The Brexit vote has had a wider impact beyond the UK and Europe, temporarily derailing the US Federal Reserve’s plan to raise interest rates and allowing other governments to argue that there is a crisis under way that needs to be addressed with more forceful stimulus.
Japan is a case in point. It’s 6000 miles from the UK, but Brexit is having a positive influence on policy. Prime Minister Abe highlighted the risk of the UK leaving the EU as one of several storm clouds gathering for the world economy. He delayed the introduction of a sales tax to 2019 – something he previously said would happen only if there were a major natural disaster or a financial shock of Lehman proportions – and he is tabling an outright fiscal stimulus programme.
Meanwhile, the foreign exchange market is putting pressure on Japan to ease monetary policy. The yen strengthened further on the outcome of the EU referendum as capital was repatriated to Japan and the market priced out early interest rate hikes in America. The US economy is performing reasonably well and the labour market is tightening. Add in rises in commodity prices and inflation is likely to pick up. Yet Brexit uncertainty has stayed the Fed’s hand from raising rates and they may now not raise rates before November’s presidential election. Lower US rate expectations hit the US dollar, which is not what Japanese businesses hoping for a weaker yen wanted to see.
Inflation in Japan is too low. With control of both lower and upper house, Abe now has fewer obstacles to fiscal easing and the Bank of Japan will soon announce the results of a comprehensive review of monetary policy, which points to coordinated easing.
Exactly what form stimulus would take is far from clear. But it is clear that the Bank of Japan is willing to work more closely with the government, promising “highly accommodative financial conditions” to deliver “synergy” between monetary and fiscal policy. With interest rates at very low or negative levels, the Japanese government has scope to borrow at virtually zero cost for long-term funding. It is often said that you cannot borrow yourself out of debt, but borrowing to invest where the return is greater than the cost of borrowing is actually positive from an economic point of view. There are still risks to this course of action: investing in non-productive assets – as Japan has done at times in the past – obviously fails to beat the zero-cost hurdle.
It is possible to look at this as a U-turn by the Japanese but in reality it is a rebooting of Abenomics. The underlying premise was always to boost nominal growth. Growing your way out of debt is better than spending cuts and tax increases.
Abe may in fact take some political comfort from the Brexit vote. Arguably, it demonstrated that UK-style fiscal austerity should be avoided if social cohesion is to be maintained. And with UK policy swinging towards borrow and spend, recent developments in this part of the world add credibility to the sort of combined fiscal and monetary policy stimulus that Japan expects to get nominal growth back into positive territory and end deflation.
Japan was first into the debt-deflation trap. It looks like it will be the first to use fiscal policy more imaginatively to try to break out of it. We expect a number of developed market governments to be watching with interest.