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					Japanese Economy 2004
-Prospect for Continuous Recovery and Risks-


                  (Summary)




                 December 2004
     Directorate General for Economic Research
                   Cabinet office
                                          Contents




Chapter 1 Recent Economic Trend··························································1



     Section 1 Recovery Continuing ······························································ 1


     Section 2 Rise in Crude Oil Price and its Economic Impact ······················· 10




Chapter 2 Prospect for Continuous Recovery ········································· 16



     Section 1 Features of Business Cycles and Their Changes ························ 16


     Section 2 Consumer Confidence and its Impact on Private Consumption ···· 21
                            Chapter I Recent Economic Trend


Section 1 Recovery Continuing


(Development of the Japanese Economy in 2004)
•   The economy continues to recover with an improvement in the business sector
    leading to better employment condition, which, in turn, supports the sentiment of
    the household sector. Output gap has been shrinking with the recovery lasting for
    nearly three years.
•   GDP growth decelerated in latter half of 2004, reflecting the slower growth of the
    world economy and a stock adjustment in the information and communication
    technology (ICT) related goods. Nonetheless, the recovery continues, while some
    risks remain as follows.


i) Prospect of the world economy
Although the world economy is expected to recover continuously in 2005, attention needs
to be paid to concerns over the sustainability of financing the current account deficit in
the US, which could generate pressure to weaken the US dollar, and possible
consequences of the monetary tightening in China.


ii) Stock adjustment in the ICT related goods
The ICT related companies remain to be cautious as they have started reducing their
production immediately, responding to the increase in inventories. The duration of the
stock adjustment process depends on how quickly demand could recover both in domestic
and overseas markets.


iii) Impact of the hike in oil prices
The impact of the hike in oil prices on corporate profit has been offset by an increase in
sales and a high productivity growth.




                                            1
Figure1-1-2 Trend of Output Gaps shince 1990's
                      Though Output gaps had continued to deminish,it recently spread a little,

       (%)
        4.0

       3.0

       2.0

       1.0

       0.0

      -1.0

      -2.0

      -3.0

      -4.0

      -5.0
               ⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡⅣⅡ
              Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ Ⅰ Ⅲ (quarter)
              1990   91   92     93    94     95    96     97    98    99    2000   01     02     03   04   (year)

                Note:Output Gaps=(actual“GDP”-potential“GDP”)/Potential“GDP”




(Stock Adjustment in the ICT Related Goods)
•       Adjustment in production and inventories has continued in the ICT related goods,
        triggered by a decline in exports of digital home appliances and semi-conductors.
•       The following observations suggest that there are some differences between the
        current adjustment phase and the burst of the ICT bubble in 2001. The duration of
        the stock adjustment process depends on how quickly demand could recover both in
        domestic and overseas markets.


i)            Manufacturers have begun to cut their production aggressively even at an early
              stage of the adjustment despite the fact that the level of inventories has been
              much lower than that in 2001.
ii)           A recent drop in prices for electronic parts and devices, which is gradually leading
              to lower prices for end products such as digital home appliances, could stimulate
              demand.
iii)          During the current recovery phase, the industrial production has been driven not
              only by the ICT-related goods but also by non-ICT goods. The expected recovery of
              the world economy could lead to a recovery in non-ICT goods as their inventories
              remain at a low level.



                                                            2
Figure1-1-9 Trend of the ICT-related goods

(1)Early stock adjustment in the ICT-related goods compared with the time of the ICT bubble
        (2000=100
          150
                                      delay in stock
                                       adjustment
          140
                                                                                early stock
                                                                                adjustment
          130
                          Inventory                        Production
          120


          110

          100


           90

           80


           70
                 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 (Month)
                                                                                            (year)
                   1999        2000         01         02            03           04


(2)The fall of prices continues in integrated                  (3)Compared with the ICT bubble,
  circuits and liquid crystal device                              contribution of non-ICT goods
                                                                   is large
  (2000=100)
  110                                                              (%)
                                                              12
                                                                          contribution of non-ICT goods
  100                                                                                     contribution of the
                                                              10                          ICT-related goods
   90                     Integrated Circuits
                                                               8
   80

   70                                                          6

   60
                                                               4
   50             Liquid Crystal Device
                                                               2
   40
        1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10 1 4 7 10
                                                               0
          2000       2001      2002       2003     2004                     IT bubble             This time

  (Sources) METI:Indices of Industrial Production seasonally adjusted, BOJ:Corporate Goods Price Index
    (Notes) Figure (3)
            IT bubble : %chage from the 4th quarter in 1998 to the 4th quarter in 2000
            This time : %chage from the 2nd quarter in 2003 to the 2nd quarter in 2004
            Information-related goods here is adding semiconductor products machinery,
             household electronic machinery,etc. to Information-related goods in Indices
            of Industrial Production




                                                       3
(Corporate Profit and Fixed Capital Investment)
  • Corporate profit is increasing rapidly. The negative impact of the deterioration in
   terms of trade due to higher material costs and a hike in oil prices on corporate profit
   has been offset by a higher growth of sales.
  • Sales breakeven point has declined to the level, which is as low as in early 1990s. It
   reflects the reduced personnel costs and interest payments on debts as well as the
   effect of economy of scale with sales starting to grow fast.
  • Fixed capital investment is expected to increase in FY2004, though it decelerated
   slightly in the middle of 2004. However, some leading indicators such as machinery
   orders suggest that investment by electronics industry could slow.


Figure 1-1-12 Break-even ratio

                      Break-even point ratio has fallen to the level of the first half of 90s
   (%)

  93

  91                                       Non-manufacturing

  89

  87

  85

  83

  81
                                                                          Manufacturing
                                                                                                       All industries
  79

  77

  75
       80   81   82    83   84   85   86   87   88   89   90   91   92   93   94   95   96   97   98    99 2000 01      02   03   04




                                                                    4
     Figure 1-1-13 Business Investment Trends
      
      Business investment is expected to remain on an increasing trend in the second half FY2004.
                          (Year-on-year changes,%)
             60%
             50%                                                                                       1H FY2004
                                                                                                       (result)
             40%
                                                                                                                 2H FY2004
             30%                                                                                                 (Forecast)
             20%
             10%
               0%
             -10%

                               ies          ica
                                                ls              ry             ry              ry           lin
                                                                                                               g
                                                                                                                       tio
                                                                                                                           n          ing
                        st r                                ine           ine              ine          tai         ica             as
                      du               hem             ach           ach              ach            Re           un           Le
                  l in               C
                                                  al
                                                     m             nm              lm              d             m
             Al                               tri              tio             ica              an            om
                                                                          ct r               le            nc
                                         d us            o rta           e                sa           tio
                                      In              sp              El              ole           ma
                                                Tr
                                                   an                             Wh            for
                                                                                             In
     (Source) Short-term business sentiment survey (tankan) ,Bank of Japan




(Employment and Consumption)
•   Unemployment rate has declined reflecting the increase in the number of employees
    and the decline in unemployed persons with labour force remaining constant. Wages
    have not risen yet though the rising trend of part-time workers, which has been a
    major contributor to lowering wages, has almost stopped.
•   Consumption has been increasing modestly, led by higher sales of durable goods,
    which are sensitive to the improvement in consumer sentiment. The growth of
    consumption decelerated slightly in the later half of 2004.




                                                                             5
        Figure1-1-20 Composition of Living Expenditure
                   Expenditure for services and durables increased in the first half of 2004
        (year-on-year changes,%)
        4
                                   Sum of Goods                   Services
        3                                                  (Communication,Travel,
                                   and Services
        2                                                     Tutorial fees,etc.)

        1
        0
       -1
                                                                                  Durables
       -2
                                                                                (Automobiles,
       -3           Non-durables                        Semi-durables            TV sets,etc.)
                     (Food,etc.)                     (Clothes,Books,etc.)
       -4
             Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ (Qtr)
                                                                                                (CY)
                 2000               2001              2002               2003         2004
        Source:Family Income and Expenditure Survey(two-or-more person households(except for
               households in agriculture,forestry and fisheries sectors))and Consumer Price Index,
               Ministry of Internal Affairs and Communications.



(Monetary Policy and Financial Sector)
•   With the targeted amount of the banks’ current accounts at the Bank of Japan left
    unchanged, the growth of monetary base has decelerated. M2+CD is increasing
    slightly faster as precautionary cash holding in proportion to deposits has declined.
•   Forward rates jumped up in June 2004 as an increasing number of people started to
    expect an exit from deflation in the near future. However, they fell in the later half of
    2004. The BOJ released “Outlook for Economic Activity and Prices” in October 2004,
    in which slight positive inflation rate in terms of yoy change in CPI was expected by
    policy board members. However, the report did not have much impact on forward
    rates.




                                                       6
Figure1-1-27 Trend of short term foward rates trend

     After a hike in '04 June, short-term rates stabilized

          (%)
    0.9




    0.6


                                                                                                      Contract Month
                                                                                                      '06 Mar
    0.3
                                                                                                      '05 Dec
                                                                                                      '05 Sep
                                                                                                      '05 Jun
                                                                                                      '05 Mar
    0.0                                                                                               04 Dec
           4       5        6           7         8          9         10        11
                                                                                                (M)
                                                 04                                             (Y)


    Sources: Tokyo International Financial Futures Exchange Inc."Three-month Euroyen Futures"



(Financial Sector)
•   The ratio of non-performing loans (NPLs) to total lending in major banks was almost
    halved, declining from more than 8% in March 2002 to 4.7% in September 2004.
    Losses from disposal of NPLs stayed below the level of operating profits. Shares held
    by major banks declined substantially, amounting to 64.5% of their Tier I capital.
•   Banks hold a large amount of JGBs whose price will fall as long-term interest rates
    rise during an economic recovery. The fall of JGB prices will not affect bank profits
    as much as the fall of equity stock prices. The fall of JGB prices will not affect bank
    capital adequacy ratio to any significant extent.




                                                         7
      Figure1-1-31  Unrealized gain/loss from securities of major banks

      Relatively small gain/loss fluctuation from bond,compared to stocks

       (trilliont yen)
         6
                                                        Unrealized gain/loss change
         4
                                                                from stocks
         2

         0

        -2

        -4
                                                                     Unrealized gain/loss change
        -6                                                                   from bonds

        -8

       -10
                 '98 Mar         '99 Mar         '00 Mar         '01 Mar       '02 Mar       '03 Mar

                   ↓                ↓               ↓               ↓             ↓                ↓
                 '99 Mar         '00 Mar         '01 Mar         '02 Mar       '03 Mar       '04 Mar


      Source:     Financial Statements of Japanese Banks,Bank of Japan.
                  Financial statements of each bank('04 Mar)
      Note:       Aggregate total of securities with market value.
                  Major banks are 14 banks;
                     Mizuho Bank, Mizuho Corporate Bank, Mizuho Trust and Banking, Bank of Tokyo-
                     Mitsubishi, Mitsubishi Trust and Banking Corporation, UFJ Bank, UFJ Trust Bank,
                     Sumitomo Mitsui Banking Corporation, Resona Bank, The Chuo Mitsui Trust and
                     Banking Company, and Sumitomo Trust and Banking,Shinsei Bank,Aozora Bank.




(Fiscal policy: government revenue and expenditure)
•   An increase of expenditure is contained by austere fiscal measures including the
    reduction of public works.
•   An increase of revenue is fueled by an increase of corporate tax revenue, followed by
    an increase of consumption and income tax revenues, during an economic recovery.
•   Given the bad fiscal condition, local governments are reducing public works. They
    are also reducing personnel expenses through the reduction of government staff.




                                                           8
Figure1-1-32 Trends in general account expenditures

    Contribution in public-work related expenditures has contributed to reduce general expenditures

           (growth/contribution(%))
    10                                  growth of general
                                          settlement of
     8                                accounts(year-on-year)                     Local allocation tax ,grants etc.
     6

     4

     2

     0

     -2

     -4
                                                                    Social security
     -6
                                                Others
     -8                                                                  National debt service         Public works

    -10
          1991    92      93     94      95      96      97    98         99    2000      01      02      03         04   (fisical year)

    Note:From Ministry of Financ.Based on Settlement of accounts(Budget for FY2004)




(How will an economic recovery influence government debt?)
•     In order to check an increase of government debt to nominal GDP ratio, deficit in the
      primary balance must be reduced.




                                                                     9
Section 2 Rise in Crude Oil Price and its Economic Impact


(Crude oil price continuously soared)
 • Crude oil price (WTI future price) soared in 2004 and reached the record high in
  October. Dubai price, Japanese index price of crude oil, also rose until summer in
  accordance with WTI. Though the price turned to decline toward the end of 2004, the
  level is still high relative to the past.
 • What lie behind the crude oil price jump are: (i) the expansion in the world demand for
  crude oil especially in the US and China, (ii) the drop in spare capacity and the
  anxiety about supply shortage, which let the price be volatile, (iii) the inflow of
  speculative money into the futures market.




   Figure1-2-1 Price transition of WTI and DUBAI

                                           The crude oil price soared.

         (dollar/barrel)
  60
                                                                               the highest price
                                                                                 55.17 dollars
                                                                                    (10/26)
                                                                      the highest price
  50
                                                                        41.45 dollars
                                                                            (8/20)



  40
                                        WTI




  30




  20



                                DUBAI
  10
       1990                95                 2000         (CY)   1    2   3     4   5   6   7    8     9 10 11 12 (Month)
                                                                                                 2004               (CY)
 Notes :Daily price for 2004, otherwise quarterly price.




                                                            10
              Figure1-2-2                 World Oil Demand

              The U.S. and China are largely responsible for world oil demand increase

                         (Contribution to World Oil Demand Increase from 2002 to 2004)

                             (%)
                       6.0

                       5.0

                       4.0                          Others                               Japan
                                                    +3.1%                                +0.0%
                                   Growth of World Oil
                       3.0                                                                    U.S.
                                        Demand
                                         +5.7%                                               +0.8%
                       2.0
                                                                                        China
                                                                                        +1.7%
                       1.0

                       0.0


                   Note: From IEA "Oil Market Report".



Figure1-2-3     OPEC's Crude Oil Production Capacity and Surplus Capacity

                                      Surplus Capacity has declined
      (ten thousands barrel/day)
                                                                         (ten thousands barrel/day)

     3,500       Production Capacity         Production                                                     1,800
                    (scale on reft)          (scale on reft)          year         quarter
                                                                                                            1,600
     3,000
                                                                                                            1,400
     2,500
                                                                                                            1,200

     2,000                                                                                                  1,000

     1,500                                                                                                  800

                                                                                                            600
     1,000
                                          Surplus Capacity                                                  400
       500                                 (scale on right)
                                                                                                            200

         0                                                                                                  0
                                                                                  Ⅰ           II      III   (quarter)

                1970     75          80      85        90       95      2000                 04             (year)

         Note:1.Surplus capacity is deducation of production from produciton capacity.
              2.From IEA"Oil Market Report".




                                                               11
(The economic impact of rise in oil price)
 • In theory, a rise in oil price possibly has the following impacts on an economy: (i) real
  income transfer to oil exporting countries, (ii) rise in domestic price, (iii) downward
  pressure on corporate profit until oil price shifts to downstream price, (iv) drop in
  external demand due to economic slowdown in other oil consuming countries, (v)
  deterioration of final demand through all those impacts. Nonetheless, the impacts
  have been limited because of high energy efficiency and steady economic recovery.


(Real income transfer is limited compared with the past)
 • While crude oil price pushes up the import price, the deterioration of terms of trade
  and the real income transfer have been limited, relative to those of the past oil shock
  episodes.



       Figuer 1-2-7 Change in Terms of trade and Real income transfer

                       Terms of trade                         Real income transfer as a share of
       (Point where crude oil                          (%)               Real GDP
        began to rise=100)                             6
       110
                                                       5
                             This time
       100
                                                       4            The second oil shock

        90
                          The first oil shock          3

        80                                             2
                                                                          The first oil shock
        70                                             1                    This time
                  The second oil shock
        60                                             0
              1 2 3 4 5 6 7 8 9 10 11                        1 2 3 4 5 6 7 8 9 10 11
                                  (Quarter)                                                 (Quarter)


       Sources:System on National Account,Cabinet Office,Trade Statistics,Ministry of Finance.
       Note:Estimation of Real income trasfer was follow:
         (Px・X-Pm・M)/Pd-(Px0・X-Pm0・M)/Pd0
        Px:Export deflater                Px0:Export deflater(Point where crude oil began to rise)
        Pm:Import deflator                Pm0:Import deflator(Point where crude oil began to rise)
        X:Export
        M:Import
        Pd:Domestic demand deflater  Pd0:Domestic demand deflater(Point where crude oil began to rise)
       Import deflater is estimated under the assumptions that exchange rate is unchanged
       and that only crude oil price rises.




                                                12
(While the crude oil price raised upstream prices, the shift to downstream prices is
limited)
 • The rise in oil-related product prices has contributed to the rise in Corporate Goods
  Price Index (CGPI) since the second quarter of 2004.
 • The spillover of the rise in crude oil price to final goods price or Consumer Price Index
  (CPI) is still weak, except for gasoline price etc. The spillover effect became lower
  after the 1990s than prior to the 1980s, owing to the improvement of energy efficiency
  and the intense competition in the final goods market.


       Figuer 1-2-10 VAR Analysis of Crude Oil Prices and Consumer Price Index
             (Impulse Response)
              Consumer price index(CPI) sensitivity to crude oil price rise have diminished
       (1)From 1970 to 1989                                        (2)After 1990

           2.5%                                                    0.5%
                  Response of CPI to crude                         0.4%
           2.0%   oil price rise shocks                                        Response of CPI to crude
                                                                   0.3%
                                                                               oil price rise shocks
                                                                   0.2%
           1.5%
                                                                   0.1%
           1.0%                                                    0.0%
                                                               -0.1%                             95% confidence
                                      95% confidence
           0.5%                                                -0.2%                             interval
                                      interval
                                                               -0.3%
           0.0%
                                                               -0.4%
       -0.5%                                                   -0.5%
                  1   2   3   4   5    6   7   8   9 10                    1     2   3   4   5    6   7   8 9 10
                                                       (Quarter)                                           (Quarter)
       Sources:Trade Statistics,Ministry of Finance,Comsumer Price Index,
                Ministry of Internal Affairs and Communications.
       Note:See Appended Note 1-5 for estimation methods etc.Aggregate impulse response functions.




 (Economic recovery makes the impact on corporate profit modest so far)
 • While the output/input price ratio is deteriorating partially reflecting the rise in crude
  oil price, the impact of oil price rise on corporate profit of manufacturing sector has
  been absorbed because of (i) the decline of the energy input ratio including crude oil in
  manufacturing sector, and (ii) the increase in sales due to the economic recovery and
  the improvement in productivity.




                                                   13
Figure 1-2-11 Factor-by-Factor Contribution to Year-on-Year Changes of Ordinary Profits(Manufacturing)

           (Year-on-year contribution, %)
   150
             Year-on-year changes in ordinary profits              Other factors   Unit sales
                                                                                   factor
   100
                  Personnel cost factor
    50


     0


    -50                                        Sales price
                                               factor          Output/input price ratio (other)
                                            Output/input price ratio (pertoleum)
  -100
            Ⅰ     Ⅱ     Ⅲ      Ⅳ     Ⅰ      Ⅱ        Ⅲ   Ⅳ     Ⅰ      Ⅱ        Ⅲ    Ⅳ     Ⅰ       Ⅱ    Ⅲ   (Qtr)
                                                                                                           (Year)
                    2001                        02                        03                      04

(Source)    Financial Statement Statistics of Corporations by Industry, Ministry of Finance ,
            Input-Output Price Index of Mnufacturing Industry by Sector , Bank of Jpan ,
            2000 Input-Output Tables for Japan , Mnistry of Internal Affairs and Communications and
            Trade Statistics , Ministry of Finance




(Macroeconomic impact: smaller domestic impact but some concerns for external
channel)
• The direct influence of the sudden rise in crude oil price is restricted owing to the
 higher energy efficiency. On the other hand, the indirect impact via its influence on
 the US and China is possible, whose oil consumptions per unit of GDP are much
 higher than Japan.




                                                         14
 Figure 1-2-13             Oil Consumption per unit of GDP of Japan, US and China



    (in 1990 US = 100)               Crude Oil Consumption/GDP

      250
                231

                                                                       China


      200

                                                                                                174



      150
           
             
                                                                         US
             100
      100
                                                                                                81

                                                               Japan
             42
       50
                                                                                                35




        0
            1990      91   92   93    94    95     96     97    98      99     2000   01   02    03(Year)


  Sources:    Petrolium Statistics、World Bank "World Development Indicators"
           British
  Notess :1.Calculated using GDP on dollar basis in 1995.
               
      2.The of the United States in 1990 as 100.




(Conclusion)
 • So far, the impact of oil price rise in 2004 on the Japanese economy is generally
  modest.
 • The oil price, however, still remains high though the recent price is slightly declining.
  Judging from the supply and demand, some points out that oil price will continue to be
  high to some extent. Thus, the development of oil price should be continuously paid
  attention to.




                                                     15
                         Chapter II Prospect for Continuous Recovery


Section 1. Features of Business Cycles and Their Changes


(1. Features of Japanese Business Cycles)
•     Average duration of the Japanese business cycles is around 50 months, which is
      relatively short in comparison with other developed countries where an average cycle
      lasts for 6 years. Average duration of the recessions in Japan is around 17 months,
      which is longer than in other developed countries whose recessions last only one year
      on average.
•     Expansionary phases in developed countries tended to last longer in the 1990s.
      Although the expansion in Japan also became longer from the 1980s to early 1990s,
      it has been shortening since the later half of 1990s. According to the past experiences,
      countries which suffer from high rigidity in markets or fragility in financial sector
      tend to have shorter cycles.
•     Contribution rate of personal consumption to GDP growth dropped in the 1990s.
      Instead, contribution of fixed capital investment rose substantially, explaining 60%
      of the changes in GDP in late 1990s. However, the trend has changed slightly during
      the current recovery phase as personal consumption plays a bigger role in supporting
      the recovery.


Figure2-1-2 Comparison of Average Business Cycles between Japan and G7
                 Japan:Shorter business cycle and relatively lnger recession period



                         Expansion Period             Recession Period
        Japan
                            2.8 years                    1.4 years


                                   4.2 years


                                     Expansion Period                          Recession Period
    G7 average                           5 years                                   1years


                                               6 years




                                                       16
        Figure2-1-7 Contribution rate of Demand in phase of Economic expansion
           Contribution rate of Consumption declined in 1990's,but Private Investments increased

                    (%)
           80.0
                                                  Private Consumption           Business Investment
           70.0
           60.0
           50.0
           40.0
           30.0
           20.0
           10.0
             0.0
          -10.0
          -20.0                                    Foreign demand               Public Demand
                                                                                                        (Business
          -30.0                                                                                          Cycle)
                       4       5      6       7       8     9       10     11     12     13      14

         Sources:National Accounts,The Determination of Business-Cycle Peak and Trough,Cabinet Office
         Notes :1.We used 68SNA by Expansion Phase in 9th cicle from Expansion phase in 4th,and used 93SNA
                      since Expansion Phase in 10th. And,We used chain-Index since recession phase in 12th.
                   2.This figure dosen't involve Private inventry and Private resicential investment.
             So,Sum of them is not equal 100%.




2. Features of cyclicality of major economic indicators and their changes


(Consumption and business cycles)
•      Correlation between real GDP and personal consumption declined in the 1990s. This
       reflects the following factors.
i)        lower correlation between income and business cycles
ii)       lower correlation between income and consumption
iii)      bigger weight of services which are insensitive to business cycles.




                                                                 17
                       Figure2-1-11 Ratchet Effect
                                       Since the late 1990s,Ratchet effect has increased
                       (Propensity to Consume,difference from previous year,%)
                       8
                                                                               (81.1Q-95.4Q)
                        6                                                   y = -0.591x + 1.9848
                                                                                 R2 = 0.4944
                        4

                        2

                        0

                       -2

                       -4                 (96.1Q-03.1Q)
                                      y = -0.9582x + 0.6393
                       -6                  R2 = 0.5192

                       -8
                            -4         -2           0          2          4          6         8
                                                        disposal income,real(year-on-year changes,%)
                       Source:National Accounts,Cabinet Office




Figure2-1-12 Composition of Final Consumption Expenditure of Households classified by Type
                        Bigger weight of services which are insensitive to business cycles caused
                        the decline of correlation between GDP and final consumption expenditue
   (1)changes in composition                                                (2)correlation between expenditure
 (%)                                                                               classified by type and GDP
                                                            (correlation)
  60                                                          0.6

  50


  40                                                          0.4
                            2002
  30            1980

  20                                                          0.2

  10


    0
                                                                0
          durable       semi-      non-durable   services             durable        semi-          non-       services
           goods       durable       goods                             goods        durable       durable
                        goods                                                        goods         goods


Source:National accounts,Cabinet office
Notes: Correlation is estimated for cyclical movement extracted by BP filter.Estimation period is from 1980 to 2002.




                                                              18
3. Structural Changes in Labour Market and Corporate Sector


  • A trend unemployment rate, which is obtained by extracting cyclical components
    from actual unemployment rate, had risen continuously through the 1990s. However,
    the trend unemployment rate seems to stop rising, judged by the fact that a recent
    drop in unemployment rate cannot be explained fully by cyclical components.


Figure2-1-19 Correlation of Unemployment rate with GDP

               (billion)         Upward trend of Unemployment rate is slowing down                                 (%)
600,000                                                                                                                  6
                                                       Trend of Unemployment rate
550,000                                                   smoothed by BP Filter
                                                             (scale on right)                                            5
500,000
450,000                                    Real GDP                                                                      4
400,000
350,000                                                                                                                  3
                                                                                                   Unemployment rate
300,000                                                                                             (scale on right)     2
250,000
200,000                                                                                                                 1
          1970 72          74   76   78    80    82    84    86        88    90    92    94    96    98 2000 02     04 (CY)

 Cyclical movement extracted by BP filter
 (The difference between actual number and trend)

 0.20
 0.15                                                                   Real GDP
 0.10
 0.05
 0.00
-0.05
-0.10
-0.15                                                                   Unemployment
                                                                            rate
-0.20
          72      74       76   78    80    82    84    86        88        90    92    94    96    98   20   02    04 (CY)

         Interrelation                 70-       70-79       80-89           90-99        95-
GDP and Unemployment rate              0.818      0.864       0.247           0.853       0.666
Cyclical movement                     -0.571     -0.380      -0.710          -0.756      -0.802

Sources:National Accounts, Cabinet office and Labor Force Survey, Ministry of Internal Affairs and communications




                                                             19
4. Features of the Current Recovery Phase


•   A recent improvement of the health of corporate and banking sector could strengthen
    ability to resist external shocks.
•   Although consumption tends to be smoothed out over the cycles, its contribution to
    GDP growth has risen in the current cycle with employment condition improving.
    However, recovery in income is essential to its sustainability.
•   Contribution of net exports has become larger, reflecting strong growth in export
    markets and a stabilisation of the world market share of Japanese exports, which
    had declined over the past decade. A momentum of the recovery is likely to be
    maintained as the world economy is expected to continue to grow.
•   A recent drop in unemployment rate, which could reflect a change in the long-term
    trend, would contribute to the growth of personal consumption.




                                            20
Section 2 Consumer Confidence and its Impact on Private Consumption


1 The Recent Development of Consumer Confidence and How it is Determined


(Consumer confidence is in declining trend, though it recently recovers mainly due to the
  improvement in employment environment)
 • Consumer confidence index is generally low even in the economic expansion phase,
  except for the “bubble” era, and in declining trend. Since the latter half of 2003,
  however, the index has recovered to the level of the mid-90s mainly due to the
  improvement in households’ prospect of “employment environment.” By age group, the
  prospect of “income growth” is improving especially among the 20s.


      Figure 2-2-2 Decomposed contribution of consumer confidence

              Consumer confidence has recovered mainly due to the improvement of employment environment

             (year-on-year changes, index)
        10
         8                                                                      Employment

         6
         4
         2
         0
        -2
                                                                                                  Overall
        -4                                                                                        livelihood
        -6                                                   Income growth
                                                                                Consumer confidence index
        -8
       -10                                                        Willingness to buy durable goods
       -12
               3    6   9   12   3    6        9   12   3     6        9   12   3   6        9   12   3   6    9   (quarter)

                    2000                  01                      02                    03                04         (year)


         Sources: Consumer confidence survey, Cabinet office




 (What determine consumer confidence)
 • Employment-related and asset-related indicators (such as new job offer and stock
  price) as well as the information other than statistics (e.g. the volume of news on
  employment anxiety) principally cause consumer confidence index.


                                                        21
•Adverse shocks in society does not necessarily have statistically significant negative
 impact on consumer confidence index, though it is possible that the impact of the
 Niigata-Chuetsu Earthquake (October 2003) is reflected in the short term
 development of other confidence index (e.g. Economy Watchers Survey).


      Figure 2-2-5 Number of articles about employment anxiety

                Number of articles about employment anxiety and consumer confidence
              (number of articles)                                                           (index)
        120                                                                                              30


        100                                                                                              35
                         Consumer confidence
                      (right scale, upside down)
         80                                                                                              40
                                                                                                              Consumer
                                                                                                              confidence
                                                                                                               worsens
         60                                                                                              45


         40                                                                                              50
                                     Number of articles
                                     about employment
         20                                                                                              55
                                          anxiety

          0                                                                                              60
           19828384 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99200001 02 03 04


              Notes: "Number of articles about employment anxiety" is the number of articles regarding
                     deterioration of employment and unemployment appeared in the main national newspapers
                     and the weekly economic magazines.




                                                        22
          Figure 2-2-6 Changes in Economy Watchers Survey

          Significant deterioration of consumer confidence in Tohoku in Oct.2004 and widening
          internal disparities



                      Household activity-the DI for future economic conditions
            60

                                   all of Japan



            50




            40

                                                                          Tohoku



            30
                  8     9    10 11 12    1    2   3   4    5    6     7     8   9   10 11   (month)
                                                                                             (year)
                            2003                               2004

          Source: Economy Watchers Survey, Cabinet Office.




2 Consumer confidence contributes to private consumption to some extent


(Consumer confidence has impact on the actual consumption through durable good
 expenditures)
• The improvement in consumer confidence has a positive impact on durable good
  expenditure at least in the short run. Since the share of durable goods in total
  expenditure is in increasing trend, it is likely that the amelioration in confidence index
  so far has led to the increase in overall private consumption.




                                                      23
  Table 2-2-8 Relations between Consumer confidence and Consumption
              by Granger causality test
  There is a Granger causality from consumer confidence to consumption.
                      Consumer confidence to Consumption (Reference)Durable goods and Consumer confidence
                           F value         P-VALUE           (year-on-year changes, consumption)
  Private consumption               4.2              0.043 40
  Durable goods                    10.9              0.001
                                                                         30

                                                                         20

                                                                         10
  Sources:System on National Account,Consumer confidence survey,
                                                                  0
        Cabinet office
  Note:1983 2Q-2004 2Q for Private consumption.                 -10
                                                                                                          y = 0.9927x + 7.9426
       1983 2Q-2003 1Q for Durable consumption.                 -20                                              2
                                                                                                               R = 0.2054
                                                                        -30
                                                                              -15   -10      -5      0        5       10      15
                                                                                          (year-on-year changes, consumer confidence)




(Consumer confidence influences the short-run fluctuation of consumption expenditure)
 • Controlling disposable income and elderly population ratio etc. that affect consumption
  in the longer term, the change in consumer confidence index yet has some impact on
  short-run fluctuations of private consumption. Indeed, the rise in consumer confidence
  index during the latter half of 2003 to the first half of 2004 possibly contributes to
  consumption expenditure growth.


          Figure 2-2-9 Contribution of consumer confidence to consumption

               Consumer confidence contributes to consumption growth since the third quarter of 2003

                     (% changes from the previous quarter)
               2.0
                                                                Private consumption
               1.5                                       (changes from the previous quarter)


               1.0

               0.5

               0.0

              -0.5                                                   Contribution of consumer
                                                                            confidence
              -1.0
                                                                                                             (quarter)
                         Ⅰ       Ⅱ       Ⅲ       Ⅳ       Ⅰ       Ⅱ          Ⅲ       Ⅳ       Ⅰ         Ⅱ
                                   2002                                03                        04             (year)


              Sources: National accounts, Consumer confidence survey, Cabinet office
                Note: Contribution of consumer confidence is calculated by the error correction model
                        of Appended figure 2-9 in original report.



                                                          24
(In addition to elderly consumers, young households, the 20s, supports private
 consumption through the improvement in their confidence)
• In this economic recovery phase, the growth of young households’ consumption (i.e.
 20s) is remarkable as well as that of elderly households. The expenditure of the young
 consumers is possibly influenced by the improvement in their confidence.
• Consumer confidence also has some positive influence on anew purchase of digital
 home appliances.


   Figure 2-2-11 The relation between the Consumer Confidence Index and expenditure by age group of Household

   (1)Expenditure by age group of Household head
             The expenditure in their 20s becomes marked after latter half of 2003.

        (year-on-year changes %)                  Workers' Households
          20
          15                                                                     -29
                                                           30-39           60-
          10
                            50-59
           5
           0
           -5
          -10
          -15                    40-49
          -20
                  Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ                                         (quarter)
                                                                                                        (year)
                        1999             2000             01         02           03           04


                Source: Family Income and Expenditure Survey, Consumer Price Index, Ministry of Internal Affairs and Communications
                Notes: The part covered with shadow is recession period.
   (2)The relation between the Consumer Confidence Index and expenditure by age group of Household head
                There are strong relations between the Consumer Confidence Index and expenditure in their 20s.
                   years       whole period in late '90s
                                  0.368          0.519
                -29
                                 (2.136)        (2.252)
                                  0.111          0.109
                30-39
                                 (1.815)        (1.138)
                                  0.156          0.135
                40-49
                                 (1.765)        (0.891)
                                  0.050          0.294
                50-59
                                 (0.619)        (2.663)
                                  0.055          0.038
                60-
                                 (0.366)        (0.245)
                ():t-Statistic
                Source: Family Income and Expenditure Survey, Consumer Price Index, Ministry of Internal Affairs and Communications
                    Monthly Consumer Confidence Survey, Cabinet Office
                Notes: For details to Appended Figure 2-11.




3 Lifetime benefit and contribution and Confidence toward social security


(2004 amendment of public pension system slightly improved the benefit-contribution
  balance between generations)


                                                                   25
 • 2004 public pension amendment slightly improved the lifetime net benefit of the
  younger generations because it restrains the rise in premium contribution by
  introducing of fixed premium contribution rate rule.
 • Money’s worth of public pension (present discounted value of lifetime pension benefit
  divided by PDV of lifetime premium contribution) has not been altered that much after
  several public pension amendments, which has hardly redressed the generational
  imbalance.


  Figure 2-2-14 Impact of 2004 Pension System Reform on Net Lifetime Benefits

    Slight Improve in a Balance of Benefits and Contributions between generations

     (10,000 yen)
      500
      400                                   Control in future contriburion rate
      300
      200                                                      Changes in Net Lifetime Benefits
      100
         0
      -100
      -200                                                                                Reduction in
                                                                                         Pension Benefit
      -300
                                                                                                  (In 2002)
      -400
                   20s                30s                  40s              50s           60s or older
                 (Born in           (Born in             (Born in         (Born in        (Born in or
                 1973-82)           1963-72)             1953-62)         1943-52)        before 1942)

       Note. See Figure 2-2-13 and Appended Note 2-3.



(The younger the generation, the higher “anxiety about pension” and saving rate)
 • Among those who are anxious about the post-retirement living, the proportion of
  people who refer to “insufficient pension benefit etc.” as a reason had risen year after
  year and remains high since the end of 1990s.
 • Compared with the earlier cohorts, the later cohorts (e.g. the present 30s) have both
  higher proportion of those anxious about post-retirement and pension and higher
  saving rate at the same age. Although the percentage of those with savings is declining
  among young generation, precautionary saving motive brought about by “anxiety
  about pension” likely affect the behavior of those with savings.




                                                        26
   Figure2-2-18 Transition of savings rate by cohort

                   A younger generation has the higher base of savings rate.
                 (%)
            40
                                 1965 birth        1960 birth     1955 birth
                               (38 years old)    (43 years old) (48 years old)
            35           1970 birth
                       (33 years old)


            30

                                                       1945 birth
            25                                       (58 years old)


            20
                                                                  1935 birth
                                                                (68 years old)
            15



            10



             5
                  25              30            35               40              45
                                                                             (age)

                 Notes:1.Savings rate is [100-propensity to consume].
                    2.3 years moving average.
                    3.The parenthesis shows the age in the 2003 time.
                    4.Annual report on the family income and expenditure survey,
                          Ministry of Internal Affairs and Communications




4 Conclusion


• Although the improvement of consumer confidence could continue to some extent if the
 employment situation ameliorates further, it is difficult to excessively expect the
 further increase in private consumption under that condition.
• While the increase in public contributions such as pension premium rate is inevitable
 to some extent, it is important to pay sufficient attention to the economic condition




                                                27

				
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