Surprise Japanese Recession Stuns Monetarists

Despite extreme money printing and aggressive growth targets, the Bank of Japan has failed to bring Japan into growth as the world’s third-largest economy falls into recession.

Data released on Monday showed that the nation’s GDP fell 0.4% in the third quarter of 2014, causing an annualized economic contraction of 1.6%. A combination of higher taxes and demographic pressures are being blamed for the slump.

Despite extreme money printing and aggressive growth targets, the Bank of Japan has failed to bring Japan into growth as the world’s third-largest economy falls into recession.

Data released on Monday showed that the nation’s GDP fell 0.4% in the third quarter of 2014, causing an annualized economic contraction of 1.6%. A combination of higher taxes and demographic pressures are being blamed for the slump.

The country saw its sales tax rise from 5% to 8% in April, which cut consumer spending as a combination of inflation, a weaker yen, stagnant wages, and higher unemployment curtailed aggregate demand in the country.

Japan saw 6.7% growth in the first quarter of this year, followed by a 7.3% decline in the second quarter. The Japanese economy also shrank in the fourth quarter of 2013 by 1.6%, after two quarters of growth following the start of its accommodative monetary policy.

In October, the Bank of Japan surprised markets by raising its quantitative easing program by over 10 trillion yen, but that was not enough to rescue the country’s sluggish growth.

Weak Trade, Living Standards

Net exports added just 0.1% of GDP growth in the third quarter, far below expectations as the yen has weakened relative to the dollar in recent weeks. Meanwhile, stagnant wages and the higher tax rates are causing higher living costs that are keeping Japanese consumers from spending more to generate domestic demand that could offset moribund exports.

Consumer price growth rose 1% in the third quarter, which is a reversal from Japan’s 15-year deflationary rut. However, higher prices and a 3-percentage point rise in sales tax has combined to worsen Japanese living standards, as wages do not grow to accommodate the rising costs.

Thanks to over a decade of deflation, Japanese consumers are unfamiliar with rising prices and some analysts believe that the shift is actually constraining spending. Instead of a liquidity trap, these analysts believe that rising prices are encouraging greater frugality and less spending from consumers.

A Doubling Stock Market

Analysts and investors grew enthusiastic about Japanese stocks last month, helping the Nikkei 225 to post a 100% gain over two years, with most of that growth coming in 2013.  That was after the country began its QE policy, considered the most aggressive of all monetary expansions by central banks around the world.

Japanese stocks returned some of its recent gains as the Nikkei 225 fell nearly 3% in Monday trading.  However, the index is still up over 8% in the past month.

Investors worry that the recession is going to hinder fundamental growth regardless of monetary expansion, but some analysts believe that companies could benefit from a tax delay that could increase consumer discretionary spending next year.

Earlier, Prime Minister Shinzo Abe had planned to increase the sales tax again to 10% in 2015, but the sudden economic contraction is likely going to force a delay.  Sources close to the prime minister said Abe could postpone the increase until 2017.  Japan will see a general election in 2016.

Speaking to reporters, Economy Minister Akira Amari said a decision from the Prime Minister is likely to come in the next two days.