The self-induced paralysis is over. After 20 years of mostly subpar growth, Japan has finally decided to try the three magic words of central banking: whatever it takes.
Of course, it's not just about the words. Those can be, well, cheap. It's about the policy behind the words too. That shows how much the words are worth. By that standard, the Bank of Japan's (BOJ) latest words were worth quite a bit. Indeed, it announced what it called a "massive" bond-buying plan to double the monetary base over the next two years.
To translate from central-banker-speak: The BOJ is going to print $1.43 trillion worth of yen.
That's a lot of yen. And it might end up being even more. The BOJ also said it will keep buying bonds, potentially above the $1.43 trillion worth it's already promised, "as long as it is necessary" for hitting and maintaining its new 2 percent inflation target. In other words, the BOJ will print money, and won't stop, until it does what it has set out to do. It's what a certain Princeton professor would call "Rooseveltian resolve".
A Princeton professor by the name of Ben Bernanke. Back in 1998, before he joined the Fed, Bernanke tried to figure out what had gone wrong in post-bubble Japan. It's a question few could have anticipated just a decade earlier, when Japan seemed poised to surpass the U.S. as the world's premier economic power. But then its epic housing and stock market bubbles collapsed. Corporate real estate fell as much as 80 percent. The Nikkei fell from a high of nearly 39,000 to its current 12,600. Japan only avoided a full-on depression thanks to large-scale deficit-spending, but it didn't avoid a lost decade. You can see this quiet disaster in the chart below from Brad DeLong. It look at Japanese GDP per capita as a percent of U.S. GDP per capita. After decades of rapid catch-up growth that nearly caught it all the way up, Japan actually lost ground in the 1990s, and just stabilized thereafter.
In other words, Japan is rich, but the reason it's not richer, in Bernanke's opinion, is that the BOJ passively allowed a catastrophe to happen.
After the bubble burst, the BOJ turned to its normal playbook. It cut short-term interest rates to try to get households and businesses borrowing again. But with so many of them underwater on their loans, nobody wanted to borrow. Even when interest rates fell to zero. The weak economy meant inflation was weak too -- so weak that it turned negative, to deflation. And that's when things got really bad. Now, falling prices certainly sound like a good thing -- who doesn't like paying less? -- but they're poison for an economy. Falling prices eventually mean falling wages, and falling wages make debts that aren't falling harder to pay back. But even for people who could still afford to buy things, why do so today if they'll be cheaper tomorrow? In other words, deflation increases the burden of debt, and increases the incentive to hoard money. That's what we call a depression.
But what could the BOJ do? Its main tool was cutting short-term interest rates, but it couldn't cut them below zero. Well, as Bernanke (and Paul Krugman and Michael Woodford, among others) argued, it could always print money now or promise not to raise rates later. Or both! But the magic of the printing press means a central bank can always create inflation, as long as it wants it. The BOJ just had to want it.
And now it does. The new prime minister, Shinzo Abe, ran on a platform last November of ending deflation now. (Yes, Japan still has deflation, even after all this time). He pledged to not only give the BOJ a 2 percent inflation target -- compared to the 1 percent target it had, and wasn't hitting -- but also to make the BOJ hit it. The Nikkei promptly melted up, and the yen sold off. But between then and now, there have been plenty of questions about how committed Abe and Kuroda would be to so-called "Abenomics" -- aka, printing money, and lots of it. Would they lose their nerve, and fall back on the kind of limited bond-buying the BOJ had tried between 2001 and 2006? Back then, the central bank did print money (and, perhaps not-so-coincidentally, this was the only time in the past 20 years that Japan grew well), but it only printed pre-determined amounts. It wasn't open-ended.
But now, 14 years later, the BOJ finally seems to be taking Bernanke's advice. (You might say the BOJ listens to Bernanke with long and variable lags). Kuroda's announcement today made it clear: Abenomics is ready for takeoff. And so are Japanese markets. As Scott Sumner points out, the Nikkei jumped 4 percent after the BOJ announcement on Thursday -- clearly the market agrees with the academics that central banks can have a big impact even when interest rates are zero. Whether that turns to be true or not is the biggest economic story in the world right now.
For the sake of a world economy that has been turning Japanese the past five years, let's hope it is.
This article available online at: