What is Abenomics?

Abenomics is the nickname for the economic policies set out for Japan in 2012 when prime minister Shinzo Abe came into power for a second time. Abenomics involved increasing the nation’s money supply, boosting government spending, and enacting reforms to make the Japanese economy more competitive. The Economist outlined the program as a “mix of reflation, government spending, and a growth strategy designed to jolt the economy out of suspended animation that has gripped it for more than two decades.”

Understanding Abenomics

Abenomics refers to the economic policies of a particular politician, in the same way, that Reaganomics or Clintonomics does. Abenomics was promoted as a way to shake Japan’s economy out of a period of minimal growth and overall deflation. Japan’s economic troubles dated back to the 90s, also known as the Lost Decade. It was a period of marked economic stagnation in Japan, following a massive real estate bubble burst in the 1980s, and Japan’s asset price bubble burst in the early 90s.

The Japanese government responded to the economic fallout by running massive budget deficits to fund pubic works projects. In 1998, economist Paul Krugman argued in a paper titled “Japan’s Trap” that Japan could raise inflation expectations by committing to an irresponsible monetary policy for a period of time, thereby cutting long-term interest rates and promoting the spending needed to break out of economic stagnation. 

Japan adopted some of Krugman’s recommendations, expanding the money supply domestically and keeping interest rates remarkably low. This facilitated an economic recovery, beginning in 2005, but it ultimately did not stop deflation. 

In July 2006, Japan ended its zero-rate policy as Abe took power in his first term as prime minister. Abe would resign as prime minister suddenly in 2007, but continued to serve in the ruling party. Though still having the lowest interest rates in the world, Japan could not stop deflation. The country saw the Nikkei 225 drop more than 50% between the end of 2007 and the beginning of 2009. In part due to the economic malaise Japan seemed unable to shake, Abe’s party, the Liberal Democratic Party of Japan (LDP), lost power to the Democratic Party of Japan.

Abenomics and the Three Arrows

Abe began a second term in December 2012. Soon after resuming office, he launched his Abenomics plan to bolster Japan’s stagnant economy. In a speech following his election, Abe announced that he and his cabinet would “implement bold monetary policy, flexible fiscal policy and a growth strategy that encourages private investment, and with these three pillars, achieve results.”

Abe’s program consisted of three “arrows.” The first was printing additional currency – between 60 trillion yen to 70 trillion yen – to make Japanese exports more attractive and generate modest inflation—roughly 2%. The second arrow was new government spending programs to stimulate demand and consumption—to stimulate short-term growth, and to achieve a budget surplus over the long term. 

The third component of Abenomics was more complex—a reform of various regulations to make Japanese industries more competitive and to encourage investment in and from the private sector. This included corporate governance reform, easing of restrictions on hiring foreign staff in special economic zones, making it easier for companies to fire ineffective workers, liberalizing the health sector, and implementing measures the help domestic and foreign entrepreneurs. The proposed legislation also aimed to restructure the utility and pharmaceutical industries and modernize the agricultural sector. Most important, perhaps, was the Trans-Pacific Partnership (TPP), which was described by economist Yoshizaki Tatsuhiko as potentially the “linchpin of Abe’s economic revitalization strategy,” by making Japan more competitive through free trade.

Did Abenomics Work?

Like all Japanese economic policy since the bubble burst, Abenomics has worked well at times and stalled at others. Inflation targets have been met and Japan’s unemployment rate is more than 2% lower than when Abe came to power for the second time. Similarly, nominal GDP has increased and corporate pre-tax profit and tax revenues have both seen significant rises. However, Japan’s periods of success have been halted at times by global economic forces and the country’s most significant economic problem – a rapidly aging population – has increasingly taken the forefront.

What Is the After-Tax Real Rate of Return?

The after-tax real rate of return is the actual financial benefit of an investment after accounting for the effects of inflation and taxes. It is a more accurate measure of an investor’s net earnings after income taxes have been paid and the rate of inflation has been adjusted for. Both of these factors must be accounted for because they impact the gains an investor receives. This can be contrasted with the gross rate of return and the nominal rate of return of an investment.

Understanding the After-Tax Real Rate of Return

Over the course of a year, an investor might earn a nominal rate of return of 12% on his stock investment, but the real rate of return, the money he gets to put in his pocket at the end of the day, will be less than 12%. Inflation might have been 3% for the year, knocking his real rate of return down to 9%. And since he sold his stock at a profit, he will have to pay taxes on those profits, taking another, say 2%, off his return, for an after-tax real rate of return of 7%.

The commission he paid to buy and sell the stock also diminishes his return. Thus, in order to truly grow their nest eggs over time, investors must focus on the after-tax real rate of return, not the nominal return.

The after-tax real rate of return is a more accurate measure of investment earnings and usually differs significantly from an investment’s nominal (gross) rate of return, or its return before fees, inflation, and taxes. However, investments in tax-advantaged securities, such as municipal bonds and inflation-protected securities, such as Treasury inflation protected securities (TIPS), as well as investments held in tax-advantaged accounts, such as Roth IRAs, will show less discrepancy between nominal returns and after-tax real rates of return.

Example of the After-Tax Real Rate of Return

Let’s be more specific about how the after-tax real rate of return is determined. The return is calculated first of all by determining the after-tax return before inflation, which is calculated as Nominal Return x (1 – tax rate). For example, consider an investor whose nominal return on his equity investment is 17% and his applicable tax rate is 15%. His after-tax return is, therefore:
$0.17 \times (1 – 0.15) = 0.1445 = 14.45\%$0.17×(1−0.15)=0.1445=14.45%

Let’s assume that the inflation rate during this period is 2.5%. To calculate the real rate of return after tax, divide 1 plus the after-tax return by 1 plus the inflation rate, then subtract 1. Dividing by inflation reflects the fact that a dollar in hand today is worth more than a dollar in hand tomorrow. In other words, future dollars have less purchasing power than today’s dollars.

Following our example, the after-tax real rate of return is:

$\frac{(1 + 0.1445)}{(1 + 0.025)} – 1 = 1.1166 – 1 = 0.1166 = 11.66\%$(1+0.025)(1+0.1445)​−1=1.1166−1=0.1166=11.66%

That figure is quite a bit lower than the 17% gross return received on the investment. As long as the real rate of return after taxes is positive, however, an investor will be ahead of inflation. If it’s negative, the return will not be sufficient to sustain an investor’s standard of living in the future.

The Bottom Line

When you are assessing the value of your investments, it’s important to look at not just your nominal rate of return but also the after-tax real rate of return, which takes into account the taxes you’ll owe and inflation’s effect. The after-tax real rate of return can tell you if your nest egg investments will allow you to maintain your standard of living in the future.