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Political 'nightmare' haunts Tokyo stocks

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Paul Krugman, left, discusses economic policy with Japanese Prime Minister Shinzo Abe, right, and other officials on March 22.   © Kyodo

TOKYO -- The Japanese stock market started the calendar year with a steep downtrend. It has begun the new fiscal year in similar fashion, with investors wondering how Prime Minister Shinzo Abe will handle some big challenges.

     Will the government delay the next consumption tax increase, now scheduled for April 2017? Will it try to fire up the economy with a supplementary budget for the fiscal year that began last Friday? These are key questions, but something else appears to be troubling the market as well. Call it the nightmare of 2007 -- the period of political confusion that followed the ruling party's loss in an upper house election.     

     Some might say a nine-year jinx hangs over Abe's Liberal Democratic Party. The governing party suffered setbacks in upper house elections in 1989, 1998 and 2007 -- when Abe was serving as prime minister for the first time. Each case led to the resignation of the nation's leader.

     In 1989, the LDP was hurt by the Sosuke Uno government's introduction of the consumption tax and the Recruit corruption scandal. In 1998, the Ryutaro Hashimoto government was toppled amid the Asian financial crisis; it had raised the consumption tax the previous year. And in 2007, Abe made a humiliating exit from power as the government grappled with missing pension data and scandals involving cabinet members. 

     Today, the opposition camp is weaker than it used to be. But the country's political mood can change quickly.

     LDP lawmakers continue to draw criticism over questionable remarks and scandals. Domestic concerns, such as long waiting lists for day care, are sowing frustration among citizens. Data on production, exports, investment and consumption show the economy is at a virtual standstill.

     "We can't afford any optimism," a senior LDP member said of a Hokkaido by-election in late April, revealing a growing sense of crisis within the party. 

'Terrible mistake'

The Abe government believes it is imperative to do something about the economy. In March, it launched a series of meetings with renowned economists. At the third such gathering, Nobel Prize-winning economist Paul Krugman made some noteworthy remarks.

     "We are seeing the limits of monetary policy," the Princeton University professor emeritus said, according to a memo revealed on his Twitter account. "Inflation expectation seems to be fading. Wage growth is not what it should be."

     Krugman basically admitted that his proposal for beating deflation with drastic monetary easing has been less effective than expected.

     Fiscal policy is "especially effective under these circumstances," Krugman said, adding that it would be "a terrible mistake" to prioritize fiscal rehabilitation over economic stimulus. He then took a clear stand against the planned consumption tax hike.

     "Coordinated fiscal expansion" is the ideal approach to pushing through a global economic downturn, according to Krugman. In line with Keynesian thinking, Krugman's view is that ending the deflationary cycle should be goal No. 1, and that prioritizing fiscal balance in the next two to three years would be the wrong move.

Markets not convinced

Krugman is a key source of policy inspiration for the U.S. Democratic Party and a natural foe for Republicans who denounce big government and excessive monetary easing. It is an intriguing twist that Krugman is advising Abe -- known as a man of the right -- on economic policy.

     Krugman has praised Japan and Canada for adopting aggressive fiscal measures. He sees obstacles to that approach in the U.S. and Germany. He told Abe that coordinated fiscal expansion is difficult in the U.S. because of resistance from Republicans in Congress, while Germany believes in a different economic philosophy.

     But while Abe was probably nodding in agreement as Krugman spoke of the merits of stimulus, market players are reluctant to embrace his line of thinking. They question whether the government would make effective use of the money -- whether the all-out mobilization of resources would really prompt companies to spend the funds they have accumulated and spur households to consume more.

     Tokyo stocks plunged on Friday, following the release of the Bank of Japan's quarterly Tankan business sentiment survey for March. Yields on Japanese government bonds temporarily rose, narrowing negative interest rates.

     As Krugman pointed out, Japan is unlikely to wind up like Greece anytime soon, even if its fiscal health deteriorates further. But LDP policymakers will want to avoid pushing the markets into the opposition camp.

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