Supply Side Economics in Japan- The Rise of Abenomics

Abenomics is a term used to describe the policies advocated by Shinzo Abe, the current Prime Minister of Japan. It is meant to solve the macroeconomic problems facing Japan, namely excessive currency appreciation, deflation and poor consumer sentiment. It aims to address these problems through monetary policy and fiscal policy, thereby encouraging GDP growth in the long term to pay off the deficit. Abenomics is a radical set of policies aimed at pushing

Monetary policy:

Abenomics involves adopting an expansionary monetary policy which involves increasing the supply of money to the economy, causing the interest rate to decrease. This encourages consumer to spend and increases interest rates in the short term as nominal prices increase.

This also increased Japan's export competitiveness as the depreciation of the Japanese currency made Japanese products more attractive to export markets, turning the persistent trade deficits into surpluses.The yen has fallen 12% so far in 2013.

Mr. Abe targeted an inflation rate of 2%., doubling the existing goal of 1%.   The persistent deflation in Japan had led to high unemployment rates among youth and stagnating wages because the real value of money increased over time, leading to firms being reluctant to recruit more workers as a result and young workers are disproportionately affected by this. 

Abe's policies have also driven domestic demand as lower interest rates have led to increasing willingness of consumers to spend. 

Downsides of Monetary policy

The rapid devaluation of the Japanese currency could lead to many Japanese withdrawing their bank savings to invest in foreign currency if they believe that the Yen is going down in the long term. This could lead to a drain in capital of Japan's banks, leading to a deeper deficit for Japan's government as they will have to recapitalise the banks.

Another risk is that the Bank of Japan (BOJ) might default if the rate of depreciation is too rapid because the value of Japan's currency would be nearly worthless if the Yen depreciates beyond 400 yen to US$1 as Japan would then be unable to fulfil its debt obligations. 

As with all low interest rate policies, there is the downside risk of the Zero Lower Bound problem or Liquidity Trap, which refers to the situation when interest rate is zero, limiting the central bank's power to stimulate economic growth because it means that consumer sentiment is so bad that the multiplier effect is almost negligible.

Fiscal Policy:

Abenomics involves reversing high taxation to encourage in combination with monetary stimulus to settle the issue of debt sustainability. The reversal of high taxation is a supply side policy that hopes to increase the incentive for workers to be more productive, using the Laffer curve which shows that tax revenue might actually increase if taxation is lowered, provided the rate of taxation is higher than optimum.

The buying back of bonds by the Abe administration resulted in short term bonds rallying while longer terms bond yields dropped. Bonds are basically securities that the government has to pay in full at the end of the term. This signifies that the investors think that the Japanese government is more likely to default in the short term, causing the dividends to remain high because of the drastic policies put in place by the Abe administration increased the chance of default but it is a good sign that long term dividends dropped which means that investors see Abe's policies as beneficial to the economy in the long term.
In addition to that, the Abe administration also adopted a expansionary fiscal policy in tandem with quantitative easing. This increase in government spending is aimed at increasing domestic consumption and investment through the multiplier effect. In fiscal year 2013, 10.3 trillion yen ($US 116 billion) was set aside for government spending, a massive stimulus package to kickstart anaemic domestic consumption.

Drawbacks of Supply Side Fiscal Policy:

A long term low tax rate system is usually unsustainable especially in Japan's case, as they have a government debt 237% the size of GDP. In the long term, this could become a big problem for the young working class as they would have to carry the burden of paying the massive government debt incurred by the current administration.

Another drawback is that without fiscal discipline in keeping a balanced budget, these policies would be ineffective. If the budget is continuously imbalanced over a few fiscal years, in this case continuous deficits under Abe, it could result a downgrade of Japan's credit rating which would mean it would have less space to deal with any subsequent recessions.

Evaluation:
While Abenomics involves significant risk-taking, it is dealing with an extraordinary case of a massive deficit with low consumption and declining export competitiveness. Therefore, drastic measures have to be taken including the deregulation of certain sectors and reforms in others. Thus, it is a concept not without flaws but is the best that can be done in the given situation.