Prime Minister Shinzo Abe announced on Tuesday a delay in a second sales tax hike a day after Japan stunned economists when the country unexpectedly fell into recession. Abe also called for a snap election in a bid to get the public to back his "Abenomics" package of economic reforms. The move comes after the Bank of Japan surprised the global financial markets in October by expanding its massive stimulus program with more quantitative easing in an effort to reenergize struggling economy.
The world's third-largest economy is facing two problems: An imminent sales tax hike in the short-term, and with fewer young people than old, the nation has an aging population that is a drag on economic growth.
Economists theorize that Japan’s inverted age pyramid may explain why its economy has failed to respond to stimulus measures.
“Monetary stimulus is considerably less effective in economies with aging societies and populations,” said Jonathan Buss, economist at Oxford Economics. “This is an important reason why monetary stimulus seems to be so ineffective in Japan.”
There are three key reasons why monetary stimulus tends to be less effective in Asian societies -- consumption patterns, older people becoming creditors rather than debtors, and the elderly holding assets in bonds rather than stocks, Buss said.
Older people’s consumptions patterns are less sensitive to interest rates as they are attempting to run down their savings before they die. If interest rates increase, there is not really an incentive for them to increase their savings because they will not have a chance to ever spend on that return. Similarly, if interest rates decrease, the elderly are not going to substantially increase consumptions. “It’s really young people whose consumption and savings choices are sensitive to fluctuations in interest rates,” Buss said.
Second, older people tend to be creditors rather than debtors in Japan, meaning they are less reliant on credit. The credit channel of monetary policy, or the channel that relies on increasing or decreasing the availability of credit, is considerably less effective in elderly societies, according to Buss.
Third, elderly people tend to hold their assets in bonds rather than stocks. For elderly people there is not an incentive in holding risky assets, such as stocks in the equity market, because there is a very high chance that they will never be able to spend the results from the returns of risky assets. “This bias is particularly strong in Japan,” said Buss. “This means that a lot of the wealth effects from monetary policy simply don’t feed through to consumption.”
For example, Japan has seen strong stock market gains from quantitative easing over the last few years. In any other developed economy, these would have fed through to strong wealth effects on consumption; however, the effects in Japan have been much more muted simply because very few people actually hold stocks.
As China faces similar aging problems, it is not yet an immediate labor force problem in there, according to Barry Bosworth, senior fellow at the Brookings Institution in Washington, D.C. But what is a problem in China is that the country has not enforced a social safety net for older people, such as through medical care and pensions. As a result of that, people save more because they are worried about the future. Japan, on the other hand, has to look for other ways to reenergize the economy besides fiscal or monetary action, Bosworth said, such as broadening out beyond manufacturing to develop their domestic industries.
“For China, it’s a long-term problem, but for Japan it’s an immediate problem,” said Bosworth. “If they [Japan] are going to look for growth in the future it has to be in this non-tradable goods industry.”
Japan’s gross domestic product figures on Monday came in weaker-than-expected for the July-September quarter, and Japan contracted at an annualized 1.6 percent rate, compared with forecasts of a 2.1 percent gain, according to analysts polled by Reuters. The Bank of Japan is scheduled to announce its latest interest rate decision on Wednesday, followed by a press conference from the Bank of Japan discussing the country’s current monetary policy.