There’s a modest but building disenchantment with Abenomics. This could prove dangerous for the eurozone.
Japanese Prime Minister Shinzo Abe’s eponymous program designed to lift Japan out of deflation and into steady long term growth captured investors’ imaginations. It triggered a sharp slide in the yen and a boom in Japanese equities and helped to push inflation into positive territory, seemingly well on the way to providing a solution to the economy’s long term problems.
Abenomics was temporarily derailed by a consumption tax hike at the start of April, which caused Japanese consumers to bring purchases forward into the first quarter. As a result, demand then fell back sharply and the Japanese economy contracted during the following six months.
Plenty of people expect Mr. Abe’s program to pick up where it left off at the end of the first quarter by adding positive impetus to both growth and inflation through monetary and fiscal stimulus. But doubts are creeping in. Foreign inflows into Japanese equities have collapsed. And a few economists argue that Japanese monetary and fiscal policies can’t cure what really ails the economy, which is poor demographics, while the government still falls short with the third prong of Abenomics: structural change.
So why should this matter for the eurozone?
Because investors are also placing enormous faith in the European Central Bank to find a way around the single currency region’s equivalent problems with slow or no growth and incipient deflation. If Abenomics is seen to fail in its primary objectives, doubts will settle on the European project as well. That’s because the eurozone also faces Japanese-style demographics of ageing populations and falling fertility rates.
What’s more, Japan, at least, has a largely unified and homogenous population able to pull together in tough times. By contrast, Europe’s is much more likely to fragment into constituent nations.
If Abenomics doesn’t manage to cure Japan’s economic ills, the pressure on European governments to seek solutions outside of the eurozone will become enormous. This is already starting to show up with Greece. Years of austerity, the economy’s contraction by around a quarter and no sign of where solid recovery might come from means Greek voters are starting to wonder about the benefits of eurozone membership–to judge by political developments. What hope there is rests with the belief that a Japan-style round of quantitative easing by the ECB will come to the rescue.
But if unlimited QE fails to work for Japan, fatal doubts will loom over Europe’s efforts too. Much more than Japan’s economic fate rests on Abenomics.