Biting the bullet
Japan’s GDP sacrifice is a fair price for much-needed fiscal correction.
The country’s output plunged an annualized 6.8 percent in the second quarter from the previous three months, according to the Cabinet Office’s preliminary reading. The decline, which stock market investors had expected and therefore largely ignored, was a direct consequence of the April 1 hike in Japan’s sales tax, the first since 1997. Raising the levy by 3 percentage points prompted households to curb spending by a massive 19 percent.
But for Prime Minister Shinzo Abe, taking a temporary hit on private demand is an acceptable cost of mending the nation’s public finances. The government’s debt load, which the International Monetary Fund says will rise to 245 percent of GDP by 2019, makes it crucial for Abe to press on with fiscal correction.
Abe has the scope to go beyond a scheduled second increase in the sales tax next year. That’s because austerity in Japan is unlikely to be the kind of self-defeating exercise that it has proved to be in Europe. For one, even though real output took a big hit, prices of everything rose a little bit because of the additional levy; nominal GDP barely fell in the second quarter. In other words, fiscal retrenchment is unlikely to worsen the government’s debt-to-GDP ratio.
Besides, the chilling effects of the tax increase may already be thawing. A purchasing managers’ survey showed that manufacturing activity expanded for a second straight month in July. With wages, consumer spending, housing starts and bank lending also improving, the Breakingviews Abenomics Index in June rose to its highest level in 13 years.
Abe has bitten the fiscal bullet – and early indications are that the Japanese economy has survived the shock. But if further tax increases threaten to choke activity and turn deflationary, the Bank of Japan can rush to the rescue with more monetary medicine. For now, though, the central bank can afford to wait, and let Abe deliver on his promised reforms. If those take hold, the economy can take even harsher austerity in its stride.