Japan: Expansion at an end
External shocks from the run-up in commodity prices and then international financial turbulence have brought Japan’s expansion to an end. Equity prices have plummeted and the yen has appreciated substantially. With falling exports, activity is projected to remain weak through 2009, pushing up unemployment and reducing headline inflation to near zero. A recovery in domestic demand is projected to lift output growth to around 1% during 2010, still short of the growth of potential.
The cut in the policy interest rate by the Bank of Japan should be accompanied by measures to support activity by providing sufficient liquidity to the market to limit the impact of financial stress and mitigate deflationary pressures. While the fiscal stimulus announced in late October will cushion the downturn in 2009, it will be important to focus again on fiscal consolidation as the economy stabilises, given the very high public debt ratio and the costs of ageing. Structural reforms to boost productivity, particularly in the service sector, remain a priority to improve living standards in the face of a shrinking working-age population.