Irresponsible Policy Deals in an Era of Party Fragmentation

 

Irresponsible Policy Deals in an Era of Party Fragmentation

Japan today stands at a critical juncture.

Inflation has settled around 3 percent for the first time in decades, yet the political system continues to behave as if the country were still trapped in deflation. The result is a policy mix that is not merely ineffective but actively destabilizing. The recent Nikkei editorial warning against “irresponsible policy agreements in an era of party fragmentation” gestures toward this reality, but it fails to grasp the deeper structural crisis now unfolding.

I. Pro‑cyclical Fiscal Expansion in an Inflationary Economy

The government’s decision to expand the supplementary budget to a scale equivalent to 3 percent of GDP is a textbook example of pro‑cyclical fiscal policy.
Rather than smoothing the business cycle, it amplifies it.

Japan’s current inflation is driven by a combination of supply constraints, imported cost pressures, and a delayed monetary response. In such an environment, broad‑based handouts have limited multiplier effects. They do little to support vulnerable households but significantly raise aggregate demand, thereby intensifying inflationary pressure.

Calling this a “price relief package” is misleading.
It is, in effect, an inflation‑enhancing policy.

II. The Taylor Principle and Japan’s Negative Real Rates

Price stability requires that policy interest rates exceed the inflation rate—a principle formalized in the Taylor rule and widely accepted across advanced economies.
Japan is nowhere near meeting this condition.

Even if the Bank of Japan were to raise rates by 0.75 percent, real interest rates would remain deeply negative under 3 percent inflation. Financial conditions would still be excessively loose. The BOJ’s failure to respond to the global tightening cycle that began in 2022 allowed the yen to depreciate sharply, importing inflation and eroding real household incomes.

This is a classic case of being behind the curve.

III. What the Upper House Election Revealed

The electorate sent a clear message in the summer’s Upper House election:

1. disgust with the entrenched collusion between politics and money, and
2. acute anxiety over the rising cost of living.

The opposition’s call for a consumption tax cut directly addressed this sentiment.
In an inflationary environment, the consumption tax becomes even more regressive, disproportionately burdening lower‑income households. A permanent reduction to 5 percent would provide immediate and broad‑based relief.

IV. A Coherent Policy Mix: Rate Normalization and Permanent Tax Cuts

Japan needs a policy mix that is internally consistent and economically sound.
That mix consists of:

• raising policy rates above the inflation rate, and
• permanently reducing the consumption tax to 5 percent.

This combination would restore real interest rates, anchor inflation expectations, and offset the yen appreciation pressures that typically accompany monetary tightening. It would also strengthen household purchasing power, supporting sustainable growth.

V. Dual Policy Failure: Fiscal Populism and Monetary Delay

Instead of adopting this coherent strategy, Japan has embraced a contradictory mix of fiscal populism and monetary hesitation.
Short‑term handouts create the illusion of action, while delayed monetary tightening allows inflation to erode real incomes. Together, these policies entrench both inflation and stagnation.

VI. Political Decay and Geopolitical Tension

Japan’s political system is increasingly characterized by hereditary succession, entrenched privilege, and vested interests.
This institutional decay undermines the state’s ability to respond to economic challenges.

At the same time, geopolitical tensions are rising.
The notion that “a Taiwan contingency is a Japan contingency” is no longer theoretical. A deepening Sino‑Japanese cold war would impose severe economic and strategic costs on Japan, potentially delivering a decisive blow to national stability.

VII. A Diet Session That Avoided the Core Issues

The extraordinary Diet session that closed on the 17th exemplified this dysfunction.
It ended with:

• an expanded supplementary budget,
• postponed discussions on revenue sources for the gasoline tax cut,
• a reckless framework for reducing Diet seats,
• the shelving of political finance reform, and
• stalled social security reform.

These are not the actions of a political system preparing for the future.
They are the symptoms of a system drifting without direction.

VIII. The Most Serious Crisis of the Postwar Era

As Japan approaches 2026 (Reiwa 8), the country finds itself without a coherent economic strategy, without political leadership capable of confronting structural challenges, and without a clear sense of national direction.

Regrettably, Japan is now facing what may be the most serious crisis of the postwar era.

Tomo Nakamaru

An ex-World Bank economist