The spectre of deflation returns as Japan heads into recession, but this time the policymakers are ready.
By Takahide Kiuchi, Chief Economist, Nomura Securities Co. Ltd. 26 December 2008
The slowdown in overseas economies, the decline of global stock markets and the rise of the yen are putting serious downward pressure on the Japanese economy. Still, Japan seems to be in relatively good shape to ride out the storm.
Japan likely fell into recession in the first half of 2008. Because of the global financial crisis, industrial production in the fourth quarter of 2008 may record the biggest decline in three decades, falling 5 percent from the previous quarter. Japan’s two top manufacturing industries, information technology and autos, are leading the way downward.
We expect the Japanese economy will emerge from a negative growth period in the second quarter of 2009 thanks to economic stimulus packages in both Japan and the U.S. The government of Prime Minister Taro Aso has announced a $52.5 billion package that is expected to be implemented by March 2009. The measure includes $21 billion in benefits to Japanese households, a tax break for housing loans and aid to local governments amounting to $10.5 billion. The package is expected to push up consumer spending by some 2 percent as early as February or March and increase real GDP by 0.4 percent or 0.5 percent within a year.
Politics may also influence the economy in 2009. The most likely scenario is that Prime Minister Aso will call a lower house election in January or April after ratification of the economic stimulus package as the second supplementary budget. Even if the ruling Liberal Democratic Party (LDP) is defeated and the left-wing opposition Democratic Party of Japan (DPJ) forms a government, the new administration is likely to implement another stimulus.
One Silver Lining
We also expect the new government in the U.S. will implement an economic stimulus package of $200 to $300 billion, which should boost Japanese exports to the U.S. Even if Japanese growth turns positive in the spring of 2009, it will take time for real recovery to get under way. We expect the Japanese economy will enter a true expansionary period in the second half of 2010, after the U.S. economy begins its full-scale recovery around the middle of that year.
One silver lining is that the slowing economy has reduced inflationary pressures. Japan’s consumer price index (excluding fresh food) seems to be headed downward after peaking in August 2008 at a 2.4 percent annual rate. We expect year-on-year change in the CPI will turn negative in May or June 2009.
If you’re worried about deflation, the most useful indicator to watch is the output gap. That measure will likely bottom out in 2010 at minus 3 percent, which indicates that potential total supply exceeds actual total demand by 3 percent. That would be better than the deflation-spiral record of minus 5 percent in 2001. During the expansionary period of 2002 to 2007, a seriously ailing Japanese economy finally recovered. And Japanese companies mostly solved the problem of the “three excesses” — excess debt, excess production capacity and excess labor. In this sense, the current Japanese economic condition is much healthier than the one of several years ago.
A remaining concern is the stability of the banking system. Japanese banks have solved their non-performing loan problems almost completely. Yet weakening local economies and a decline in stock prices could potentially cause serious problems among small regional banks. Instability in the banking system could deepen and prolong the economic slump.
At its October meeting, the Bank of Japan (BOJ) decided to cut the target for the uncollateralized overnight call rate, its key policy rate, from 0.5 percent to 0.3 percent. The rate cut is the first by the BOJ since it guided interest rates to zero in 2001.
In our view, the BOJ rate cut can be seen as keeping Japan in line with the coordinated international moves to lower interest rates. We think the U.S. rate cut in particular had a major bearing on the BOJ’s decision. The view that Japanese rates were suddenly too high compared with those in the U.S. risked putting further upward pressure on the yen and undermining share prices. Instead of seeking economic stimulus, the Japanese rate cut was aimed at creating financial stablility.
The BOJ’s monetary easing raises the prospect of a return of the zero interest rate policy if monetary easing continues overseas. Thus, the BOJ could cut interest rates again before the end of the fiscal year in March. We also see a possible resumption of the “quantitative easing” policy of recent years, when the BOJ flooded banks with excess liquidity. It appears that there are considerable doubts within the BOJ about the effects of quantitative easing on the economy and consumer prices, but it seems to be generally regarded as an effective means of stabilizing the banking system.
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Global Financial Crisis: Sinking Sun
The spectre of deflation returns as Japan heads into recession, but this time the policymakers are ready.
By Takahide Kiuchi, Chief Economist, Nomura Securities Co. Ltd.
26 December 2008
The slowdown in overseas economies, the decline of global stock markets and the rise of the yen are putting serious downward pressure on the Japanese economy. Still, Japan seems to be in relatively good shape to ride out the storm.
Japan likely fell into recession in the first half of 2008. Because of the global financial crisis, industrial production in the fourth quarter of 2008 may record the biggest decline in three decades, falling 5 percent from the previous quarter. Japan’s two top manufacturing industries, information technology and autos, are leading the way downward.
We expect the Japanese economy will emerge from a negative growth period in the second quarter of 2009 thanks to economic stimulus packages in both Japan and the U.S. The government of Prime Minister Taro Aso has announced a $52.5 billion package that is expected to be implemented by March 2009. The measure includes $21 billion in benefits to Japanese households, a tax break for housing loans and aid to local governments amounting to $10.5 billion. The package is expected to push up consumer spending by some 2 percent as early as February or March and increase real GDP by 0.4 percent or 0.5 percent within a year.
Politics may also influence the economy in 2009. The most likely scenario is that Prime Minister Aso will call a lower house election in January or April after ratification of the economic stimulus package as the second supplementary budget. Even if the ruling Liberal Democratic Party (LDP) is defeated and the left-wing opposition Democratic Party of Japan (DPJ) forms a government, the new administration is likely to implement another stimulus.
One Silver Lining
We also expect the new government in the U.S. will implement an economic stimulus package of $200 to $300 billion, which should boost Japanese exports to the U.S. Even if Japanese growth turns positive in the spring of 2009, it will take time for real recovery to get under way. We expect the Japanese economy will enter a true expansionary period in the second half of 2010, after the U.S. economy begins its full-scale recovery around the middle of that year.
One silver lining is that the slowing economy has reduced inflationary pressures. Japan’s consumer price index (excluding fresh food) seems to be headed downward after peaking in August 2008 at a 2.4 percent annual rate. We expect year-on-year change in the CPI will turn negative in May or June 2009.
If you’re worried about deflation, the most useful indicator to watch is the output gap. That measure will likely bottom out in 2010 at minus 3 percent, which indicates that potential total supply exceeds actual total demand by 3 percent. That would be better than the deflation-spiral record of minus 5 percent in 2001. During the expansionary period of 2002 to 2007, a seriously ailing Japanese economy finally recovered. And Japanese companies mostly solved the problem of the “three excesses” — excess debt, excess production capacity and excess labor. In this sense, the current Japanese economic condition is much healthier than the one of several years ago.
A remaining concern is the stability of the banking system. Japanese banks have solved their non-performing loan problems almost completely. Yet weakening local economies and a decline in stock prices could potentially cause serious problems among small regional banks. Instability in the banking system could deepen and prolong the economic slump.
At its October meeting, the Bank of Japan (BOJ) decided to cut the target for the uncollateralized overnight call rate, its key policy rate, from 0.5 percent to 0.3 percent. The rate cut is the first by the BOJ since it guided interest rates to zero in 2001.
In our view, the BOJ rate cut can be seen as keeping Japan in line with the coordinated international moves to lower interest rates. We think the U.S. rate cut in particular had a major bearing on the BOJ’s decision. The view that Japanese rates were suddenly too high compared with those in the U.S. risked putting further upward pressure on the yen and undermining share prices. Instead of seeking economic stimulus, the Japanese rate cut was aimed at creating financial stablility.
The BOJ’s monetary easing raises the prospect of a return of the zero interest rate policy if monetary easing continues overseas. Thus, the BOJ could cut interest rates again before the end of the fiscal year in March. We also see a possible resumption of the “quantitative easing” policy of recent years, when the BOJ flooded banks with excess liquidity. It appears that there are considerable doubts within the BOJ about the effects of quantitative easing on the economy and consumer prices, but it seems to be generally regarded as an effective means of stabilizing the banking system.
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