Japan’s GDP shrinks dramatically after a tax rise and a typhoon
Abe Shinzo has repeated his worst economic blunder by increasing the consumption tax for a second timeFeb 17th 2020ECONOMISTS STILL puzzle over Abenomics, the experimental mix of policies introduced by Japan’s prime minister, Abe Shinzo, seven years ago, in an effort to ward off the country’s deflation and stagnation. But two lessons are clear. Japan’s bond market is remarkably docile. And its households are painfully sensitive to increases in the consumption tax, a broad value-added tax imposed on many of their purchases. After the government raised the tax from 8% to 10% on October 1st, the economy shrank at an annual pace of 6.3% in the fourth quarter of 2019, according to figures released on February 17th (see chart).The tax increase was an unforced error. The government faces no immediate need for additional revenue. Despite gross debt nearing 240% of GDP, its borrowing remains absurdly cheap. The yield on a ten-year government bond is stuck at about zero, where the country’s central bank, the Bank of Japan (BoJ), has pegged it since 2016. That peg obliges the BoJ to buy as much government debt as necessary to keep long-term interest rates low. Such an accommodative stance is needed chiefly because private spending has been weak—too weak, at least, to lift inflation, currently at 0.8%, to its target of 2%. Thus the consumption-tax rise was doubly strange. It made it even harder for firms to sell their goods to Japan’s inhibited consumers, so that Japan’s government could sell fewer bonds to an automatic buyer. It was like shifting weight to the waterlogged side of a ship.The error was foreseeable as well as unforced. A rise in the same tax in April 2014 was followed by a similarly dramatic contraction in the economy, undermining the early momentum of Mr Abe’s reflationary push. The government had hoped to avoid a repeat of that experience by adding various offsetting measures, including free education for pre-school children and a “rewards” system for customers who paid cashlessly. These measures may have softened the blow in some ways: consumer spending on non-durable goods fell by less last quarter than it did in the 2014 episode. Unfortunately, these offsetting measures were themselves offset by another aggravating factor: the impact of Typhoon Hagibis, which inundated many towns and killed almost 100 people in October. As a consequence, capital spending by firms shrank even faster than it had after the tax increase six years ago.Japan’s prospects for recovery are threatened further by coronavirus. Covid-19 has already killed one person in the country; 53 have been infected (not counting hundreds diagnosed on a cruise ship docked in Yokohama, south of Tokyo). Japan is tightly integrated into Asian manufacturing supply chains that will be disrupted by factory shutdowns in China. It has also been counting on the Tokyo Olympics, which start in July, to lift spirits and spending. That happy prospect must now be in doubt. The government has already said that only elite athletes will be allowed to take part in the Tokyo marathon on March 1st.Faced with these fiscal, natural and viral setbacks, what will the BoJ do? Since 2016, when it cut the interest rate on some bank reserves to -0.1% and pegged longer-term yields to zero, it has seemed largely out of ideas. Inflation has persistently undershot its target, which would call for easier monetary policy. But its negative interest rates are already unpopular with banks, insurance companies and savers. And they might prove counterproductive if they inflict too much damage on Japan’s financial institutions, which struggle to pass the negative rates on to their own depositors.A possible solution, proposed by Stefan Angrick of Oxford Economics, a British consultancy, would be for the BoJ to pay higher interest rates on some bank reserves, to shore up the banks’ profitability, but even lower rates on the remainder, to help stimulate borrowing. This tiered system helped Switzerland’s central bank cut interest rates to -0.75%.One twist is that all three of Japan’s recent disasters—the tax increase, the typhoon and the virus—tend to put upward pressure on prices, even as they have depressed demand. That nascent inflationary pressure might deter the central bank from easing further, even as the economy remains weak. Japan might then finally escape its long stagnation, but only by entering an unhappier period of stagflation.Reuse this contentThe Trust Project