A savings glut is threatening to pull Japan's economy back into a deflationary quagmire. A short-term fiscal boost may be needed to prevent a setback from becoming a slump.
Six months after Japan raised its sales tax by three percentage points, consumer spending is still reeling. The government was recently forced to downgrade its assessment of the economy for the first time in five months. In the second quarter, when household consumption shrank an annualised 19.5 per cent, private financial savings zoomed to 19 trillion yen ($174 billion), almost double the previous 12-month average. Though wages are still rising slowly, Japan is facing a "paradox of thrift" - the Keynesian idea that virtuous individual saving can be collectively harmful.
Of the 19 trillion yen of savings, only a net five trillion went into the financial system. The rest - equivalent to 11 per cent of GDP - went into newly issued government bonds. Most of these bonds ended up with the Bank of Japan, which bought them from the market.
The Bank of Japan, though, is reaching the limits of how much more it can do to prevent a slide into deflation. Expanding its already-large balance sheet may not be very effective. If printing more yen weakened the currency further, some savings would leave the country via a current account surplus. But an already-weak yen and anaemic global growth limit the helpfulness of such a strategy.
One obvious move would be for the government to delay next year's scheduled second increase in the sales tax rate. But doing so would undermine Japan's efforts to get its public finances under control in the longer term.
A better solution would be to give the economy a boost with a short-term fiscal stimulus. For example, the government could distribute vouchers that give families a rebate on purchases made within the next six months. Distributing three to 4 trillion yen in this way would give consumption a short-term boost.
It's worth a try. The government launched a 5.5 trillion yen fiscal stimulus in January to help companies mitigate the consequences of higher sales taxes. But corporations won't invest if consumers don't spend. Finance Minister Taro Aso has hinted at a supplementary budget. It's needed before the slump deepens.
