Japan could use a dose of stimulus. GDP is still 3% below the level first reached five years ago. So, in my view, macroeconomic stimulus is necessary but not sufficient. Stimulus alone, without structural reform, is just another shot of heroin that will make Japan even more of a stimulus addict than it already is.
However, the reaction in the currency and stock markets, if they continue, could be a big boost to the LDP in the July Upper House elections.

What differentiates Abe from some of his predecessors is that he wants to combine strong doses of both fiscal and monetary policy. What chance is there that this will have a better effect than past efforts?

Years of effort have shown that monetary stimulus alone is insufficient to elevate growth or defeat deflation.
Interestingly, Paul Krugman, who previously downplayed the role for fiscal policy, has now admitted that it takes a fiscal-monetary combination would boost growth.
This is a remarkable turnaround for him. In a comment on Adam Posen, who proposed just additional monetary stimulus and called fiscal stimulus counter-productive, Krugman wrote:

Posen is going with the notion that unconventional monetary policy, by working both on asset demand and on expectations, can do the job. Maybe, but most of us have taken the limited payoff to quantitative easing as a cautionary tale. There's a lot to say for the notion of using temporary fiscal stimulus [combined with monetary ease--rk] to push the output gap down, ideally even causing some economic overheating, to jump-start the transition to an inflationary regime.
That's what I've been arguing for years.

However, Krugman is wrong that the fiscal-monetary combo would be a lasting fix. Fiscal stimulus adds real demand to an economy that lacks sufficient domestic private demand in a slump. Monetary stimulus prevents interest rates from rising in response, which would make the fiscal stimulus self-defeating. In fact, the BOJ has succeded in knocking 3-4 year bond rates down to about as low as the overnight rate of 0.1%, while longer term rates are at near-record lows. In a healthy economy, stimulus raises the operating rate of firms and lowers unemployment. That causes firms to do even more hiring and investment and causes consumers to be more willing to spend. These reinforce each other and the vicious cycle of recession is transformed into the virtuous cycle of self-sustaining private-led growth.
This allows the stimulus to be safely withdrawn.
Krugman is wrong because Japan is not a healthy economy.

The recovery in 2002-2007 was led by an incredible dependence on a growing trade surplus fed by a super-cheap yen. 40% of all GDP growth in those years came just from growth in the trade surplus. Another 30% came from business investment, much of which was tied directly or indirectly to exports. That's why Japan's GDP fell 9% when the global slump occurred. During that decade the real price-adjusted value of the yen vis-a-vis its major trading partners fell to a level 30% below its average since 1986. Even at its highest nominal level in 2012, the real value of the yen was still below its quarter-century average.

Abe wants to repeat this by driving down the yen. But Tokyo does not have control over the yen rate. That is determined in global markets. The yen is falling in part because of Japan's spate of trade deficits, and Abe's comments were the trigger that turned abound sentiment among currency speculators. But there is absolutely no linkage in the data between easy money by the BOJ and the yen rate. The stock market is rising because it has been highly (89%) correlated with the yen since 2005. When the yen gets cheaper stocks rise.
Moreover, as some in Japan have pointed out, a cheaper yen has its costs as well as benefits, one of the costs being much higher energy prices and a transfer of purchasing power from Japan to oil sheiks.

What about consumer demand? In the 15 years since 1997, GDP had grown a meager 8%, but the total compensation of all employees combined has not grown at all, partly due to a long period of falling real wages per worker as well as a fall in the number of workers. The aged now receive virtually nothing on their bank accounts.
People are spending as much as they can, with the savings rate now around 2%. The problem is not lack of will to spend, but lack of wallet. If you want households to spend more, they need more income. The consumption tax hike will leave them with less income.
So, how can they be expected to spend more once stimulus is withdrawn. Why will firms that cannot run their plants at profitable operating rates borrow to expand capacity no matter how low interest rates are?
Business investment is about 18% below its peak of five years ago.

So, while Abenomics may boost the economy for a while, once the stimulus is withdrawn, it will do what it has done before after previous bouts of stimulus or a cheap
yen: fall back to stagnation. Meanwhile, what Abe proposes is a decade-long Y20 trillion (4% of GDP) per year program of public works. That's the old bridges to nowhere approach, whereas there are lots of worthwhile projects that are being ignored. (By the way, it is not entirely clear how long Abe will be able to keep this stimulus going since he seems to have reversed himself and caved into the demand from the Finance Ministry to limit deficit bonds to Y44 trillion, the same level as in initial budgets of the past few years.)

What Japan needs is to use the macro stimulus as anesthesia to help the people who would be hurt by serious structural reform. But that costs money, e.g.
for a stronger social safety net. But Abe is not even giving much lip service to real reform. 154 of the LDP candidates who won got the endorsement of the farm lobby by promising to stop Japan from joining the Trans-Pacific Partnership. Abe says it wiill take years to figure out an energy policy. There is no approach to increase firm efficiency by more competititon. No social safety net so that bad firms can die and better firms replace them at a rate equal to the pace in other rich countries.

A lot of economists believe in assorted magic wands and Japan has been a grand guinea pig for their assorted nostrums. For example, a majority of US economists still believe that the BOJ can create inflation any time it wants to, if it just announced a target and printed enough money. And many, like Posen and Krugman, argue that deflation and a "low" yen are Japan's main problems. To me, this is like saying you can cure a fever by targeting the thermometer to read 98.6. But Abe is now seen as trying it out and so they are cheering him on. In my view, this is just as wrong-headed as the warnings that Ben Bernanke was going to create inflation in the US by printing so much money after the Lehman shock, or as Herbert Hoover saying that, if people and firms spent as if there were no Depression, that alone would cure the Depression.
Once interest rates hit zero, the normal linkages between easy money and inflation break down, as years of experience in Japan and the last five years in the US have shown. Deflation is a symptom, not a cause. It reflects weak demand. If enough fiscal stimulus creates enough demand, that will help fight deflation--until the stimulus is withdrawn.

But, for now, the public sees Abe doing what the did not do six years ago: put the economy on the front-burner.

Richard Katz
The Oriental Economist Report