By Nikunj Gupta

Edited by Anandita Malhotra, Senior Editor, The Indian Economist

We all have looked up to Abenomics since the 2012 December Japan general assembly elections elected Shinzo Abe to his second term as Prime Minister of Japan. To take a quick peek into the actual Abenomics plan for new readers, Abenomics is based upon “three arrows” of fiscal stimulus, monetary easing and structural reforms.  The program is a mix of reflation, government spending and a growth strategy designed to jolt the economy out of suspended animation that has gripped it for more than two decades.

By February 2013, the Abenomics policy led to a dramatic weakening of the Japanese yen and a 22% rise in the TOPIX stock market index. The unemployment rate in Japan fell from 4.0% in the final quarter of 2012 to 3.7% in the first quarter of 2013, continuing a past trend.

We all know about these figures but this is not what has grabbed the world’s attention is it. Japan stunned economists in November, unexpectedly falling into recession. Data revealed Japan’s GDP for the most recent quarter contracted at an annualized 1.9 percent rate, higher than the initial 1.6 percent annual rate reported last month, igniting concerns about Abe’s effort to spur growth.

With 80 trillion yen already being pumped into the economy, Japan’s recession came as quite a shock to many economists.  The main object of concern regarding the Japan scenario leading to curiosity among many people is that what led to such a drastic fall in GDP even after the extensive so called Abenomics coming into action. But looking closely into matter, we discover that the consumption tax has really been the crucial point

At least one element of Prime Minister Shinzo Abe’s recovery plan was ill-conceived: increasing the country’s consumption tax from 5 percent to 8 percent.

The point of Abenomics was to try and engage in fiscal consolidation without harming growth or jeopardizing the Bank of Japan’s plans to increase inflation. It was initially thought monetary easing would be enough to allow Japan to raise taxes without undermining growth or inflation. Abe’s fiscal arrow was a combination of the consumption tax, followed by a stimulus program to offset the consumption tax in the short run. In October, Japan instituted more monetary easing as inflation stalled following the tax hike in April. The Bank of Japan agreed to inject 80 trillion yen, or $720 billion, into the economy through its quantitative easing program.

The consumption tax hike certainly weakened the economy, but it was also an unavoidable step for Japan. It was just a question of when to hike taxes

But that’s not Japan’s only problem. Lower energy prices are also taking a toll. While some countries including the U.S. are benefiting from the recent plunge in oil prices, Japan is not. The devaluation of their currency and the devaluation of oil have basically offset each other. So, where other countries see positive growth because of low energy costs, Japan might not have that on their side.

In the meantime, experts forecast the U.S. dollar will be worth 125 Japanese yen before the end of 2014. The dollar Monday traded at 120.72 yen. That could be an advantage for Japan as currency devaluation could lead to higher exports.

Japan could get the economy moving because it’s cheaper for the world to buy Japanese products. Importers of Japanese goods could buy more than they might have previously and it would be less costly to do business with them. But the disadvantage is that a weaker yen leads Japanese businesses to have far less purchasing power around the world — limiting access to global goods and pushing up energy costs significantly.

 What they want to do is persuade the world that Japan has inflationary intentions, even if that means the rest of the world sees Japanese decision-makers as reckless.

The Japanese people will soon have a chance to decide what they think of Abenomics. The country’s snap election, which Abe called last month, is set to take place on 14th December 2014.

“It’s quite striking that despite the massive scale of monetary loosening, that even just a fairly small tax increase is enough to plunge the economy into recession,” said Jonathan Buss, an economist at Oxford Economics.

 Nikunj Gupta is First year student pursuing economic honors at St. Stephens College with an ardent desire to pursue Masters in economics at post graduate level and make a career in corporate sector afterwards. He loves listening to music no matter what the time of day is or the place is. Being a foodie and a couch potato, he loves to cook, eat and watch sitcoms. He has a keen interest in studying more about finance and stock markets. He devotes the rest of the time to photography and playing sports like badminton.

Posted by The Indian Economist | For the Curious Mind