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Dealing with sharply relaxed fiscal and monetary policy in Japan

After several months of signaling that they would be loosening fiscal and monetary policy, Japanese authorities announced at the beginning of 2013 a three-pronged macroeconomic growth strategy, comprising new public works spending of ¥10 trillion, a new monetary policy aimed at reaching a 2 percent inflation target in the medium term, and structural policies aimed at increasing total factor productivity growth. For the moment, the precise nature of the programs is not entirely clear—for example, only about half of the announced new spending appears to be net new spending. Similarly, the impact and details of announced to incite firms to invest, reduce protection in the service and agricultural sectors and stimulate female labor participation is unclear. The monetary easing, which, as announced, would about the same size as the third round of quantitative easing (QE3) in the United States, has only just begun.

Japanese quantitative easing can be expected to affect developing countries in three ways:

  • The yen’s depreciation is likely to dampen developing-country exports (figure 17). However, income elasticities are typically larger than price sensitivities and in this particular instance, developing countries gain from increased import demand from Japan might outweigh the losses associated with the Yen’s (real) depreciation;
  • By adding to the looseness of global monetary conditions, through lower global interest rates and perhaps increased capital inflows, potentially adding to overheating pressures, especially in developing East Asia & Pacific;
  • Through increased demand for final goods and intermediate products used in Japanese exports, mainly benefiting countries involved in the supply chains of Japanese exporters.
  • Longer-term unless the structural component of the reform agenda is successful in boosting productivity and GDP growth, the fiscal and monetary stimulus elements are unlikely to have a lasting positive effect for developing country GDP, while increased liquidity and indebtedness could prove destabilizing.

Figure 17
Japanese depreciation has pushed up developing country real effective exchange rates

Source: World Bank, IFS, JP Morgan

Ultimately the overall impact on individual developing countries will depend in part on the importance of Japan as a trading partner, the size of liquidity leakage from the Japanese economy, the extent that individual developing countries attract additional capital flows, and the extent to which the quantitative easing boosts Japanese final and intermediate demand for the exports of developing countries (box 6 and the Exchange Rate Annex cover different channels and likely impacts in more detail).

Finally, the financial impact of Japanese quant­itative easing could be attenuated by the scaling back or even withdrawal of U.S. quantitative measures (see the following discussion for more on this point).

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