OECD Economic Outlook, Volume 2024 Issue 1

Japan

Real GDP growth is projected to moderate to 0.5% in 2024 before strengthening to 1.1% in 2025, as domestic demand rebounds. Private consumption will be supported by wage growth and fiscal measures. Government subsidies for green and digital investment and high corporate profits will boost business investment, despite potential supply constraints. Headline inflation is projected to moderate as imported energy and food prices stabilise, before rising as wage growth gains momentum.

Rebuilding fiscal buffers and ensuring debt sustainability should be prioritised, given increasing debt service risks associated with a possible rise in long-term interest rates. Announcing concrete revenue and expenditure measures to enable a medium-term fiscal consolidation path would boost the credibility and sustainability of fiscal policy. The recent decision to terminate negative interest rate policy is appropriate given OECD projections of sustained inflation around the 2% target and robust wage growth. The Bank of Japan should continue to gradually raise the short-term policy interest rate. Reforming the traditional labour model of lifetime employment and seniority-based wages would boost employment, especially of older and female workers, and help address demographic headwinds.

Domestic demand is weak, but there are emerging signs of recovery

Following robust growth in the first half of 2023, real GDP contracted by 0.8% in the third quarter and grew by 0.1% in the fourth quarter as high inflation weighed on private consumption. However, high‑frequency indicators of consumption showed signs of improvement in early 2024, reflecting inflation and wage developments and rising expectations. Headline consumer price inflation has moderated with decreasing energy prices and slowing food price inflation but remains above target at 2.7% in March. Corporate near‑term and three-year-ahead inflation expectations have remained above 2% since the first half of 2022. Nominal wages have been trending up and are expected to gain momentum. The tentative outcomes of the Shunto wage negotiations for FY 2024 are stronger than last year, with 5.2% average headline wage growth and 3.6% base pay growth for all firms under the Japanese Trade Union Confederation as of 18 April.

Industrial production and exports experienced a temporary drop in early 2024 due to supply constraints related to fraud in the vehicle industry. However, business investment is picking up, supported by high corporate profits, and business surveys point to robust future investment plans. Exports of goods have been stagnant, partly due to weaker demand from Asia and the euro area. The total number of inbound tourists has surpassed pre-pandemic levels, but the number of Chinese tourists has remained low.

Japan: Inflation and labour market indicators

1. As of 18 April. The horizontal axis shows fiscal years.

Source: Ministry of Internal Affairs and Communications; Japanese Trade Union Confederation.

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Japan: Demand, output and prices

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Japan: Investment and economic growth indicators

1. Seasonally adjusted data for non-financial corporations.

Source: Ministry of Finance; Cabinet Office; OECD Economic Outlook 115 database; and OECD calculations.

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Macroeconomic support is projected to gradually decrease

The fiscal stance is projected to tighten in 2024-25 with the end of pandemic-related measures and energy subsidies. However, measures in the November 2023 economic package, such as cash handouts to low-income households disbursed in December and temporary cuts to income and residential taxes to come into effect in June, will support private consumption. The cost of these measures, at around JPY 5 trillion (0.9% of GDP), is projected to keep the fiscal deficit high, at 3% of GDP in 2024. Subsidies for gas and electricity will be phased-out by the end of May. The government announced new extensions for the subsidy for gasoline prices, which the OECD projections assume will remain in place until the end of 2024, albeit gradually declining over time. The government increased the defence budget (plan) by JPY 1.4 trillion and 1.1 trillion in FY 2023 and FY 2024, respectively, and the OECD projections assume a further increase of JPY 1.0 trillion in FY 2025. The budget for child-related policies will also be raised by around JPY 3.6 trillion by FY 2028. The gross public debt-to-GDP ratio is projected to edge down but to remain high at 238% in 2025.

On 19 March, the Bank of Japan announced the end of yield curve control and an exit from its negative interest rate policy and stated that it will guide the uncollateralised overnight interest rate to be around 0% to 0.1%, by applying a 0.1% interest rate to excess reserve balances. Purchases of exchange traded funds and Japanese real estate investment trusts are also terminated. However, Japanese Government Bond purchases will continue at broadly the same pace to help avoid an abrupt change in bond market conditions and may be increased if long-term interest rates rise rapidly. Close monitoring to confirm that wage growth will be robust enough to sustain inflation at target and support private consumption will be key. OECD projections of sustained inflation around 2%, increasing wage growth and a positive output gap imply further increases in the short-term policy rate are warranted, with the policy rate assumed to rise to 0.75% by the end of 2025. Any policy shifts should be gradual and well-communicated in order to anchor market expectations.

Growth will moderate in 2024, before picking up in 2025

GDP growth is projected to moderate to 0.5% in 2024 before improving to 1.1% in 2025, as domestic demand rebounds. Private consumption will be supported by rising wages and the temporary tax cuts. Government subsidies and high corporate profits will boost business investment, while public investment is projected to remain robust. The contribution of net exports to growth is projected to decline over the next two years. The labour market will remain tight, contributing to higher wage growth in 2024‑25. Headline consumer price inflation is projected to moderate before converging to the 2% target as government subsidies end and wage growth gains momentum.

Weaker-than-expected global growth, including in China, further supply chain disruptions due to geopolitical tensions and renewed price pressures on food and energy would lower growth. Continued low real household income growth could exert a drag on domestic demand. A loss of confidence in Japan’s fiscal sustainability and an increase in the sovereign risk premium could adversely affect the financial sector and the real economy, with large negative global spillovers. On the upside, growth could be stronger in the event of a faster-than-expected rebound in consumption, especially of services, on the back of additional recovery of inbound tourism, wealth effects from the well-performing stock market and stronger‑than‑expected wage growth.

Structural and fiscal reforms are needed for resilient and sustainable growth

Rising age-related spending pressures and additional planned spending on the green and digital transformation, defence and child-related policies would weigh on the fiscal balance and public debt without timely offsetting revenue measures. Record-high gross government debt, at about 240% of GDP in recent years, calls for a detailed credible medium-term fiscal consolidation strategy, with measures on both the revenue and expenditure sides. Increasing health and long-term care spending efficiency, gradually raising the consumption tax rate, complemented with well-targeted cash transfers to low-income households, and improving the fiscal framework by restricting the use of supplementary budgets are key. Limiting demographic headwinds requires multipronged reform. Enforcing the “equal pay for equal work” provision in the Work Style reform and further increasing the mandatory retirement age would help ensure fair treatment regardless of employment status and reduce irregular employment. Reforming the traditional labour model of lifetime employment and seniority-based wages would encourage labour mobility and boost employment of women and older persons. Implementing a comprehensive strategy to integrate migrants, including by preventing discrimination against them and improving their access to education and housing, would also help cope with population decline. Additional productivity-enhancing reforms to improve the innovation framework and greater incentives for productive start-ups would not only help address ageing pressures but also boost potential growth. Diversifying energy sources, increasing the share of renewables and enhancing the electricity grid would improve energy security and facilitate the green transition.