Japan: A roller coaster ride

Japan: A roller coaster ride

Japan: A roller coaster ride

Global Economic Outlook Q3 2012

The Japanese economy continues to swing dramatically between downturns and recoveries. Steadying the growth engine depends on factors such as external demand and changing monetary policy.

Japan’s economy seems to be on a dizzying roller coaster ride. In 2011, the economy experienced negative growth. Then, in the first quarter of 2012, the economy grew at an annual rate of 4.1 percent, one of the best rates of growth of any developed economy. Now there is fear that the economy may actually contract again in the second quarter. What is going on?

To begin, the recession of 2011 was largely the result of the March 2011 earthquake and tsunami. Recovery was always bound to come eventually. Then the very strong growth in the first quarter of 2012 was a bit deceptive. More than half the growth stemmed from strong consumer spending, especially purchases of automobiles. Yet this growth was boosted by temporary government incentives that have since expired. Business investment actually declined in the first quarter, and exports were flat. So the strong performance did not represent a sustainable burst of activity.

Heading into the second quarter, it is increasingly apparent that the strong growth of consumer spending will not be repeated. In fact, retail sales in April declined from the previous month. The automotive incentives are gone. Business investment, on the other hand, is expected to grow due to reconstruction spending. The latest Tankan survey of business sentiment reveals improved confidence on the part of Japanese business executives, especially in the nonmanufacturing sector. Exports grew at a strong pace in April, largely because of the very strong growth of exports to the United States. Exports to Europe and China, on the other hand, have faltered. As Europe continues to slide, it is likely that Japan’s exports to Europe will continue to decline. Meanwhile, imports of energy continue to grow due to the ongoing idling of Japan’s nuclear reactors. Consequently, the deteriorating trade balance could make a negative contribution to economic growth in the second quarter.

As for the coming year, there are a number of factors that will influence the performance of the Japanese economy. Of course, reconstruction spending will have a strong positive impact, and the slowdown in Europe and China will have a strong negative impact. What other factors will make a difference? Monetary policy has been relatively aggressive compared to recent Japanese history. On the other hand, monetary policy has been relatively reticent compared to that of some other countries.

As of writing this outlook, it is not clear whether the tax increase will actually become law. If it does, expect a negative impact on growth in 2013

Indeed, a debate is raging over whether the degree of quantitative easing (asset purchases by the central bank) undertaken so far is sufficient. Quantitative easing (QE) is intended to boost expectations of inflation, thereby reducing real interest rates. Recently, there have been several rounds of increased QE. One measure of successful QE is whether inflation has increased. In Japan, inflation has increased only slightly, and it appears that expectations have barely moved. Another measure of QE is the impact on the exchange rate. While the yen initially depreciated at the start of each round of QE, it appreciated thereafter, but there has been no sustained effect on the yen. Consequently, it is reasonable to say that QE has not yet had its intended impact. Will the Bank of Japan do more? The answer is that we don’t know.

Another factor influencing the economy will be government fiscal policy. For now, the government is intent on raising the national sales tax, first from 5 to 8 percent next year, then from 8 to 10 percent in 2015. The purpose is to close the long-term budget gap that will result from the pension and health costs associated with an aging population. Fiscal consolidation is unambiguously a good idea—at least in the long run. The problem, however, is that the tax increase is intended to take place in the short run—which could stifle growth. There has been a huge national debate about this, with one faction of the ruling party opposing the prime minister’s proposed tax increase with such vehemence that it has decided to leave the party. As of writing this outlook, it is not clear whether the tax increase will actually become law. If it does, expect a negative impact on growth in 2013.

Finally, an important factor that will influence growth will be the value of the yen. Of course, monetary policy will play a role, but there are other influences as well. Lately, Japan has been seen as a safe haven for investors—despite the fact that Japan’s sovereign debt is more than 200 percent of GDP. Investors recognize that the debt is sustainable, mostly held domestically, and that Japan has a stable if dysfunctional political system. The extremely low return on Japanese sovereign debt reflects the fact that investors have great confidence in Japan. The very high value of the yen reflects this as well. At a time of great uncertainty, especially concerning the future of Europe, the safe-haven aspect of Japan has led to an uncomfortably high value of the yen. This in turn has hurt export competitiveness. Thus, the two factors that are most likely to influence the yen are events in Europe and decisions made by the Bank of Japan. Neither can be easily predicted.


Ira Kalish

Ira Kalish is director of global economics, Deloitte Research, Deloitte Services LP.

Japan: A roller coaster ride