The economy is expected to slowly normalise, as the nationwide state of emergency has been lifted. Japan’s relatively less extensive lockdown restrictions will constrain the damage to the economy. An expected V-shaped recovery of the Chinese economy will spur external demand. These factors will reduce the immediate pressure on the government to aggressively expand policy support. The large reserve fund allocation can provide the government some flexibility to provide additional support if needed.
But it will take some time for the planned fiscal stimulus to materialise. The majority of individuals and firms are reportedly yet to receive the cash distribution announced in the supplementary budget, and small firms have complained about the complicated process of applying for support. The imminent challenge for the government is to accelerate disbursements to mitigate economic damage to those affected.
Disappointingly, the current package does not contain measures to promote the digitalisation of public services, which is far behind that of many other countries. The government is reluctant to link individuals’ numbers on their ‘My Number Card’ to their bank account, even though people now recognise that the lack of integration makes it difficult to quickly receive emergency relief payments.
Japan’s large fiscal stimulus is a heavy burden on its fiscal balance. The fiscal deficit will widen to around 14 per cent of the GDP this year. The revenue shortage will be financed entirely by issuing additional government bonds, all of which will be absorbed by the Bank of Japan (BoJ). The government will likely avoid fiscal consolidation until after a fully-fledged recovery is underway. This will help contain a fiscal drag in 2021, but it will make it difficult for the Ministry of Finance (MoF) to resume the scheduled path of achieving a balanced primary balance by the mid-2020s.
Japan will continue to lack a long-term fiscal consolidation strategy, at least over the next few years. Any attempt to raise tax rates — including the politically-sensitive consumption tax — will be avoided, especially if the economy remains below its pre-COVID-19 level. The government will likely postpone the target year for achieving the primary fiscal balance to 2030 or later. Long-awaited social security reforms will also be delayed.
The government should effectively tackle both short-term and long-term fiscal policy issues. To this end, the government should reconfirm its medium-term strategy of fiscal consolidation, identify the COVID-19-related deviation from the originally planned path of the fiscal balance, and construct a scheme to manage the deviation separately from the long-term strategy. The government should launch the new plan to finance the COVID-19-related fiscal deficit over the next few years, like the special tax measures introduced after the 2011 Tohoku earthquake to finance reconstruction.
On the monetary policy side, the BoJ’s response to the COVID-19 crisis has been limited compared to the Federal Reserve, the European Central Bank and other central banks. The BoJ increased liquidity provision to the market and decided to purchase Japanese government bonds without an upper limit. But the BoJ has not lowered policy rates or provided interest subsidies to banks by paying them to borrow.
A new aspect of the monetary policy response to the COVID-19 crisis is to support credit provision to SMEs, which have been most seriously hit by the sharp plunge in demand. The BoJ introduced a new measure to provide funds for financial institutions to support the financing of SMEs. The government also expanded 100 per cent credit guarantees to fund very small firms.
The aggressive use of government-affiliated banks is another focus of the government measures. This may raise the risk of a changing role of government-affiliated banks; while these banks have conventionally supported lending for industry development, they are now forced to commit to bailing out ailing enterprises.
These policy measures are also susceptible to moral hazard problems. When the 100 per cent guarantee was introduced for private loans to SMEs during the global financial crisis, it prompted banks to lend even to firms that had experienced a long-term deterioration in performance. A similar problem will likely be repeated this time. Prolonged policy support could slow firms’ restructuring while raising banks’ credit costs, possibly leading to the tightening of lending standards.
A remaining issue to be addressed by the BoJ is how to achieve both smooth credit provision to SMEs and a resilient banking system. One possible solution is to introduce a new scheme similar to the United States’ Main Street Lending Program. The BoJ and the government could purchase loans from banks which aggressively provide loans to SMEs facing COVID-19-related funding difficulties.
Even if the BoJ succeeds in achieving the above-mentioned targets, it will take a long time to normalise its policy, as it will for the MoF, which is derailing far from the path of fiscal consolidation. The economy is expected to remain below its pre-COVID-19 level, even if it recovers smoothly after a sharp drop in the April–June period. The widened and prolonged slack in the economy will likely constrain the inflation rate to well below the BoJ-targeted 2 per cent, which now seems unachievable in the foreseeable feature.
Takashi Oshio is Professor at the Institute of Economic Research, Hitotsubashi University.
This article is part of an EAF special feature series on the novel coronavirus crisis and its impact.