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Japan Economic Situation

During the past decades, Japan has been a subject of unrealistically pessimistic expectations of numerous economists worldwide. In particular, many experts predicted that Japan would become a victim of unending stagnation and never develop its economy again. Between 2002 and 2003, Junichiro Koizumi, the Prime Minister of Japan, and Heizo Takenaka, his economic policy expert, cleaned up the country’s banking system. As a result of the mentioned cleanup, the Bank of Japan (BOJ) stopped promoting deflation that made the country experience its longest period of postwar expansion. After some time, these expectations flipped. Following Shinzo Abe’s election in December 2012, a number of people in Japanese markets and politics began to set unreasonably high expectations for 2014. However, after three years of Abenomics and the record monetary stimulus from the Bank of Japan, the country’s economy is still experiencing a roller-coaster cycle of expansion and contraction. The aim of this paper is to analyze the economic challenges Japan is facing based on different economic concepts and models.

In early 2013, the elected Prime Minister of Japan Shinzo Abe launched three-pillar approach or the so-called “Three Arrows of Abenomics” to exit deflation and revitalize the economy. The policies of Abenomics included the following: a bold monetary policy, flexible fiscal policy, and a growth strategy. The bold monetary policy was launched in early 2013. This led to the introduction of quantitative and qualitative easing (QQE). Then, the government launched flexible fiscal policy, which consisted of two large fiscal packages. In a year, the growth strategy, also known as Japan revitalization strategy, was introduced and revised (OECD 2015).

Concerning the growth strategy, it is considered the most crucial component of Abenomics. Without this strategy, the fiscal effort and monetary expansion will not succeed in helping Japan achieve fiscal sustainability and faster growth. However, this strategy comprises of ten key reform measures that needed to be more ambitious and rapidly implemented. The most important of the key reform measures are the following: stabilizing the size of labor force by promoting the participation of women and elderly people; expanding the inflows of foreign workers; enhancing the country’s integration into the world economy through trade agreements; and improving the business climate by enhancing corporate governance, mobility, promoting venture capital investment and labor flexibility (OECD 2015).

After three years of implementing the three-pillar approach and record stimulus from the central bank, the economy of Japan is still experiencing a roller-coaster cycle of contraction and expansion. According to the median estimate of the economists who responded to survey by Bloomberg, there has been a pessimistic forecast that Japan’s economy shrank by 0.8 percent on an annual basis in the last quarter of 2015 (Fujioka 2016). Moreover, the GDP report in Fig. 1 below shows that Japan’s economic performance has zigzagged over the past three years of Abenomics.

The country’s economy has actually grown in seven quarters and experienced contraction in five quarters since the BOJ Governor Haruhiko Kuroda and Prime Minister Shinzo Abe ramped up their stimulus programs in order to spur investment and consumer spending, increase wages and end deflation (Fujioka 2016). This shows the uneven progress achieved by Kuroda and Abe in spurring growth.

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Causes of Roller-Coaster Cycle of Expansion and Contraction in Japan

One of the major reasons for the economic expansion and contraction in Japan is the effect of the aging population. Essentially, Japan has the highest life expectancy in the world and a retirement age of 65 years. Thus, the working population in Japan is very small while the elder population is very large – exactly such a situation limits the level of the country’s economic growth. In addition, since the younger people tend to consume more than the elder people do, it affects the growth of the domestic consumer market.

As the demand for commodities reduces, their price also reduces, which affects the monetary value attached to the commodities and vice versa as depicted in Fig. 2 above. Moreover, Japan’s wages are calculated on the basis of seniority, which makes it difficult for the local companies to hire elderly people. As a result, there is an increase in the social welfare cost and the one-third of government spending is allocated to this even if the government deficit is rising every year (Yoshino & Taghizadeh-Hesary 2015a,b). This affects the demand for commodities, thereby resulting in a change in the GDP.

Secondly, the banking system of Japan raises concern about the economic situation in the country. For instance, the Basel capital requirement forced local banks to hold 8% capital, which then made banks start reducing their loans in order to avoid the shortage of capital. This resulted in a credit crunch that made it difficult for a startup business to access loans from banks (Yoshino & Taghizadeh-Hesary 2015a,b). This, in turn, reduced the demand for goods and services, causing the deflation. One can explain the above-described situation with the concept of demand and supply, according to which exactly demand and supply determine the price and value of products. Furthermore, inflation overkill dampens the recovery of private consumption by allowing prices of products to rise too much within a short period. This creates premature havoc of the balance sheets of banks and the BOJ by including runaway reactions to government bond yield (Economics Intelligence Unit 2013). However, simultaneous plunge in bond prices and prolonged rise in the interest rates could undo any progress achieved in Japan’s growth strategy.

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Thirdly, excessive contractionary monetary policy contributed to the current economic bubble in Japan. This monetary policy was over tightened, which drastically reduced the lending capacity of the banks, thereby causing deflation. The government demanded the BOJ to implement an aggressive monetary easing to achieve its target quickly. However, the recent easing of monetary policy caused the inflation due to the depreciation of the Japan currency. Moreover, a simple aggregate demand and supply model clarify the reason why high prices for energy produced inflation in Japan. The demand side of the economy makes the prices of energy resources rise while consumption declines – such a situation causes a change in price. This also reduces the output level due to reduced consumption in the economy. Therefore, deflation occurred as a result of low demand, low growth, and increased real interest rates, which caused the monetary tightening. One should also know that easing of monetary policy reduces the interest rate, which then increases the demand for commodities, including the crude oil. This, therefore, creates inflationary trends in the market (Yoshino & Taghizadeh-Hesary 2015a). As such, Japan’s high demand for oil and liquefied natural gas is able to cause disruption in economic growth, which is the result of the zigzagged GDP status.

Conclusion

The economic challenges modern Japan is passing through are caused by the lack of effective and efficient public investments, which would result in the unprecedented rate of economic growth. In 2013, the elected Prime Minister of Japan Shinzo Abe launched three-pillar approach or the so-called “Three Arrows of Abenomics” to exit deflation and revitalize the economy. The policies of Abenomics include the following: a bold monetary policy, flexible fiscal policy, and a growth strategy.

The bold monetary policy was targeted at setting the price stability at 2 percent as the year-on-year rate of consumer price index changes (Global-macro Research Institute 2016). As for the flexible fiscal policy, the government aimed to implement a short-term flexible and timely fiscal policy while firmly expressing its political will to restore fiscal balance. Finally, the growth strategy was aimed at raising taxes to cover increasing social security spending, encouraging the expansion of domestic consumption, and encouraging the involvement of women and elderly people in the labor force.

The excessive contractionary monetary policy that was implemented contributed to the current economic bubble in Japan. The monetary policy was over tightened, thereby drastically reducing the lending capacity of the banks and causing deflation. Moreover, the government demanded the BOJ to implement an aggressive monetary easing to achieve its target quickly. The easing of the monetary policy caused the recent inflation due to the depreciation of the Japan currency. However, one should also know that easing of monetary policy reduces the interest rate, which then increases the demand for commodities, including the crude oil. This, therefore, creates inflationary trends in the market. As such, Japan’s high demand for oil and liquefied natural gas is able to cause disruption in economic growth, which is the result of the zigzagged GDP status.

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