Challenges to Revitalizing the Japanese Economy

In this forecast, we examine the future Japanese economy to FY2015. Major assumptions made in the forecast are: The world economy will grow by about 4%, oil prices would drop to $28/barrel, and the yen would gradually appreciate by about 10%. In other words, the terms of trade that have deteriorated significantly this fiscal year will gradually look better. We also assume that to recover sustainability of government finances, the consumption tax rate will be raised by 3 percentage points in FY2008, and 2 in FY2013. Under these assumptions, the Japanese economy should be able to attain growth of about 2%. In the first term of the forecast period (FY2004-2006), the slowdown in the economy will not be enough of a " recession " to mark lower growth than the potential growth rate, and the economy will recover in FY2006. This is because the overseas economies will support the economy, lower oil prices will help improve the terms of trade and corporate profits will improve quite briskly. Prices will stop falling and become flat. A resulting decline in real interest rates should help sustain the economy. In the middle term of the forecast period (FY2007-2010), consumer prices will begin to actually rise (in FY2007) under an economic expansion led by domestic demand. The Bank of Japan will terminate its policy of quantitative easing in FY2007, but will maintain a relatively easy monetary stance in terms of real interest rates until FY2008. The end of deflation will improve business sentiments, thereby stimulating corporate sector activities. This pickup will be amplified by the demand creation effects of regulatory reform centered in the non-manufacturing industries. Employee compensation growth will be restrained due to continued corporate efforts to improve profitability, but consumption will grow by an average 2% due in part to the increase in property income. In the last term of the forecast period (FY2011-2015), growth of just under 2% may be attained. This is an expansion centered on domestic demand and led by consumption and business fixed investment of the non-manufacturing industries. The macroeconomic policies in the first and middle terms of the forecast period must be very carefully managed in order to eliminate deflation. The petering-out of deflation will lead to lower real interest rates. The economy is estimated to be stimulated by a gradual increase in nominal interest rates. As for fiscal policies, we assume a special tax reduction will …