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Japan economy: A new policy landscape
April 18 2013
FROM THE ECONOMIST INTELLIGENCE UNIT
As the dust settles after the announcement in early April by the Bank of Japan
(BOJ, the central bank) of its ambitious new programme of monetary expansion, it
is worth taking stock of the main features of the policy and its implications. There
is no question that the BOJ has embarked on a radical course that will be keenly
watched by policymakers and financial investors around the world. But while
anticipation of the policy change and its subsequent announcement have already
had a pronounced effect on financial markets, the ability of the new measures to
fulfil their main purpose of generating sustainable mild inflation and reviving
Japan's "animal spirits" remains in doubt.
It is hard to overstate the scope of the BOJ's new stance, which should be understood in the
context of the dramatic change in policy outlook that has occurred since the Liberal
Democratic Party (LDP) returned to power in December 2012. The new prime minister,
Shinzo Abe, is pursuing expansionary policies in an effort to put Japan on a sustainable
economic growth path and overcome deflation. Since the start of 2013 his administration
has introduced an emergency fiscal-stimulus package, has presided over two major
adjustments to monetary policy in quick succession and has championed the appointment of
a less inflation-averse BOJ governor, Haruhiko Kuroda. In particular, the central bank's
most recent policy decision on April 4th constitutes a radical escalation of its commitment to
monetary expansion, with the introduction of an asset-buying programme far greater in
scale than anything that it has attempted in the past.
Policy shake-up
The shake-up of economic policy partly reflects a political calculation based on the size of
the LDP's new majority in the House of Representatives (the lower house of parliament)—
where the party controls 294 seats out of 480, following big gains at the December 2012
general election—and its hopes of regaining control of the House of Councillors (the upper
house) in July this year. Mr Abe, who is in his second stint as prime minister, is well aware
that his previous premiership in 2006-07 was cut short as a result of neglect of the
economy. He does not intend to repeat that mistake, and government policy in the next few
months will in part be geared towards winning the upper house poll.

Mr Abe's economic agenda is having its greatest impact in the area of monetary policy. The
prime minister has put pressure on the central bank to increase monetary stimulus. This
initially resulted in the announcement at the BOJ's January policy meeting of a shift to an
explicit 2% inflation target and the introduction of an open-ended quantitative easing (QE)
programme from 2014. At the time, we considered these policy changes to be potentially
the most important in Japan for many years, but they have been trumped by more recent
events, following Mr Kuroda's appointment as governor of the BOJ on March 20th.
New course
Mr Kuroda, a former president of the Asian Development Bank, has wasted little time in
setting a new course. In early April the BOJ switched from targeting interest rates to
targeting the monetary base, under a programme that it calls "quantitative and qualitative
easing". This recalls the period 2001-06, when the BOJ pioneered QE (then still an obscure
policy internationally) by targeting the levels of current-account balances that commercial
banks held with it. Although the central bank's latest programme is similar in some respects
to the original one, it is much more ambitious. The BOJ aims to double Japan's monetary
base from ¥138trn (US$1.4trn) at end-2012 to ¥270trn by end-2014. It will increase its
holdings of Japan government bonds (JGBs), exchange-traded funds and real-estate
investment funds. The bank will also buy longer-dated JGBs, with the aim of encouraging
risk appetite further along the yield curve.
Monetary expansion has been accompanied by fiscal stimulus. In late February parliament
approved a ¥10.3trn (US$105bn) central-government funding package focused on
infrastructure. Adding in local-government and private-sector projects, the total value of
stimulus is ¥20.2trn, equivalent to 4.2% of annual GDP. The budget for 2013/14 (April-
March), which was approved by the lower house on April 16th, includes a 15.6% increase in
public works spending. The total budget, however, is just 2.5% larger than last year, and
although additional funds have been allocated to sectors that will boost economic activity,
the government has made spending cuts in other areas.
Will it work?
The question is whether Mr Abe's policy changes will work on a chronically sluggish
economy that has resisted previous stimulus efforts. Anticipation of QE, and its subsequent
announcement, has boosted Japan's stockmarket and weakened the yen—notwithstanding
some reversals in the past few days that are likely to have reflected investor concerns about
the global economy (weak Chinese GDP data released on April 15th probably played a role).
The wealth effect of rising Japanese asset prices could boost the real economy at the
margins. At the same time, the BOJ's asset programme will almost certainly contribute to
further yen weakness, benefiting exporters. Our latest monthly forecast for Japan expects
the yen to be weaker than previously envisaged, with the currency averaging ¥98.3:US$1 in
2013 and ¥102:US$1 next year.
However, we remain doubtful about the ability of unorthodox monetary easing to flow
through into wide-ranging and sustained gains in the real economy. Such improvements will
require structural reforms; these are also part of Mr Abe's agenda, but their success is far
from certain in the face of entrenched interests. Lingering overcapacity, high public debt
and negative demographic factors will also continue to weigh on growth.
We have recently revised up our projection of Japanese economic growth in 2013. We now
expect real GDP growth of 1.1% this year, up from 0.9% in our previous forecast. However,

the upgrade is unrelated to the latest policy changes. Instead, it reflects the government's
recent upward revision to national-accounts data (which now show that in the final quarter
of 2012 GDP stagnated rather than contracting), as well as improving business and
consumer confidence.
Weak data
Yet for now, signs of the improved growth momentum that we continue to expect in 2013
remain scarce. The BOJ's latest quarterly Tankan survey of business sentiment was
inconclusive, combining a degree of overall improvement with evidence that companies plan
to reduce investment. Industrial output fell by 5.1% year on year in February, marking nine
consecutive months of decline in this indicator. The disappointing trend in external demand
for Japanese goods has also continued.
Further, we remain sceptical that the BOJ will hit its target of 2% inflation in "about two
years". Although deflationary pressures have been diminishing gradually in the past four
years, and the new measures will build on this progress, there is much further to go before
higher inflationary expectations become entrenched. The picture is complicated by potential
tax developments. Our inflation forecast for 2013-17 is predicated on the assumption that
increases in the consumption tax will take effect in April 2014 and October 2015. However,
the approach of the upper house election, and the unpopularity of the planned tax
increases, could prompt Mr Abe to hold fire. Abandoning the tax rises would lower price
levels, making the BOJ's inflation target harder to attain.
Economist Intelligence Unit
Source: Economist Intelligence Unit