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Vol. 37, No. 2, April 2010


After peaking in October 2007, the Japanese economy plunged into an unprecedented tailspin, but it appears to have pulled out of the dive around March last year. By that time inventories had been whittled down, and a package of stimulus measures featuring incentives for purchasers of eco-friendly cars and appliances was taking effect. Now fiscal 2010, which starts in April 2010, is drawing near, and it seems likely that the economy will continue on an unsteady footing, with deflation persisting and the employment picture looking grim. Currently there is a large differential between actual demand and potential gross domestic product; this deflationary gap, as it is known, is equivalent to about 7% of GDP. We can therefore expect companies to continue to go slow on capital investments, while consumers, discouraged by the chilly job climate, tighten their purse strings. Product prices will continue to decline, pushing wages lower, and if service prices are also marked down, deflation is liable to pick up speed.

On the external front, meanwhile, companies in North America and Europe have not yet managed to clean up the problems in their balance sheets resulting from asset deflation, and so the recovery power of Western economies remains weak despite extremely low interest rates. These economies will probably mark time during 2010 as the effects of earlier fiscal stimulus measures gradually wear off. But China and Asia’s other emerging economies are staging a strong comeback. Their stimulus measures have produced good results, and their companies are not having to struggle to regain a sound financial position.

Even though the Japanese economy will probably enter a cooling-off period this spring as the effects of fiscal stimulus wear off, it is highly likely that the slowdown will be brief, since exports to expanding Asian economies should pick up speed. Still, the recovery of industrial production is lagging far behind the renewed growth in South Korea and Taiwan. At the end of 2009 South Korea’s industrial production had moved above the 2008 level, and Taiwan’s had more or less recovered the lost ground, but Japan’s was just 84% of the previous year’s level. A number of factors are involved. The excess production capacity in the manufacturing sector was too large to be overcome by the business cycle upturn; growth these days is operating under the constraint of a decline in the nation’s labor force, which is beginning to have adverse effects; consumption in Western countries has continued to slump; meanwhile, demand for Japan’s high-quality products has so far failed to bounce back.

This is a situation in which much will depend on the skill of the government in piloting the economy forward. Because the yawning gap between supply and demand will prevent private demand from entering a self-sustaining recovery process, people are watching closely to see what monetary and fiscal measures the authorities come up with. The articles in this section explore the problem points and features of the budget for fiscal 2010, the first budget drafted under the new administration led by the Democratic Party of Japan, and they also touch on issues relating to Japan’s ultraloose monetary policy.

The article by Yosano Kaoru, a prominent Liberal Democrat who served as minister of finance in the previous administration of Prime Minister Asô Tarô, is harshly critical of the budget assembled by Prime Minister Hatoyama Yukio’s team. The fiscal 2010 budget is an extraordinary one. Total expenditures will mount to ¥92.3 trillion, including ¥20.6 trillion in debt-servicing costs. On the revenue side, taxes are expected to bring in only ¥37.4 trillion, which will necessitate issuing government bonds to the tune of ¥44.3 trillion. The Hatoyama administration plans to draw down surplus funds in special accounts as far as possible, raising ¥10.6 trillion from such "buried treasures" as foreign exchange reserves, but it also wants to get started on implementing the proposals set out in the political manifesto the DPJ presented to voters in the August 2009 general election. This will result in a truly huge budget even if only some of the new spending items, such as ¥2.7 trillion to distribute half of the proposed child allowances and ¥0.5 trillion to eliminate tuition for public high schools, are approved. Yosano points out that making use of hidden reserves represents only a temporary solution, and he comes down hard on the administration for not fashioning a sustainable fiscal policy.

The new spending proposed in the manifesto will require an estimated ¥12.6 trillion in new revenue resources starting from fiscal 2011. Last November the Hatoyama government staged a flashy screening of budget requests aimed at weeding out wasteful spending, but though it had hoped to free up trillions of yen, the screeners in the end were able to trim the total requested appropriations by only ¥677 billion. What the Hatoyama government has in mind is a restructuring of the way in which the nation redistributes income, but it wants to accomplish this without fundamentally changing the tax system. In Yosano’s view, this is a course that could bankrupt the Japanese state. To be sure, Japan is by no means the only developed country with ballooning fiscal deficits. The ratio of deficits to GDP has risen to around 10% in quite a few countries. There is a danger, accordingly, that interest rates on government bonds will increase. This will become an especially serious threat to Japan if the government does not produce credible long-range plans for sustaining public finance.

Monetary policy is a controversial topic these days. The piece below by Iwata Kikuo urges the Bank of Japan to become even more aggressive in combating deflation by underwriting government bonds directly. This is prohibited in principle by the Public Finance Law, but in special circumstances the central bank can directly buy government bonds up to an amount approved by a resolution of the National Diet. In a companion article, Ikeo Kazuhito argues against this idea. He too is concerned by ongoing deflation, but he does not approve of pinning responsibility for quelling it on the central bank. What is required, he says, is the implementation of a long-range growth strategy. He favors continued use of conventional monetary easing tools over a switch back to the unconventional policy of quantitative easing.

Quantitative easing is the monetary policy the BOJ pursued from 2001 to 2006. This policy loosened the monetary reins to an extreme degree in order to reduce the cost of raising funds for companies and households and thereby energize the real economy. The vast quantities of funds created remained bottled up in money markets, however, where they were unable to give business a boost. One of the problems was that many financial institutions were still struggling to reduce heavy loads of nonperforming loans. Today that constraint has been removed, but because companies now have an excess of production facilities, a return to quantitative easing would have only a limited effect.

Kôno Ryûtarô, chief economist at BNP Paribas (Japan), has written elsewhere that labor productivity and capital profitability are being held back in Japan by the tendency for economic resources to accumulate in inefficient industries as a result of continuing public involvement in the affairs of private enterprises. This intervention, he says, has suppressed the natural rate of interest and sapped the effectiveness of the ongoing efforts to stimulate the economy with fiscal spending and the provision of public credit guarantees. Under the circumstances, he says, little can be expected of any attempt to make money easier still by adopting measures to realize ultralow interest rates. We must hope that the Hatoyama administration will reach a better understanding of macroeconomic issues like these. Instead of focusing narrowly on honoring the pledges in the DPJ manifesto, it should draw up a trustworthy long-term economic plan and present it to the public. (Nariai Osamu, Professor, Reitaku University)

© 2010 Japan Echo Inc.