Many economists have hoped that reconstruction activity from last year's earthquake and tsunami will continue to boost domestic demand. Thanks to the stimulus measures taken after the disaster, public investment continued to grow at a brisk pace in the first half of 2012. In the second quarter, public investment contributed 0.3 percentage points to real GDP growth, which is the brightest spot of the economic outlook.
Of course, the effect from this restructuring activity (as with any emergency stimulus package) will eventually wane. Will the Japanese government engage in additional stimulus measures? Japan shares the same dilemma with other advanced countries: More stimuli to vitalize the nation's private sector are sorely needed, but the government's fiscal situation makes it a mission that is impossible to accomplish.
Japan's government debt-to-GDP ratio is the highest among OECD countries, at above 200 percent. The good news is that most of this debt is owned by Japanese residents, so that there is little chance that the government becomes insolvent or be forced into debt restructuring. The bad news, however, is that any effort by the government to tackle its debt problem in the near future will risk dampening domestic consumption.
Japan recently doubled its consumption tax in an attempt to lower the country's public debt figures, which certainly deflates the desire to boost consumption and hence growth. There is little that can be done on the monetary side, either, since Japan's key interest rates have been between zero and 0.1 percent since December 2008. The double jeopardy of debt reduction and economic growth is the most popular tune on global stage nowadays. Japan is now co-leading the chorus.