It is being speculated that the Japanese economy has entered a recessionary phase. Moreover, the impact of the recession on various policy responses such as the consumption tax hike, economic stimulus measures, and additional monetary easing is drawing much attention.
Japanese Economy "Worsening" as per the Composite Index
The Cabinet Office announced in May that it had downgraded its overall assessment of the leading indicators for the Composite Index (CI) for March to "Worsening", indicating a high possibility of an economic downturn. It was the first time in the 6 years and 2 months since January 2013 that the economy was described as "worsening", indicating that the Japanese economy may have entered a recessionary phase around the end of last year.
However, this decision is made mechanically and differs from the official government economic assessment presented in the Monthly Economic Report. When the composite index satisfies the two conditions of "the three-month backward moving average has been declining for more than three months in a row”, and "the difference between the current month and previous month is negative”, the overall assessment is "worsening." The assessment of “worsening” was maintained in the April trend index announced in June.
Even with the results of the March index, the government kept its basic economic assessment unchanged in its monthly economic report for June, maintaining that the economy was recovering at a moderate pace. Moreover, the real GDP for the first quarter of 2019 grew significantly, up 2.2% year-on-year, as per the revised data. As a result, views on the domestic economy have been mixed.
Global Recession is What Matters
The final decision on the economic phase and the determination of the turning point of the business cycle is made by the Director of the Economic and Social Research Institute at the Cabinet Office. It is based on the historical diffusion index developed from each business group adopted for the composite index as well as the discussions of the Study Group of Business Conditions. It can take a considerable amount of time to be decided.
For example, the decision to tentatively set the previous peak of the business cycle (March 2012) was taken more than a year later (August 2013). Moreover, the confirmation for the same was given only in July 2015, more than 3 years later. As described above, it takes a considerable amount of time to make a judgment on the economic situation, and when such a judgment is made, the economic situation has usually already changed significantly.
The important question is not whether or not the economy is retroactively judged to have fallen into a recession at a much later stage, but how much it actually deteriorates. During the previous recession in Japan, which began at the peak of the economy in March 2012, the global economy as a whole did not deteriorate to the extent to be classified as a recession, nor did the sense of economic downturn intensify in Japan. This type of recession is of little economic significance. Since the domestic economy is strongly influenced by the global economy, what is crucial is whether the economy has fallen into a recession on a global scale.
Currently, there is no clear evidence that the global economy is moving towards a recession. In that case, even if Japan is later judged to have entered a recessionary phase, it is likely to end up as a minor short-term one.
The monthly changes in the three-month backward moving averages of the leading indicators for the Composite Index (CI) show that the deterioration peaked in January but has been improving steadily since February. It is likely that the domestic economy will not deteriorate further, but rather the worst phase has passed.
Impact of the Consumption Tax Hike is Not Significant
However, if the US-China trade conflict intensifies further, it could lead to a recession in the global economy over the next year. In addition, financial imbalances that have been accumulated as a result of the prolonged low-interest rate have entered an adjustment phase, which may lead to a sudden recession in the global economy due to the turmoil in financial markets.
In Japan, the consumption tax hike is scheduled to be implemented in October. However, the impact on the domestic economy is not likely to be severe, given the implementation of a 2 trillion-yen economic stimulus package to offset the negative impact on real household income.
However, the domestic economy is strongly influenced by the global economy, and its effects are usually larger. If the global economy enters a recessionary phase, the domestic economy will inevitably deteriorate considerably.
In that case, it is necessary to understand that it would be quite difficult to stop the deterioration of the economy through domestic policy measures such as postponement of the consumption tax hike, introduction of economic stimulus measures, and additional monetary easing.
Nomura Research Institute, Ltd.
Corporate Communications Department