Chapter 1 Japanese Economy Aims for Long-term Growth

Key Points of Chapter 1

The economic recovery has entered its fourth year as the disposal of negative legacies after the burst of the bubble has been completed. In the second half of 2004, the economy faced its temporary pause, mainly due to adjustments in the IT-related areas. The adjustment of IT-related producer goods have marked steady advancement and is projected to be completed in a much shorter period compared to the time of the burst of the IT bubble earlier.
The main reasons for the continued economic recovery at a level beyond the average of the post-war period are: (1) the "three excesses" - employment, capital stock, debt - have been largely eliminated and the business sector has been strengthened; (2) the labor share returning to a long-term equilibrium level; and (3) the household employment and income environment have improved due to the upcoming mass retirement of the first baby boomer generation (hereafter "Dankai generation").

The price of crude oil has been increasing since 2002, yet Japan has not been hit by the negative pressure of this trend at a considerable level, as its dependency on oil has lowered. However, it is necessary to be aware of risks such as pressure on corporate profits, uncertainty about the future leading to greater caution on the part of companies and households, and a slowdown in the world economy, etc.
Exports have been stagnant since the second half of 2004. Exports of electric machinery and general machinery to China, which continues on its growth track, are slowing down. Attention must be given to the overseas economic trend, as exports affect production in Japan.

Through an intensive adjustment period, moderate economic recovery has been maintained. Furthermore, the expected results have been mostly achieved, including the issues of normalization of the non-performing loans at major banks and stabilization of the financial system. On the other hand, moderate deflation persists and overcoming such phenomena continues to be a critical issue.
Resource allocation of people, goods and capital has become fluid and flexible, indicative of the movements to enhance the supply side. As a result, the unemployment rate decreased and productivity recovered.

Deficit in the primary balance of the national and regional governments is projected to improve by 1.5 percentage point over a three-year period until FY2005 (deficit of 5.5% in FY2002), mainly due to reduction in public investment. Increase in government revenue reflective of the economic recovery has also contributed to the improvement in the primary balance. Meanwhile, social security expense continues to be the factor for increase in primary balance deficit.
As for the quantitative easing policy that has been put into effect since 2001, the policy duration effect of restraining the increase in medium- and long-term interest rate has been achieved. Effective monetary policy to avoid deflation is important, while taking into account the trend and expectation of the market so that the increase in the future prospects of the prices will contribute to overcoming deflation.

The private demand-led recovery is expected to continue through progress in the adjustment of IT-related producer goods, a moderate increase in consumption resulting from an improvement of employment and incomes and others. It is necessary to be aware of the long-term increases in crude oil prices, the possibility of an autonomous cycle of adjustments in inventories and capital stock resulting from maturing of the economy, etc.