Most economic summits are pretty dull, and the recent G-20 meeting in Washington, D.C., was no exception. But in giving tacit approval to the remarkable policy experiment taking place in Japan, it did something of great importance. With fears that his policies could start a currency war, or worse, laid to rest, Japanese Prime Minister Shinzo Abe, who was elected at the end of last year, is now free to continue his all-out effort to revive the world’s third-largest economy — an endeavor that has big implications for the U.S.
For far too long a moribund Japan has been a drag on the rest of the world. A revived Japan would boost growth in many other countries, the U.S. included, and it could also serve as a strategic counterweight to China. Perhaps most important, a success for Abenomics would demonstrate that countries suffering the aftereffects of a big speculative bust — that’s us, folks — don’t have to settle for decades of economic decline, as Japan, until recently, had been doing.
Next year will mark the 25th anniversary of my first trip to Tokyo, and I remember it well. The Nikkei was approaching 39,000, and Japanese companies like Sony and Matsushita were widely believed to be taking over the world. In 1991, two years after my visit, the stock market and real estate bubbles burst, and since then Japan has been trapped in one of the most extended slumps ever to hit a major economy. The prices of most goods and services have been falling for more than a decade, and nominal GDP is barely higher than it was in 1995. Housing prices are still 50% lower than they were in 1990. The Nikkei is at roughly a third the level of its 1989 peak — and that’s after rising by about 50% since November. In some ways, it’s as if Japan fell asleep for an entire generation.
The Nikkei’s recent bounce reflects Abe’s determination to open the monetary spigots in an effort to tackle deflation and revive spending. In April, Haruhiko Kuroda, the new head of the Bank of Japan, announced that the central bank would buy enough bonds in the next two years to double the amount of cash in circulation — a policy that mimics the Fed’s policy of quantitative easing and doubles down on it. In aiming to raise the inflation rate to positive 2%, Abe and Kuroda are also targeting the stock market, the real estate market, and the exchange rate — all of which have moved sharply in the direction the government intended. On top of all that, Abe’s government is introducing a modest stimulus package and trying to remove some of the structural factors that have been holding Japan back, such as subsidies to inefficient farmers and monopolies in power generation.
If ever an economy needed a big jolt, it’s Japan’s. Ever since the bubble burst, households and businesses have been concentrating on paying down their debt rather than borrowing and investing. Only higher government outlays have prevented an even deeper slump. But financing that additional spending has ballooned the ratio of net public debt to GDP to about 135%. (In the U.S., the ratio is 73%.) As fears rise that Japan could eventually face a Greek-style debt crisis, the stakes for Abenomics couldn’t be higher.
So far, the results are encouraging. The value of the yen has fallen by about a fifth, so Japanese exporters are more competitive, and their profits are rising. Higher prices for stocks and real estate have boosted household wealth. In fact, after years and years of deleveraging, Japanese businesses and households are now in pretty strong financial shape. The big question is psychological: Can Abe persuade them to overcome their caution and start borrowing and spending again? If he can, there’s every prospect of jump-starting growth. With a highly skilled labor force, cutting-edge technology, and, even today, a strong position in many global markets, the country should have a bright future. Now seems as good a time as any for Japan to awake from its slumber.
John Cassidy is a Fortune contributor and a New Yorker staff writer.
This story is from the May 20, 2013 issue of Fortune.