When the global financial crisis struck in 2008, the US and Europe had a ready model for how not to respond: Japan.
Policymakers such as then Federal Reserve chairman Ben Bernanke had spent years thinking about Japan’s descent into deflation after its financial bubble burst in 1990. Japan, they decided, had cut interest rates halfheartedly and was slow to clean up its banks. With aggressive stimulus and bank recapitalisation, they would get different results.
For a few years, it seemed to work, but now a decade on from the crisis, inflation is below target on both sides of the Atlantic, the European Central Bank is mired deep in negative interest rates, and the Fed is cutting rates from a peak of just 2.25-2.5 per cent. It is a process many investors dub “Japanification”.
Policymakers around the world fear getting trapped in a Japan-like situation of permanently low inflation and interest rates, leaving them with no space to stimulate the economy when times are bad.
That raises the question of whether what is happening in the US and Europe really is the same as what took place in Japan during the 1990s because many Japanese analysts draw a strong link between the country’s economic outcomes and its rapidly ageing demographics.
“From my point of view, what happened has nothing to do with Japan itself,” said Kiyohiko Nishimura, who as a Bank of Japan board member and deputy governor from 2005 to 2013 was on the front lines of the fight against deflation. “The problem here is not unique, it’s universal. In some sense this is kind of inevitable and we have to face it.”
For BoJ policymakers who were heavily criticised by foreigners in the 1990s and 2000s for passivity in the face of deflation, Japanification elsewhere is something of a vindication. Mr Nishimura believes that the slide in Japanese inflation and interest rates was ultimately due to demographics and that something similar is now happening in other countries.
Japan took decades to accept its demographic future, he said, with repeated forecasts that a return to higher birth rates was imminent. That led to overcapacity and deflation because companies mistakenly overinvested in the expectation of a higher population.
“It’s really a structural thing. This is the first time in human history that many people are facing a very long retirement,” he said. “Japan is a spearhead of that change.”
The demographic argument is still contentious in Japan, however. As a simple matter of numbers, it is widely accepted that fewer people of working age means slower growth and a smaller economy, but there is a debate about whether ultra-low inflation and interest rates are an inevitable consequence.
Heizo Takenaka, who as economy minister from 2001 to 2005 carried out the belated clean-up of Japan’s banks, is clear that mistaken monetary and financial policy were important during the initial descent into deflation. He argues that the US, Europe and Japan are all suffering from a declining real interest rate, but demographics are not the root cause.
“I do not support this idea. About 24 countries around the world are experiencing a declining population but only Japan is suffering deflation,” he said. “If our economy is completely globalised, then even if the domestic population declines, the global population is growing. This is not the decisive factor.”
Japan’s real problem, said Mr Takenaka, is a failure to carry out structural economic reforms to open up new growth opportunities. He argued that the less-regulated US economy was doing better at avoiding Japanification while Europe was doing worse.
For Mr Nishimura, the issue is not population decline but population ageing. The proportion of Japan’s population of working age peaked in 1991, he points out, while for the US it peaked in 2008 — more or less coincident with their financial crises. The next two decades will involve dramatic ageing in developed countries with Korea and China also at a turning point.
The US should benefit because it will age slower than Japan but it also has less private savings to fall back on, argued Mr Nishimura. Japan in the 1990s and 2000s had a buffer because the rest of the world was growing fast and still offered high investment returns, so it could export capital. That is much harder for the US and Europe today.
Many economists still believe it is possible to combat Japanification — or secular stagnation as former US Treasury secretary Lawrence Summers calls it — given a suitably aggressive monetary and fiscal policy. But if the likes of Mr Nishimura are correct, and the root causes are demographic, then the world’s Japanification is only just getting started.