The Japanese Recovery After Deflation

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Japan’s economy has rebounded on the back of Abenomics, the policy of quantitative and qualitative easing that has devalued the yen and given Japanese export-based businesses a much needed competitive edge. Even though Japanese Prime Minister Shinzo Abe’s coalition won an important electoral victory that cemented his economic approach, devaluation has recently subsided, causing some to worry that the recovery could be in trouble. According to Societe Generale analysts Takuji Aida and Kiyoko Katahira, Japan needs a few more years of devaluation to rebuild aggregate wages before the recovery is secure.

Export-led recovery in productivity

Aida and Katahira figure that Japan needs to pass through five distinct financial stages before it will have finally leave years of deleveraging and stagnation behind it, and that they are currently well into the third such phase. The first was the export-led recovery in productivity. Exports went up, but corporate saving rates (deleveraging) also went up, causing the yen to strengthen and the Japanese stock market to underperform global markets. Next, as the corporate savings rate peaks and then flattens employment finally starts to improve and local demand improves. Lending to smaller businesses grows during this phase, but the yen remains strong and the market continues to underperform.

japan savings rate v demand

During the third phase, “economic recovery and depreciation of the yen encourages corporates to use more savings for corporate activities such as investment and employment,” write Aida and Katahira. “Phase 3 started when Mr Abe became Prime Minister and accelerated when the BoJ started its new Quantitative and Qualitative Easing policy in April. Supported by further yen depreciation, the Japanese stock market also surged. In this phase, the stock market will easily outperform the global stock market.”

The next step is for aggregate wages and domestic demand to increase to the point that they can support rising prices for consumer goods, stocks, and real estate. If the global recovery continues, and rising local demand increases inflation to healthy levels, then the corporate savings rate should finally start to go negative and Japan will have the chance to eliminate the deflationary pressures that have haunted it for so long.


Unfortunately there are two main obstacle that could prevent this from happening. Currency devaluation has already stalled out. If the US Federal Reserve begins tapering QE in the next few months that should devalue the Yen, helping the recovery, but if the Fed decides that QE needs to remain in place much longer than that Japan will have to find another tactic. Also, Prime Minister Abe will soon have to decide whether or not to implement a consumption tax that could reduce domestic demand at just the point in the recovery that it needs to be strengthened.

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