Novermber 28 2017, 18:00 JST

Japanese economy continues to overheat

Summary

Cabinet Office estimated the output gap of the economy in the 2017 July-September to be 0.5% of Japan's potential GDP. It means that the economy is operating beyond its sustainable capacity, although only by 0.5% for now. The labor shortage problem, a popular theme in Japan nowadays, is one evidence of the ongoing overheating. As Japan continues to grow above its potential growth rate of 1%, it will escalate. As the BoJ governor Kuroda often stresses, the overheating is a necessary step for Japan to produce inflation. In our view, it is imperative for the Japanese policymakers to keep stimulating the growth in the next 2 years to raise the output gap even higher and faster. As the experience of 2008 shows, a negative shock in the economy can quickly cool down the output gap and the hope of reflating the Japanese economy. For Japan to minimize the risk of falling back to a severe deflation, Japan needs to raise its inflation soon so that the country's long-term inflationary expectation could be adjusted up. The chance of reflation is increasingly now or never and such sense of urgency are driving the policymakers in Japan to maintain their aggressive easing measures, despite the criticism for its side-effects.

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