The failure of Japanese exports to grow on the back of substantial yen depreciation has been a surprise to many observers. Explanations that have been put forward include substantial outsourcing of Japanese production and the desire of exporting firms to raise profits on export sales by maintaining (i.e. not cutting) prices in destination markets.
As Japan takes policy steps to bring about a durable recovery and escape deflation, it is imperative both for the success of those measures and for the global economy that Japan’s economic policies work primarily through an increase in domestic demand. Sustaining domestic demand growth will depend on sustained rises in business and residential investment and household consumption that would be supported by wage increases that exceed inflation. In this respect, it is important that Japan carefully calibrate the pace of overall fiscal consolidation. Monetary policy cannot offset excessive fiscal consolidation nor can it substitute for structural reforms needed to raise trend growth and domestic demand.*2
…, the Japanese authorities should carefully calibrate the pace of the overall fiscal adjustment, inclusive of expiring fiscal stimulus and reconstruction spending, so that it does not result in too rapid a consolidation that prevents escape from deflation, stalls Japan’s growth, and undermines the success of its reform program.