After nearly two decades of deflation, Japan unexpectedly has fallen into a recession in the third quarter of this year. In a preliminary economic report released by the Cabinet Office on November 17, GDP was reported as falling at an annualized pace of 1.6% in the third quarter of 2014. In combination with the previous quarter’s 7.3% decline, this GDP decline has caused Prime Minister Shinzo Abe to dissolve the parliament and call for snap elections two years before the next scheduled elections.
The sales tax hike in April from 5% to 8% was intended to alleviate the substantial amount of Japanese government debt, now currently valued at two and a half years’ national economic output. Government experts had not expected a negative impact as the sales tax hike followed the injection of stimulus money by the bank of Japan. However, many are attributing the decline in growth to the sales tax hike, as consumer spending inevitably decreased as a result. Companies also reduced their inventories of finished goods at a rate higher than was expected, which hurt current growth in the economy. The tax was originally scheduled to rise again to 10% next October, but Abe made the executive decision to delay the increase an additional 18 months.
When Prime Minister Abe first took office in early 2013, he vowed to relieve the deflation and rid the country of its public debt during his time in office. As a result, the Japanese economy initially grew at a tremendous rate and stock prices rose rapidly. With the recent decline, however, the government plans to centralize economic policy changes upon growth rather than decreasing public debt. In Europe, too early emphasis on reducing debt is believed to be the blame for its economic woes according to critics. Fortunately, when the continent focused less on debt reduction and more so upon monetary easing, economic growth took place.
Former US Treasury Secretary Lawrence Summers believes that Japan should implement fiscal policy by increasing spending and cutting taxes to increase the direct flow of money into the economy. And while the majority of the Japanese government is beginning to agree with Summers’ opinion, those in the finance ministry are more concerned that Japan’s continual high levels of debt will cause investors to lose interest in the country’s business opportunities.
Summers believes that Japan, like many advanced economies, is stuck in a phase called “secular stagnation”, which essentially means that economic growth is either negligible or nonexistent due to factors outside the normal cyclical ups and downs. Since Japan is one of the first countries to be a clear fit for the theory of secular stagnation, it is difficult to determine which approach will be most beneficial. On the other hand, the country’s actions will serve as either a model of what to do or what not to do in the future.