Around 6 months ago, Japanese Prime Minister Shinzo Abe announced a 28 trillion yen stimulus programme to boost Japan’s economy. This was a while ago, but given the time that fiscal stimuli can take to have a real economic effect, now is a good time to follow up. First, it’s worth summarising the key points of the package:
- It responded to the Brexit shock, in which people were buying yen as a safe haven, pushing up its value.
- It introduced ¥2.5trn in welfare spending, ¥1.7trn in infrastructure spending, ¥0.5trn for SME businesses, ¥2.7trn for reconstruction after natural disasters.
- A payment of ¥15,000 each for 22 million low-income individuals.
- Marked as a return to Abe’s original economic strategy.
The Myth of the Yen Impact
The Japanese yen has long been a key concern for policymakers in their decision-making process. As Japan’s economy relies a relatively large amount on trade, currency plays a big role its economic outlook. Devaluating the yen so as to boost economic growth is a typical tactic. In theory, it would seem likely that the weak yen can drive exports and thus the economy. But, practically, the numbers tell a different story.
From the chart, we can see a clear positive relationship between Japan’s GDP and the price of the yen against the dollar. Another point to note is that there is a time lag between fluctuations in the yen and changes to GDP. In essence, a stronger yen leads to a higher GDP level. It is no doubt that a depreciating yen can benefit some parties like exporters – more competitive prices means more sales, and a better premium earned when converting overseas profits to the local currency – but it harms private consumption since consumers have to spend more to buy the same quantity of imported goods.
The Need for a Shift in Focus
So a focus on consumption is important for Japan. The Japanese economy relies heavily on household spending and consumption, which accounts for 60% of its GDP. It implies that one direct way to boost its economic growth is to boost consumption.
It’s for this reason that the sales tax imposed in 2014 did not work well. GDP growth and Real Consumption Activity dropped significantly afterwards. Even though it is recovering, it is still far below its previous level. A key factor affecting consumers is the incentive to purchase. It is also why some inflation – say, 2% – is good for an economy. People tend to buy today to avoid higher prices tomorrow.
Japan is renowned for its government debt, which has risen whenever the administration tried to grow the economy using fiscal stimulus methods. It used it again six months ago. There would have been government borrowings and debts used to fund Abe’s latest package. What’s more, the government debt-to-GDP ratio is already 229.2%, continuing a trend of increase over the years.
Why is its ratio that high? There are three major reasons:
- Unexpected slowdown after strong growth in the 1980s.
- An ageing population leading to increasing public expenditure.
- High government spending aiming for higher inflation.
More government expenditure might work if the objective were to raise inflation and inflation expectations. However, the package might have added undue pressure to Japan’s shaky fiscal situation. The main concern is: how will Japan play out the endgame?
Japan is going nowhere fast. One of the reasons is that it is hard to find a balance among several issues: GDP growth, inflation, an ageing population, and debt control. They are all connected and affecting each other. It still remains to be seen how the Abe administration tackles this.