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(Macroeconomics) Japan's worst postwar economic downturn could force new leader to boost stimulus

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Article Link: boost-stimulus-idUKKBN25Z00R


By Leika Kihara, Daniel Leussink

TOKYO (Reuters) - Japan’s economy sank deeper into its worst postwar contraction in the second quarter as the coronavirus jolted businesses more than initially thought, underscoring the daunting task the new prime minister faces in averting a steeper recession.


Other data put that challenge in perspective, with household spending and wages falling in July as the impact of the pandemic kept consumption frail even after lockdown measures were lifted in May.


The world’s third-largest economy shrank an annualised 28.1% in April-June, more than a preliminary reading of a 27.8% contraction, revised gross domestic product (GDP) data showed on Tuesday, suffering its worst postwar contraction.


The data will put the new prime minister, to be elected in a ruling party leadership race on Sept. 14, under pressure to take bolder economic support measures.


Chief Cabinet Secretary Yoshihide Suga, the frontrunner to become next premier, has signalled his readiness to boost spending if he were to lead the country.


“The risk ahead is that the effect of measures taken so far, such as pay-outs to households, will peter out,” said Koichi Fujishiro, an economist at Dai-ichi Life Research Institute.


“If COVID-19 weighs heavily on wages, the new administration could take additional steps to help households.”


The government has so far unveiled a $2 trillion package of stimulus measures, adding to an enhanced easing programme from the Bank of Japan (BOJ).


Japan recently saw a renewed rise in infections but has been spared the kind of big casualties seen in western countries. Total infections stood at 72,321 as of Monday, with 1,380 deaths versus a global tally of over 27 million cases and more than 888,000 deaths.


The main culprit behind Tuesday’s downward GDP revision was a 4.7% drop in capital expenditure, much bigger than a preliminary 1.5% fall, suggesting the pandemic was hitting broader sectors of the economy.


“We can’t expect capital expenditure to strengthen much ahead. Companies won’t boost spending when the outlook is so uncertain,” said Hiroshi Miyazaki, senior economist at Mitsubishi UFJ Morgan Stanley Securities.


Japan’s economy has shown some signs of life after suffering three straight quarters of contraction, with factory output rising in July at the fastest pace on record thanks to rebounding demand for automobiles.


Yet separate data on Tuesday suggested any recovery will likely be modest, as household spending fell a bigger-than-expected 7.6% in July year-on-year, while real wages declined for the fifth straight month, pointing to more pressure on consumer spending.


FILE PHOTO: A woman walks past at a shopping district, amid the coronavirus disease (COVID-19) pandemic in Tokyo, Japan August 17, 2020.


REUTERS/Kim Kyung- Hoon/File Photo

Broad impact

The health crisis has ravaged a broad array of sectors, with firms such as automaker Honda Motor Co 7267.T forecasting a 68% decrease in annual operating profit.


Analysts polled by Reuters in August said they expect the economy to shrink 5.6% in the current fiscal year to next March, and grow just 3.3% the following year.


The fresh batch of data will be among factors the BOJ will scrutinise at its rate review next week, when it is widely expected to keep monetary settings unchanged.


The central bank eased policy twice this year to pump money to cash-strapped small firms, complementing two big government spending packages.


The BOJ is widely expected to hold off on ramping up stimulus for now as steps to spur demand could get people moving more freely into shops and risk spreading the virus.


The global and domestic business climate has many Japan observers predicting a long and bumpy road to returning the economy to pre-COVID levels.


“It will probably take a long time for the economy to normalise and return to levels before the pandemic,” said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute.


Reporting by Leika Kihara and Daniel Leussink; Editing by Gerry Doyle & Shri Navaratnam


The Coronavirus Pandemic caused Japan’s worst economic recession in over 70 years, with a 28.1% fall in the Real Gross Domestic Product (GDP) in the April – June period. To combat this, Japan’s leaders introduced both expansionary fiscal and monetary policies to attempt to boost spending and increase real GDP. These policies face challenges, which limits their effectiveness in promoting economic growth.

Figure 1
Figure 1

From Figure 1, it is assumed that prior to the pandemic, Japan’s economy was operating at real GDP of Y1. The pandemic caused a lockdown which jolted businesses, bringing about a fall in sales revenue. In turn, wages fell leading to a decrease in the disposable income of households and a subsequent fall in consumer expenditure (C). Similarly, the pandemic also caused capital expenditure to fall by 4.7% resulting in investments (I) falling. Since C and I are components of AD, a decrease in both would bring about a fall in AD from AD1 to AD2, leading to a fall in real GDP of 28.1% from Y1 to Y2, while general price level (GPL) remains at P1.


In response, the Japanese administration imposed expansionary demand management policies in order to raise AD and boost economic growth.

Figure 2
Figure 2

One policy introduced is an expansionary fiscal policy which increases government spending (G) in the form of $2 trillion worth of stimulus measures. Part of the measures include pay-outs to households which are transfer payments since there is no exchange of goods and services, this provides households with more disposable income, allowing them to spend more, increasing C. From Figure 2, as C and G are components of AD, the policy aims to increase AD from AD2 to AD1, increasing real GDP from Y2 to Y1, potentially counteracting the initial 28.1% fall in real GDP.

Figure 3
Figure 3

The Bank of Japan (BOJ) also eased its monetary policy twice in order to pump more money into the economy. As seen from Figure 3, this increases the supply of money circulating from SSM1 to SSM2, increasing the quantity of money from Q1 to Q2 and interest to decrease from I1 to I2. The aim was to increase the liquidity of small firms, protecting jobs during the pandemic, ensuring that wages are secure, thereby increasing C, resulting in an increase in real GDP as illustrated in Figure 2. This would compliment the expansionary fiscal policy that was also introduced.


However, these polices are subjected to their limitations, which affects their effectiveness in boosting economic growth. For example, firms have been unwilling to increase their capital expenditure, or investments (I) by a significant amount. This is due to the pessimistic outlook during times of recession, where the expected rate of returns of these investments are lower. Thus, the expansionary fiscal policy may not have increased AD due to firms’ uncertain outlook of the economy.


In addition, household spending fell 7.6% despite the implementation of these policies. This would indicate that the $2 trillion worth of stimulus measures, along with the multiple easings of the BOJ’s monetary policy is still insufficient in boosting AD as C is still falling. This is in spite of the expansionary monetary policy being targeted at the cause of the fall in household spending, which were the fall in wages due to businesses being affected.


Moreover, further easing of the monetary policy would also be unlikely, as the BOJ is concerned about more people moving freely in shops, increasing the risk of virus transmissions which would prolong the recession, since lockdown measures may be implemented again. Therefore, the current policies in place are not only ineffective in dealing with the recession but are also inflexible since the policy cannot be further expanded.


In conclusion, expansionary policies done by the government have been largely ineffective, despite the large sum of $2 trillion stimulus measures being spent by the government, and the central bank’s targeted policy towards maintaining wages. Thus, Japan has to find alternative measures to combat the recession, as their current policy is not only insufficient, but is also unable to be expanded. Nevertheless, part of the stimulus measures in the form of transfer payments are still necessary to minimize the impact of falling wages, which have been declining for five months. Even so, Japan’s current and future policies will be subjected to time lags, and it is inevitable that the pandemic will keep Japan’s economy in a recession for the foreseeable future.