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How will the US, Japan and Italy respond?

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The Olympic flame has been passed to Tokyo and Shinzo Abe, dressed as Super Mario, took centre stage in a handover ceremony inspired by the iconic Nintendo video game. First seen in 1981 as the lead in Donkey Kong, Mario has become a globally recognised figure that spans many generations. The Italian plumber who made his debut in the sewers of New York, Mario not only serves as a globally identifiable symbol of Japan, he also draws on Italy and the US for key aspects of his identity.

As the summer in Europe is drawing to a close, and business leaders and central bankers are considering 'what next, Mario?' the focus of the Olympic handover ceremony brings together three economies - Japan, Italy and the US. While all are faring very differently, each is beset with unique challenges which will determine their future performance. By looking briefly at negative interest rates and fiscal policy, we explore how the different economies may respond to their current situation.

Negative rates have been a subject of great debate. Do they work? Mark Carney has stated he is “…not a fan of negative rates”, and Janet Yellen has proclaimed that they are a measure of last resort. However, negative rates have been a mainstay of the Abenomics of Japan, the three arrow principles of which are: monetary policy, fiscal policy, and structural reforms to encourage private investment. The impact of negative rates will vary between different economies and will depend on structural differences. In Italy, for example, where a large number of savers hold deposits in banks and most of the corporate sector receives financing from bank loans, negative rates will have a limited impact. In the US, where financing is more flexible, there is the ability to move from banks. The impact is also influenced by politics: where there is a tendency to protect savers from the impact of negative rates (Italy), there is no motivation for them to move to other savings vehicles, which limits the effectiveness of this element of monetary policy.

With the monetary policy levers in most economies already set to 11, the focus moves to fiscal solutions. Mario Draghi has been urging this in his recent communications and subtly pointing at Italy as one of the key economies in need of fiscal help. It is worth noting that monetary policy has also had a very divisive effect. Assets have inflated, leading the rich to get richer, and whilst many countries run austerity programmes, there should be little surprise that the popularity of parties targeting disaffected voters has risen. This makes implementation of fiscal policy additionally challenging for politicians.

Fiscal policy can take a number of different tracks and the leaders of Germany, France and Italy have been exploring their options on the island of Ventotene, just off mainland Italy in the Mediterranean. Primarily, their stated objective is to work out how to react to the storm caused by Brexit. However, this is only one issue facing the trio. Renzi and Holland are looking to extend Juncker’s €315bn investment plan aimed at tackling youth unemployment. The Italian premier is also looking for support from the French President to enable more flexibility to increase investment at home without breaking the budgetary rules.

The problems in Japan, Italy and beyond can be distilled down to prolonged low economic growth. This has to be the focus of government attention. The idea that significant levels of government money should be spent on targeted infrastructure projects that not only stimulate the economy but also form the building blocks of a thriving economy for the future is not a new one. This is something that is particularly pertinent now in Japan, Italy and the wider EU economies. Partnering with private finance could ensure the success of these investments. There is certainly a significant stock of ‘dry powder’ looking to be deployed, which could reduce the risk of badly-managed, government-driven schemes failing to deliver.

The US faces different challenges and the direction that will be taken, at least by the Fed, may become clearer towards the end of this week following Janet Yellen’s Jackson Hole speech to the convention of central bankers. With pressure to raise rates again this year, the speech should make it clearer as to her intent over the remaining months of the year. It will be interesting to see if she comments on global economic headwinds or other euphemisms for current low global growth, the slowdown in China, and concerns over Europe post Brexit.

Whilst the situations across the economies of Italy, Japan and the US are different, the goals are the same – to achieve long-term, sustainable economic growth. While some economies, due to their current structure, are immune to some of the medicine available (monetary policy), it will take politicians with long-term vision to find the right course and dosage. Maybe by the time the Olympics open in Tokyo, we will be able to see the fruits of their endeavours.

Jonathan Lye

All views expressed here are the author’s own and are based on information available at the time of writing.




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