the stagnation with the aid of monetary expansion, fiscal stimulus and structural reforms. Additionally, the Bank of Japan (BoJ) settled on an inflation target of 2%.
Japan was (and still is) in deep, deep troubles
In order to assess the work of Shinzo Abe, we need to analyse the condition of the Japanese economy before the introduction of any reforms. In 2012 the country’s GDP was at the same level as that of 1991. Nikkei was barely at the third of its all-time high. Furthermore, we need to remember that the Japanese society is ‘different’ to say the least. They are a nation that is rather withdrawn, especially to foreigners. This characteristic makes it hard for Japan to attract any migrant workers, even from the Asian countries. Becoming more open for foreigners is one of the main tasks for the upcoming years, as the Japanese society is an ageing one and the monetary expansion, which will add money to the Japanese economy, will need greater labor force.
OK, but did it work out?
We need to bear in mind that the Abenomics is still an ongoing process. Since Abe was appointed in December 2012, so far we can use the data from the years 2013 and 2014 to analyse the changes in the Japanese economy. The initial effects were quite plausible. Unemployment fell from 4,2% in 2012 to 3,7% in 2013, GDP grew by 1,8%, and inflation increased to 0,4% (from the deflationary levels in the years before). The real effective exchange rate of yen decreased by 20%, which made Japanese goods more attractive for export.
However, the idyll came to an end in 2014 when Abe, together with the Bank of Japan, decided to increase the sales tax (VAT) from 5% to 8%. Abe’s administration had to do it in order to cover the increased governmental debt that was incurred by the heavy expansion in the preceding year. As a result, Japanese real GDP has contracted by 6,8% in July 2014. Consumer spending fell by 5,9%, while export fell by 2,7%. However, imports fell by 3,6%, which resulted in the contraction of Japanese trade deficit by 8,3%. But it doesn’t change the fact that Japan is running a trade deficit for the 23rd straight month.
So what does it mean to us Europeans?
As we can see, the main mistake in Abenomics so far was the introduction of VAT hike. It has slowed down the Japanese economy much more than it was initially expected. But apart from that, the effects seemed to be pretty favorable. The QE initiated by Draghi has had similar effects so far. The economy started recovering, the euro has depreciated quite substantially, and unemployment started decreasing. The timespan for assessing Draghi’s program is a bit too short though; hence, we cannot draw any unambiguous conclusions. The main thing that strikes me is the duration of the QE. It is supposed to last until September 2016 (so roughly 1,5 years) or till ‘a sustained adjustment in part of inflation’. As the eurozone ended four months of deflation in April, we might see the end of QE rather sooner than later. So far it is looking good, but bearing in mind the Japanese case we shouldn’t be too enthusiastic, as ECB will face similar problems as BoJ; at some point they will have to find the money to repay their debt. And this money shouldn’t come from the printer again…