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REV: FEBRUARY 27, 2014

JULIO J. ROTEMBERG

Japan: Betting on Inflation?
After a year in office, it was time for Prime Minister Shinzō Abe to take stock of his accomplishments and decide on his priorities for the future. In many ways, the economic situation was the best it had been for some time. While preliminary estimates for the third quarter were somewhat lower, GDP growth at annual rates had equaled 4.3% and 3.8% in the first two quarters of 2013. By comparison, the annualized quarterly growth rate from 1994 to 2012 had averaged under 1% (see Exhibit 3). After a period of great disenchantment with elected officials in which there had been six prime ministers in little over six years, Abe’s approval ratings were above 60% in November 2013. In his first speech to the Diet, Abe had explained that what had led him to seek the Prime Minister position for a second time was “my deep sense of patriotism. This is because I believe that I have a mission which must be undertaken in order to rectify Japan’s present situation of finding itself in a critical situation. There is the crisis of the Japanese economy, in which we have been unable to extract ourselves from the bog of deflation.”1 To fight deflation, he had radically changed the mission of the Bank of Japan (BOJ) by appointing a new Governor, and this was referred to as his “first arrow.” Abe also had quickly passed a supplementary budget to increase government spending. His “second arrow” of fiscal policy, was meant to be “flexible” so that it would ultimately be redirected to balance the budget. Finally, in June 2013, Abe unveiled his “Japan Revitalization Strategy” or “third arrow.” This involved a large number of initiatives aimed at increasing investment, exports, GDP and foreign direct investment in Japan (see Exhibit 4). While growth and competitiveness were widely regarded as important, some of these initiatives were controversial and the strategy was criticized for lacking focus.

In addition, tensions between Japan and both Korea and China were rising, in part as a result of disputed sovereignty over two small island groups. Japan administered islands it called Senkaku, which China and Taiwan claimed under the names Diaoyu and Diaoyutai respectively. Japan, in turn, claimed islands it called Takeshima, which were occupied by Korea under the name of Dokdo. Abe’s priorities would affect not only Japan but the world at large.

Historical Background
According to Japanese tradition, Japan has had an emperor descendent from the Shinto goddess of the sun, Amaterasu, since around 660 BC. While continuous, the emperor’s rule had often been purely symbolical. Between 1603 and 1868, the strongest central authority belonged to the hereditary military leaders called Shoguns. During this period, foreigners were largely excluded from Japan and local lords called daimyo had standing armies of samurai that were loyal to them. After U.S. ________________________________________________________________________________________________________________ Professor Julio J. Rotemberg prepared this case. Funding for the development of this case was provided by Harvard Business School. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

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This document is authorized for use only by SUBHASIS SWAIN in Challenges for the Global Economy taught by Stephen G Cecchetti, at Brandeis University from...
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