Just a month ago, Japan was starting to become the envy of the global economy. By the end of May, the country's stock market had gone up over 60 percent from last November. People were buying $20,000 watches again. The Economist put this on its cover:
Today, though, with Japan's Nikkei experiencing something of a free-fall overnight, things aren't looking quite that good. What happened? And what drove the earlier boom?
Abenomics is the name given to a suite of measures introduced by Japanese prime minister Shinzo Abe after his December 2012 reelection to the post he last held in 2007. His aim was to revive the sluggish economy with "three arrows": a massive fiscal stimulus, more aggressive monetary easing from the Bank of Japan, and structural reforms to boost Japan's competitiveness.
By the end of February, the measures had resulted in a dramatic weakening of the yen and a 22 percent rise in the Topix stock market index since his election win. Japan's central bank had also yielded to pressure from Mr Abe's administration to set an inflation target of 2 percent.
Most of the enthusiasm in Japan's economy earlier this year came from just one of those three arrows: aggressive monetary policy. Abe removed the president of the Bank of Japan and replaced him with Haruhiko Kuroda, who said he would do "whatever we can" to move Japan's inflation rate from 0 percent to 2 percent. The Financial Times' Gavyn Davies called the landmark quantitative-easing program that the Bank of Japan launched in April "the Fed, on steroids." The progam helped to weaken Japan's yen, which improved hopes for exports.
For a while there, Abenomics seemed to be getting it done.
But then this happened.
Japan's stock market has fallen about 20 percent in the past three weeks, and it fell more than 6 percent on Thursday. Now, after a few months of celebration (with, of course, some nay-sayers), a big debate is brewing over the effectiveness of Abenomics. "There were huge expectations. But it didn't take long for people to realize the reality isn't that easy," Gerald Curtis, a professor at Columbia University, told The Wall Street Journal. What went so wrong, so fast?
Again, Japan's central bank may be the cause. As Buisness Insider's Joe Weisenthal put it Thursday morning, "People are doubting the Bank of Japan's resolve." Over at Slate, Matt Yglesias writes that the downturn in the Nikkei is closely correlated to public worrying from the Bank of Japan over letting inflation get too high, which has led to a fall in investors' inflation expectations.
With similar hand-wringing in the U.S., and with talk of the Fed "tapering" its own quantitative easing already tinkering with the stock markets, what's the lesson here for central banks? Again, Joe Weisenthal:
For a central bank to do its thing, it needs to be aggressive and clear in its goals, and not worry about the bumps along the road.
Fed Chairman Paul Volcker was willing to crash the U.S. economy (well, at least create a recession) to beat inflation. Ben Bernanke got called a traitor by presidential candidates, but he is committed to his extraordinary monetary policy actions.
The Bank of Japan already looks nervous. And the market is starting to bet against it.