■ Japan’s Fiscal–Monetary Policy Mix Is Drifting Away from Stability

 

■ Japan’s Fiscal–Monetary Policy Mix Is Drifting Away from Stability

— The 2026 Budget and Continued Monetary Easing Will Inevitably Fuel Inflation

This morning’s Nikkei editorial criticized the 2026 draft budget as “the largest ever, lacking a sense of responsibility.” The argument is broadly persuasive, and I would like to add several analytical points.

■1. An 11.5 Trillion Yen Surge in Government Spending Over the Next Year

Japan’s 2026 general-account budget totals ¥122.3 trillion, an increase of ¥7.1 trillion from the previous year.
In addition, the already-enacted 2025 supplementary budget amounts to ¥18.3 trillion, up ¥4.4 trillion from the prior year’s supplementary budget.

In total, government spending will expand by ¥11.5 trillion (δG) over the coming year.

Assuming a Keynesian fiscal multiplier of 1.5, the expected boost to aggregate demand reaches:

• ¥17.3 trillion, equivalent to
• 2.6% of nominal GDP (¥665 trillion in 2025 Q3).

Japan’s potential growth rate is estimated at only 0.6%, meaning:

Roughly 2 percentage points of inflationary pressure are effectively “baked in” by fiscal policy alone.

In short, despite being labeled “responsible proactive fiscal policy,” the SANAENOMICS approach is, in substance, an inflation‑enhancing policy stance.

■2. Monetary Policy Is Also Pressing the Accelerator

At the same time, monetary policy remains highly accommodative:

• Inflation: around 3%
• Policy rate: 0.75%
• Long-term JGB purchases continue, albeit tapered, keeping long-term yields artificially low

This combination keeps real short- and long-term interest rates deeply negative, thereby:

• Weakening the yen
• Stimulating aggregate demand through financial conditions

In effect, both fiscal and monetary policy are simultaneously expansionary—an unusual and risky configuration for an economy already facing supply-side constraints.

■3. Japan’s “Four Burdens” and the Risk of Structural Derailment

Japan is already grappling with:

• Demographic decline
• Chronic consumption stagnation
• Persistent currency weakness
• Elevated prices

Against this backdrop, the current policy mix pushes the economy further away from the path of price stability and sustainable growth.
It is difficult to avoid the conclusion that Japan is drifting toward a regime of inflation without growth.

■4. Key Structural Concerns Raised by the Nikkei Editorial (Summary)

The Nikkei highlighted several structural issues:

• Budget size hits a record high for the second consecutive year
• Tax revenues rise due to inflation, yet new bond issuance still increases
• Political weakness leads to accepting demands from interest groups, opposition parties, and external pressures
• Medical, education, defense, and fiscal investment programs all expand with limited scrutiny
• Debt-servicing costs are rising rapidly, squeezing fiscal space
• The government has relaxed its commitment to annual primary-balance improvement
• Japan’s debt-to-GDP ratio remains by far the worst among G7 economies

Notably, after the 2025 supplementary budget passed, long-term JGB yields spiked and the yen weakened—clear signs that financial markets are already issuing warnings.

■5. What Japan Needs Is Not “Proactive Spending” but a Redesign of the Policy Mix

Japan’s current fiscal–monetary configuration is the opposite of what is required for price stability.

A sustainable framework requires:

• Fiscal discipline through genuine prioritization and spending reform
• A credible path toward monetary normalization
• Growth strategies that raise potential output, not merely nominal demand

Without a coherent redesign of the policy mix, Japan risks sliding into a prolonged phase of stagflationary drift—inflation coexisting with structural stagnation.

T.N.