Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey : Japan: Concrete Fiscal, Growth Measures Can Help Exit Deflation

August 5, 2013

  • Japan must launch all “three arrows” of Abenomics
  • New policies have started to bear fruit, but risks remain
  • Concrete fiscal consolidation and growth measures required

The “three arrows” of Abenomics—the slew of measures named after Japanese Prime Minister Shinzo Abe—provide a unique opportunity to exit deflation and revive growth, says the IMF in its regular assessment of the country’s economy.

Bank of Japan employees stack newly printed money. The central bank has taken the lead in ending deflation through monetary easing (photo: TWPhoto/Corbis)

Bank of Japan employees stack newly printed money. The central bank has taken the lead in ending deflation through monetary easing (photo: TWPhoto/Corbis)


Abenomics was introduced after the election of Abe to the premiership in December 2012. It is aimed at reviving the sluggish economy, ending long-standing deflation and reducing public debt through more aggressive monetary easing from the Bank of Japan, more flexible fiscal policies, and structural reforms to boost Japan's competitiveness.

The central bank has taken the lead in ending deflation with its new Quantitative and Qualitative Monetary Easing framework, and there are encouraging signs that the short-term outlook is improving, say IMF economists in their Article IV report on the state of the Japanese economy. The report stressed the need to launch the second and third arrows of Abenomics—by developing credible medium-term fiscal and growth plans—to secure a sustained recovery and to bring down public debt.

New policies start to bear fruit

The first arrow has already been launched. The unprecedented monetary easing by the Bank of Japan contributed to a pickup in demand, and growth accelerated sharply in early 2013. Wealth effects from rising equity values stimulated consumption, while strong regional demand and a weaker yen resulted in an export rebound.

While private investment has yet to pick up, industrial production and retail sales are improving. Inflation expectations have also increased and headline inflation is slowly rising.

Against this background, IMF economists expect growth to reach 2 percent in 2013 and inflation to gradually increase to 0.7 percent by the end of the year, suggesting that it might be finally possible for Japan to end decades-long deflation.

Domestic, external risks

Despite the improved short-term outlook, significant risks remain both from international and domestic factors.

On the external side, a slowdown in emerging markets, especially in China, or a protracted period of slower growth in Europe could result in lower demand for Japanese exports, lowering growth below the IMF’s projection.

The most significant domestic risk is the lack of credible fiscal consolidation and structural reform plans. “Without concrete measures”, the report says, “the new macroeconomic framework lacks credibility and may fail to raise growth and inflation expectations.” As a consequence, monetary policy might become overburdened and the rest of the world could be negatively affected through a weaker yen.

In a worst case scenario, given Japan’s high public debt, the lack of a convincing debt reduction strategy could result in a shift in market perceptions and a self-fulfilling sell-off of government bonds.

Fiscal, growth measures

The adoption of concrete fiscal and structural reform measures would strongly mitigate these risks, and would greatly improve the chances for Japan to finally end deflation and revive growth.

On the fiscal side, IMF economists estimate that to bring the public debt-to-GDP ratio on a downward path a fiscal consolidation of 11 percent over the next decade is required. Implementing the planned increase of the consumption tax rate from 5 to 10 percent by 2015 is a necessary first step in this direction, but substantial additional consolidation measures to take effect after 2015 will also be necessary.

“Such a medium-term plan should be as growth friendly as possible”, says the report. Measures suggested by the IMF economists include a further increase of the consumption tax rate to at least 15 percent, broadening the personal income tax base to raise revenue and improve incentives to work, and containing pension and health spending.

Several ambitious goals

While the government’s new growth strategy includes several ambitious goals, specific measures remain to be formulated. Negotiations over Japan’s participation in the Trans-Pacific Partnership— a regional transpacific trade agreement which includes Australia, Brunei, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States, and Vietnam—is a welcome step.

IMF economists recommend that structural reforms should also include measures to raise female labor participation. They welcome the government’s plans to eliminate waiting lists on kindergartens and day-care centers, which would support women’s employment. Raising the employment of women “would give an important signal about the government’s commitment to reforms,” they say.

Other reform measures which the IMF recommends include reducing Japan’s excessive labor market duality, deregulation in the agriculture and service sectors, financial sector reforms to achieve a more efficient allocation of credit, and relaxation of immigration requirements to address labor shortages.

Reviving growth and ending deflation would be beneficial not only for Japan but also for the rest of the world. But “all three arrows should be launched for the policies to succeed and benefit the global economy,” says the report.