Abenomics and Deflation: An Analysis


On Friday 28th August, Shinzo Abe, Japan’s longest serving postwar Prime Minister announced that he would be stepping down after 12 years in the role. His long battle with ulcerative colitis, an intestinal disease that caused him to step down from his first stint as PM in 2007, has once again ended his rule over the world’s fourth largest economy.

Although his resignation due to illness brings up deja vu, the similarities between his two stints as Prime Minister end there. His first rule came during a period of huge political instability in Japan, with 6 Prime Ministers over 6 years. However, since his election in 2012, he has ruled for 8 years, in which he has introduced  a macroeconomic policy so unique that it is named after its most famous patron: Abenomics.

While many countries around the world, such as Venezuela and Zimbabwe have suffered the effects of high inflation (or hyperinflation in extreme cases), Japan suffered from a less common but worrying economic phenomenon in 2012: deflation. It had been a persistent issue in the country for over two decades when Shinzo Abe came into office with a promise to tackle this economic plague.

Deflation in Japan has been attributed to a variety of causes: one is that the output gap in Japan is negative. The output gap is a measure of the difference between the actual output of an economy and its potential output. When output gaps are negative, the actual output is well below the potential output, often due to a lack of aggregate demand. This lack of demand can lead to excess supply; following this, prices should fall to reflect the new equilibrium price: deflation.

Another core reason for chronic deflation in the Japanese economy was the liquidity trap that the Bank of Japan (the central bank) found themselves in. A liquidity trap is caused by already low interest rates; this means that central banks have very little flexibility to adjust their monetary policy in times of need. As seen in Figure 1, Japan’s recent interest rates have been very low which means that the central bank could not respond with expansionary fiscal policy in times of recession, such as the global financial crisis of 2007-08.

Other reasons for Abe’s radical new economic policies include the rise of China, a longtime strategic and economic rival of Japan, and a need for reducing reliance on the United States. These policies were meant to achieve higher economic growth and strengthening the Japanese economy. Indeed, many analysts have drawn parallels between Abenomics and the 19th century Japanese program of ‘fukoku kyohei’: enrich the country, strengthen the army.

Abenomics is based on ‘three arrows’: monetary easing from the Bank of Japan, fiscal stimulus through increased government spending and structural reforms. Abe implemented the first two of these three arrows within the first few weeks of his election. He announced a 10.3 trillion yen (£72 billion) spending program, and appointed Haruhiko Kuroda, an ideological ally, to lead the Bank of Japan with a target of 2% inflation.

Monetary easing from the BoJ came in a variety of ways. Japan lunged into the unknown by reducing interest rates into negative territory: charging people interest on saving. This stimulated spending, although its effectiveness may have been offset by savers withdrawing cash from their accounts or from banks refusing to pass on rates to consumers.

Base interest rate of Japan (1996-2020)

Use of quantitative easing also massively expanded during the Abe administration. Quantitative easing is when the central bank injects money (and liquidity) into the economy, often by buying back bonds it has produced. The central bank prints money in order to fund this purchase. Although its role as a driver of inflation has made other central banks nervous to use it, Japan’s deflationary issue was longstanding and inflation was in fact the target.

The Bank of Japan purchased over 80 trillion yen of bonds (£500 billion) per year in order to stimulate the economy. This programme involved purchasing construction bonds and was a main feature of Abe’s monetary easing policy.

Abe also attempted to reduce the value of the yen in order to further stimulate the economy and foreign investment into Japan. Many Japanese economists believed the yen had appreciated artificially due to external factors and supported this policy.

Abenomics successfully reduced the value of the yen against the dollar by February 2013 due to a dumping of yen on foreign exchange markets. However, this led to other issues. Following the 2011 Fukushima disaster, Japan’s use of nuclear power plants, and hence its power production, had fallen dramatically. This led to higher imports of fossil fuels from countries such as China and Australia, further increasing government debt and the current account deficit.

Abe’s attempt at expansionary fiscal policy was also unsuccessful. Although his massive spending package covered most parts of the Japanese economy, his rise on consumption tax from 5% to 8% was believed to have slashed up to 1.1% of Japan’s economic growth from 2013 to 2014 – a huge sum.

Abe’s structural reform has taken significantly longer, particularly because of external factors affecting the political process, such as the Japanese bureaucracy and other negotiations, such as Japanese participation in the Trans-Pacific Partnership.

Inflation in Japan, measured by CPI (2011-2020)

The results of Abe’s results are mixed. His mission to increase inflation in Japan has been mostly successful. As seen in the graph above, inflation peaked at around 3.8%. However, in recent years, inflation has decreased to around 0-1%. The GDP of Japan has also been stagnant since 2016 after suffering a major fall in 2012 due to a variety of factors – the Fukushima disaster, the eurozone crisis and the 2011 tsunami are only a few of the causes.

Nominal GDP of Japan (2010-2020)

Another important factor to consider is the effect of Covid-19 on the Japanese economy and the potential it has to wipe out any of the gains that Japan has made. Although we will not be able to analyse the scale of the losses due to Covid-19 for months, if not years, the earliest stats that have come out show a gloomy and pessimistic economy: private consumption, a key measure of the health of the economy, contracted by 25%.

Although Abe’s economic promises may not have lived up to their hype, it is important not to judge him solely by his performance on that front. He provided stability for a country that had experienced incredible political turmoil throughout the 2000s. Furthermore, his work on a foreign policy front of navigating a new relationship with Donald Trump and an aggressive China and North Korea deserve commendation as well. History will look on Shinzo Abe favourably as a voice of reason and calm in an increasingly erratic world.


  1. Nishizaki K., Sekine T., Ueno Y., Kawai Y. (2012) Chronic deflation in Japan, Tokyo: BIS Papers.
  2. Leaders (2020) ‘A reformer bids farewell’, The Economist, 3rd September, p. 3.


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