Annual Report on

The Japanese Economy and Public Finance


- Japanese Economy Heading for New Growth Era

with Conditions for Growth Restored -

Cabinet Office

Government of Japan

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Chapter 1

Japanese Economy Heading for New Growth Era and its Challenges

Key Points of Chapter 1

Section 1 Background for the Continued Economic Recovery and Future Challenges
- After getting out of a temporary slowdown in mid-2005, the Japanese economy has been continuing its recovery, with consumption, investment and external demand contributing to the recovery in a balanced manner. The long-lasting recovery is backed by the recovery of the world economy and stable exchange rate and other financial conditions in addition to the normalization of the corporate and household sectors.
- Although the sharp rise in crude oil prices is a potential destabilizing factor, its impact has so far been limited, as the world economy has been continuing its recovery and malignant inflation is under control. However, it is necessary to pay attention to world economic trends and a rise in interest rates worldwide.

Section 2 Prospects for Overcoming Deflation and Related Challenges
- Amid the continued economic recovery, there are signs of a change of the trend in long-term price declines. Consumer prices are almost at the previous year's level, excluding specific components, such as rising crude oil prices and other special factors.
- In order to achieve sustained economic growth and price stability, it is necessary for the Government and the Bank of Japan together to continue to promote effective macro-economic policy management. It is to be desired that the Bank of Japan will continue to implement appropriate monetary policy management based on its recently announced "New Framework for the Conduct of Monetary Policy."

Section 3 Financial Market Recovery
- In early 2006, the financial markets began to reflect the recovery of the economy. Stock prices and interest rates are rising and bank lending and land prices are recovering. International correlation in financial markets has increased, with worldwide excessive savings influencing long-term interest rates in various countries.
- Since the household, corporate and public finance sectors of the Japanese economy has long adapted to economic activities under the zero interest rate policy, it is necessary to pay attention to future changes in economic environments, such as a rise in interest rates.

Section 4 Trends in Fiscal Policy
- The deficit in the primary balance of the central and local governments is expected to decline to about 2.8% relative to GDP in FY2006 from 5.7% in FY2002, thanks to cuts in public investment and an increase in revenue brought about by economic recovery. However, social security expenses are expected to increase due to the aging of the population. Therefore, in order for the government to achieve a surplus in the primary balance, it is necessary to make considerable policy efforts in both expenditure and revenue and enhance the potential growth rate.

Section 5 Summary

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