Japan's economy is weakening, but the country will find it more problematic than other Group of Seven leading industrialized nations to deploy the orthodox policy tools they are using, or contemplating using. With interest rates already extremely low a rate cut would not seem a very effective stimulus and Japan is still experiencing a hang-over from its past fiscal excesses.
This is the rainy day that reserves are theoretically meant for. Policymakers should consider taking a quarter of Japan's reserves and giving it back to its citizens. Each person, if the money were distributed equally, would receive about $1,900 (€1,300) or 5.25 per cent of Japan's per capita gross domestic product. At the end of January, Japan held nearly $968.4bn in currency reserves. This is far in excess of any reasonable need. As the sovereign wealth funds illustrate, countries that have accumulated vast reserves are using them differently from the way major industrialized countries traditionally did.
Drawing down a quarter of Japan's reserves -roughly $242bn -would still leave it with plenty. If Middle East and Asian central banks, through their SWFs, can buy distressed global banks or stakes in private equity firms, surely Japan can use a fraction of its reserves to stimulate its own economy, especially when other policy tools seem ineffective. Doing so would bolster support for Yasuo Fukuda, the prime minister, who has yet to receive a popular mandate and steal the thunder from critics of Japan's vast reserves.
Japan needs to focus on boosting consumption not investment. The source of many of its economic woes, such as reliance on exports and relatively low return on capital, appears to be excess investment and insufficient consumption.
Yet, if the refund is used to bolster savings, the economic impact could disappoint. Fortunately, it appears that the famed Japanese savings rate is largely an echo of the past. According to figures from the Organization of Economic Co-operation and Development Japan's savings rate (as a percentage of disposable household income) has fallen 8 percentage points since 1998 -a deeper decline than even the profligate US. In 2006, Japan's savings rate fell below 3 per cent.
The 2006 Family Income and Expenditure Survey estimated that, on average, the Japanese consumed 72.5 per cent of their disposable income. This propensity to consume has slipped in recent years, but it would suggest that, of the $1,900 rebate from reserves, Mr and Mrs Watanabe may spend as much as $1,300. Even this may exaggerate the level of consumption that could come from this innovative use of reserves. The rate of return on domestic saving and investment has been all but destroyed in Japan and this has encouraged a drop in spending at home. Japanese households and institutions have shifted a sizeable part of their wealth overseas. The sharp decline in global equity markets at the start of the year, coupled with the sharp appreciation of the yen in recent months (14.4 per cent against the dollar and 10 per cent against the euro in the past six months), may encourage Japanese households to use some of their windfall to go bargain-hunting abroad.
Yet even with liberal allowances for domestic savings and purchases of foreign assets, the stimulus would be greater, relative to the size of Japan's economy, than the $140bn-$150bn package discussed in the US. Indeed, if even a miserly half of the $1,850 rebate ends up as effective demand for Japanese goods and services, it will be worth more than 2.5 per cent of GDP.
Using reserves to stimulate domestic demand also meets the criteria economists identify for successful fiscal stimulus. It is a one-off payment, which by definition is temporary. It is targeted towards household consumption and not investment. It is timely, insofar as it can be enacted by the start of the next fiscal year, which starts on April 1.
Japan needs to respond to the powerful domestic and international economic headwinds. Necessity dictates that policymakers use the most effective tools at their disposal. Past sins make traditional monetary and fiscal policy measures less useful than appears to be the case for other major industrialized economies.
Using a fraction of Japan's vast reserve holdings could go a long way towards providing much-needed support for the world's second largest economy. To the extent that this stimulus would also defeat.