TOKYO - The Japanese economy in 2023 had two distinct features. Macroeconomic indicators, such as GDP and employment, were broadly in good shape. But economic trends that are unsustainable kept worsening, raising concerns about Japan’s future economic stability.
Japan’s real GDP growth in 2023 was slightly above 1 per cent — modest, but not bad given potential growth estimated at below 1 per cent. The output gap — the difference between actual and potential output — is closing, the unemployment rate, which ticked up during the COVID-19 crisis, has fallen and the national jobs-to-applications ratio is well over 1.
Consumer price inflation is currently around 3 per cent, exceeding the Bank of Japan’s (BoJ) 2 per cent target. Corporate profits are buoyant, share prices have reached a post-bubble high and inbound tourism has recovered to pre-COVID-19 levels, benefiting industries hit hard by the pandemic.
Despite these positives, most of the Japanese populace is unhappy. The source of their discontent is that, although nominal wages are rising, the pace at which they are rising is slower than that of inflation. This has eroded real wages, undermined consumption and cast doubt over the continuation of modest economic growth.
The wage–price gap has affected macroeconomic policy decisions. Although the BoJ took several steps to marginally relax its yield curve control, it refrained from normalising extremely loose monetary policy. This decision is grounded in the absence of the so called virtuous cycle of wage and price increases. In November 2023, the government introduced a fiscal package aimed at ‘completely overcoming deflation’. The odd reference to ‘deflation’ reflected the notion that unless wages rise to meet or supersede inflation, the economy is seen as not free from deflation.
Whether these policies are appropriate, given the unsustainable trends in the economy, is questionable. The Japanese yen’s exchange rate has weakened substantially since 2021, making an already ‘cheap Japan’ even cheaper and lowering US dollar-valued GDP. Although it is difficult to pin down the equilibrium exchange rate, it is clear that the current exchange rate is way out of line and requires a major correction. The weak yen is the result of large interest rate differentials between Japan and other advanced economies. It is up to the BoJ to reduce the exchange rate misalignment.
The BoJ has good reason to start normalising policy, since consumer price inflation is already above its target. Although wages are still lagging, monetary policy is not a tool for raising ‘real’ wages, which are determined by real factors, such as labour productivity and labour market conditions. It is misdirected to continue super loose monetary policy on account of slow wage growth, as if by doing so the BoJ could somehow bring about higher real wages.
The government’s November 2023 policy package contained measures that could contribute to higher productivity. The third and fourth pillars of the package, aimed at stimulating domestic investment and digitisation, are consistent with sustainable real wage growth. These pillars are also consistent with the New Form of Capitalism initiative that Japanese Prime Minister Fumio Kishida put forth in June 2022.
The package, however, focused more on Kishida’s need to appease the public by offering quick relief from the impact of inflation. The first pillar included a continuation of stop-gap fuel subsidies and an across-the-board income tax cut. The second pillar contained a variety of subsidies to encourage wage increases. These measures did little to improve the economy’s supply-side performance, meaning that any relief that households and workers get from the package will not last long.
No doubt to Kishida’s disappointment, the tax cut drew fire from all quarters as being ad hoc and untargeted. More importantly, much of the package was designed to counter another unsustainable aspect of Japan’s economy — the high and rising public debt and deficits.
Japan’s public debt-to-GDP ratio has been high for decades without inducing any crisis. The BoJ has absorbed a staggering amount of government bonds and bills, leaving little room for private investors to sell them. Although interest rates have risen somewhat, they are still lower than the nominal GDP growth rate, making the debt dynamics benign. In this context, there may be no need to worry about a fiscal crisis.
The likelihood of a fiscal crisis depends on whether inflation remains moderate. Manageable inflation would allow the BoJ to limit the extent of its policy normalisation. Once the BoJ’s support is lost, the government’s funding cost could rise substantially, creating a vicious debt dynamic. Wage increases in coming years, which both the BoJ and the government hope for, could be a counter-blessing in disguise. If they accelerate inflation, the BoJ would be compelled to take strong action, squeezing precarious public finances.
The BoJ has long characterised wage increases that match or surpass price increases as ‘virtuous’. They would indeed be virtuous if improvements came from the economy’s supply-side. Yet if the Japanese public are hoping that they can get something virtuous from the BoJ’s inaction or the government’s subpar action, they are likely to be disappointed.
Masahiko Takeda is Senior Fellow in the Australia–Japan Research Centre at the Crawford School of Public Policy, The Australian National University.
