Opinion

Why you should care about the fate of Abenomics

Let's have a chat about the zero lower bound

There were two important news stories out of Japan yesterday: The country slipped into a recession, and Prime Minister Shinzo Abe called for snap elections. Abe himself said that the elections would be a referendum on "Abenomics," his controversial economic agenda that has been very good for the stock market but, perhaps, not so good for the rest of the economy. Abenomics serves as a potential blueprint for the sluggish economies of the eurozone and the United States, because Abenomics is a response to a problem that these countries now face. In other words, you should care what happens next.

So, what is Abenomics about?

Abenomics is about, quite simply, the zero lower bound.

What's that?

Usually, the recommended economic policy response to a recession is for the central bank to cut the interest rates it pays out to private banks. This means that banks lend more, increasing the money supply in the economy. That theoretically fills people's pockets and gets them spending again. Presto, the country gets out of recession.

For the past 30 years, that advice has generally worked pretty well. But there's a problem: What if there's a recession, and your central bank interest rate is at zero? That's the problem of the zero lower bound.

Think about it: The central bank can't have a negative interest rate, because banks would then charge a negative interest rate to their customers, who would then just withdraw their money and hold cash. Nothing would be accomplished.

Japan hit the zero lower bound some time in the 1990s, and since then its economy has been basically stagnating, so it's been the test case for the zero lower bound problem. Since the 2008 recession, though, both the U.S. and Europe have been at the zero-lower bound, so the question now has global resonance.

There are basically two answers to the zero lower bound question.

The first is, essentially, there's nothing you can do, at least in terms of monetary policy. Interest rates are not magic pixie dust. If you hit the zero-lower bound, then you have to look at other tools, such as fiscal policy (cutting taxes or raising government spending or both), or various regulatory reforms.

But another camp says that, no, when the zero-lower bound is hit, the central bank can still work its magic. When you have a recession, the money supply in the economy will still be too low, so the manager of the money supply — the central bank — has to figure out a way to increase it. The typical answer is for the central bank to buy assets, typically government bonds, on the open market, to inject that money in the economy. That's where we get the infamous quantitative easing policy.

But here's the thing: Japan has been doing quantitative easing since the 1990s, with very little to show for it. A-ha, crows the first camp! See! Can't defeat the zero-lower bound.

No, no, no, says the second camp. This doesn't count because whenever Japan did quantitative easing, it did so timidly. Japan was stuck in such a deflationary spiral, the second camp cries, that only a massive bout of quantitative easing could help it. There is a certain amount of psychology involved: The point of monetary policy is to get firms and households to change their behavior. If they perceive that the central bank doesn't really take its own policy seriously, they won't change their behavior.

(At this point, you will pause to note that, as always in economic policy debates, both cases are coherent and falsifying either would require the ability to prove a negative. But let's move on.)

What Japan really needs, then, these people argue, is a truly massive bout of quantitative easing, where the central bank essentially says: "We're going all in. We're just not going to stop doing quantitative easing until we see real change." Until a central bank does that, you really haven't tested our hypothesis.

And this is what Abenomics is all about: Shinzo Abe won a general election on a mandate to do exactly this, to pull out all the stops in trying to engineer a monetary policy-based spurt of growth in Japan. The central bank has engaged on a massive program to buy all sorts of assets.

So, has it worked? Isn't Japan in a recession now? Well, the jury is still out. (And always will be, since we don't have an Earth 2 to serve as a control group.)

But I will say this: Central banks, which have the ability to make money out of thin air, don't actually need to conjure up these very schemes with interest rates and quantitative easing. They can just mail checks to people. This wouldn't just be more effective; it would also be more just, since in practice, in many cases, quantitative easing amounts to trickle-down economics.

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