COVID-19 infections continue to rise across Japan every day. We need to assume that this highly contagious novel coronavirus will keep on seriously affecting people’s lives and the economy for a considerable period of time, and the government’s management of the economy to respond to the situation will be a major challenge going forward.
Just like many other countries around the world, Japan has taken unusual and aggressive steps to cope with the pandemic-induced downturn of the economy. As the COVID-19 crisis appears to be growing even more protracted, we are confronted with the serious challenges of how to keep up and develop the extraordinary policies — and how to cope with the side effects of these aggressive measures.
The serious economic turmoil first manifested itself in global trade, long the driving engine of growth. The volume of global trade in April plummeted 16 percent from a year earlier — a decline even steeper than when the Great Depression hit in the late 1920s — as nations severely restricted the mutual movement of people and goods through various measures such as lockdowns.
The United States, which greatly influences global growth, introduced far more extensive economic measures than others, given that its COVID-19 cases have topped 5.38 million, the most in the world, and because it is facing a presidential election in November. Despite the massive measures, however, the U.S. economy in the April-June period plunged an annualized 32.9 percent from the previous quarter. And the huge fiscal spending to counter the pandemic is expected to push the government’s deficit to a record $3.7 trillion.
The aggressive monetary easing by the U.S. Federal Reserve Board has lowered real interest rates, leading the dollar index to fall by 4 percent in July — the sharpest decline in 10 years. These are among the examples of the major changes in macroeconomic balance that are taking place. The challenge is to keep up appropriate macroeconomic management from medium- to long-term perspectives, while at the same time responding to the immediate problems arising from the pandemic.
Japan’s economy has also been severely affected by the crisis, with the April-June gross domestic product contracting by a postwar-worst 27.8 percent in annual terms from the previous quarter. Since the beginning of the year, the government has taken bold and unprecedented steps to cope with the pandemic, including a uniform ¥100,000 payout to each individual and up to ¥2 million in financial support for businesses and self-employed people who have lost significant sales. All of these steps were inevitable over the short term, given the stark reality of the economic losses due to COVID-19. But those measures have given rise to new problems.
One is the deterioration of Japan’s fiscal condition. From the early 2000s to the Lehman shock of 2008, the nation’s annual general account budget hovered around ¥83 trillion. Increased fiscal spending in response to the global financial crisis pushed up the annual budget to the range of ¥100 trillion — a level that was maintained in subsequent years. But fiscal spending surged to ¥160 trillion this year due to the massive measures taken to deal with the pandemic. Tax revenue in fiscal 2020 is estimated at around ¥63 trillion, according to the medium- to longer-term economic and fiscal forecasts released by the government in late July. That means the government will incur nearly ¥100 trillion in fiscal deficit — three times more than in recent years.
Monetary policy has also contributed to the major macroeconomic changes. Money supply in terms of M2 jumped 28 percent in June alone — compared with year-on-year rises of less than 3 percent in the years before the new coronavirus hit. The figure shows that the Bank of Japan took monetary steps to back up the government’s aggressive economic policy action.
In the past, bold expansionary fiscal and monetary policy like this was implemented in times of war. The most symbolic phenomenon to emerge from those measures was devastating inflation. We need to keep in mind that the massive fiscal measures and sharp increase in money supply this year could pave the way for some big changes in the economy. At this point, it’s hard to tell what specifically will happen, but it seems unlikely that inflation as in the past will take place. Popular sentiment has been dampened by the pandemic, and demand for consumption and investments is expected to stagnate. Meanwhile, the increased money supply will likely head toward assets such as securities and real estate. In other words, the chances of an asset inflation are higher than those of an ordinary inflation. In fact, the stock market continues to be strong even as the GDP contracts significantly.
The government will face even more serious challenges in its macroeconomic management as the COVID-19 problems become more protracted. Currently, the unemployment rate remains quite low at 2.8 percent, but statistics show that aside from those who have lost their jobs, there are large numbers of people on furlough leave, remaining on the payroll because their employers receive government subsidies to keep them employed. It is feared that many more companies will go bankrupt and far greater numbers of people will lose their jobs once these subsidies and other financial support for businesses expire beginning this fall.
The problem is that when this happens, it will be difficult to offer the same levels of payouts and support for the affected people and businesses due to the tight fiscal constraints. The policy must shift from relief measures in the form of financial payouts to loans aimed at supporting self-help. Of course the loans must be provided interest-free and to be repaid over a long period (with a substantial period of deferred repayment — so that the recipients can repay the money through self-help efforts). The government should also consider specially treating these loans in the calculation of businesses’ capital-to-asset ratio.
Another important point to consider is to reduce the bloated fiscal spending over a long period of time. If government spending is kept high — as in the post-Lehman shock years — subsequent fiscal consolidation will become extremely tough. The macroeconomic management under the COVID-19 crisis will have to tread a difficult and narrow path.
Heizo Takenaka, a professor emeritus at Keio University, served as economic and fiscal policy minister in the Cabinet of Prime Minister Junichiro Koizumi from 2001 to 2005. He is a member of the government’s Industrial Competitiveness Council.
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