TOKYO -- Markets are beginning to pin their hopes for Japan's economic recovery on ambitious government outlays as the central bank's monetary easing runs low on fuel.
"I expect the original third arrow of Abenomics to fly higher and faster," Bank of Japan Deputy Gov. Hiroshi Nakaso said in a March 3 speech. By "third arrow," Nakaso was referring to government-led economic growth strategies -- the third focus of Prime Minister Shinzo Abe's economic plan.
Japan's central bank has until now has made few outright requests of the government, preferring to take all possible action on its own. Yet the BOJ is growing weary of carrying the brunt of economic stimulus, and options for further easing are running short, indicating that a change is in order.
"People are increasingly realizing that not everything can be solved through monetary policy alone," Nakaso told a press conference after his speech. The Group of 20 finance ministers and central bank governors committed to mobilizing both fiscal and monetary policy to protect the global economy at their meeting in Shanghai at the end of February. That stance is particularly relevant to Japan, which has become dependent on solutions from the central bank.
Despite BOJ Gov. Haruhiko Kuroda's assertions to the contrary, "options down the road" for monetary policy "will thin out" as the central bank continues to act, former Vice Minister of Finance Toyoo Gyohten has said. Takahide Kiuchi, a member of the BOJ policy board, voted in January against introducing negative interest rates for just that reason, fearing that putting all its cards on the table too early would leave the bank with little recourse in a crisis.
The effects of current policies have begun to weaken. The yen softened almost constantly for several years after Abe took office in September 2012 on promises of bold monetary easing, supporting a gentle economic recovery. Yet that trend has wavered since the BOJ adopted its negative-rate policy, with the currency at times gaining and at times losing value.
"There are limits to the extent to which negative rates" can stimulate the economy in a healthy manner, Bank of England Gov. Mark Carney warned his counterparts in Shanghai. The European Central Bank nevertheless introduced a host of new easing measures Thursday. Markets took the bold move as a sign that easing was reaching its limits, causing the euro to strengthen. The BOJ, too, is facing "stiffer than anticipated headwinds" from the banking sector and the political opposition, a staffer said -- making further cuts to interest rates dicey.
Markets' hopes are now turning to what is seen as the only remaining option -- fiscal policy. The Abe government faces the task of formulating an economic support plan ahead of this summer's election for the Diet upper house. "If we can't go through with the consumption tax hike" to 10%, currently planned for April 2017, "and raise revenue, we will be completely lost," the prime minister has said. Yet many suspect Abe could postpone the hike and announce sweeping economic policies, along with a supplementary budget, ahead of the Group of Seven summit that Japan will chair in May.
The finance ministry has been unable to hide its unease about mounting expectations for government spending. "A full-out policy push still includes monetary measures," one official insisted. Japan's national debt totals more than 1 quadrillion yen ($8.79 trillion). Having to finance massive spending increases without the revenue boost provided by a timely tax hike is the ministry's nightmare.
Kuroda, a tax-bureau alumnus himself, has pushed the government to implement the consumption tax hike on schedule, noting that its effects on the economy "will be a little over half as large as those from the last increase" in April 2014. Yet the BOJ's negative interest rates have ironically given the government some room to borrow further by lowering coupon payments.
Of course, both monetary policy and fiscal spending are stopgap measures designed to keep the economy from sliding until deeper structural reform can be put in place. Strategies aimed at higher medium- to long-term growth must form the core of Abe's signature economic program. If painful yet necessary labor-market and other reforms are put off for too long, even an all-out policy push will eventually lose its power.