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The power of decisive policy action

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4 March 2013 09:26

Mike Callaghan is Director of the Lowy Institute's G20 Studies Centre.  

Comparisons between the Japanese Prime Minister Shinzo Abe and the President of the European Central Bank (ECB) Mario Draghi may be rare. But the two men do have something in common. They have both demonstrated the power of decisive policy action. What the world economy badly needs is more decisive policy responses, particularly in the US, but it still appears to be elusive.

Prime Minister Abe has a plan to force the Japanese economy out of deflation and serial recession based on monetary expansion, fiscal stimulus and structural reforms. The policy steps are not new. Japan was the first country to embark on quantitative easing and it has had endless fiscal expansions, with the legacy of a public debt bill in excess of 230% of GDP. As Stephen Grenville has pointed out, 'Abenomics' is more of the same, 'but this time with feeling'.

Yet Prime Minister Abe has convinced markets, at least for the time being, that he has a plan and he is committed to achieving growth. This sense of purpose was conveyed in his second policy speech to the Japanese parliament, with his emphasis on restoring a 'strong Japan'.  Whether Abenomics works will ultimately depend on whether all aspects are implemented, most importantly the structural reforms that are badly needed to revive private sector growth and prepare Japan for a rapidly aging population.

But he has convinced markets that he is serious, certainly in terms of aggressive monetary policy with the appointment of Haruhiko Kuroda as the new governor of the Bank of Japan. The result is that, since the election, Japan's stock market has increased by more than 30%. 'Mr Abe has brought back confidence, and that means money is flowing back into markets', said one Japanese trader.

In a similar vein, it was Mario Draghi's promise in September 2012 to take decisive action through Outright Monetary Transactions (OMT) which quelled concerns that the euro may break up. Draghi's promise to purchase potentially unlimited bonds from countries like Spain if they applied for a European bail-out was a circuit breaker in the eurozone crisis (although perhaps just as well it has not been tested). After months of indecision and confusion, Draghi's decisiveness boosted confidence. In his own words, 'market confidence has visibly improved on the back of our decisions as regards outright monetary transactions'.

Draghi's decisiveness helped to remove immediate fears that the common currency would fall apart, but he only bought the euro time and it will have to press ahead with structural reforms.

Notwithstanding all the faults and economic challenges confronting Japan and Europe, Abe and Draghi have demonstrated the power of decisiveness. If only we could get similar action elsewhere. The US badly needs a burst of decisive policy leadership. This would boost confidence and drive investment expenditure. Unfortunately, President Obama has recently told the US public to prepare for a lengthy fiscal crisis which will weaken growth because of the problems of doing a deal with Congress. What will it take to see some decisive policy action in the US?

Photo by Flickr user Marshall Astor.

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