I have already spoken a lot on VAT rate hike in Japan and the negative impact that this fiscal measure has had on the economic outlook (see **here**, **here** and **here**)

The negative GDP growth number for the second quarter was not a surprise. It dropped by -6.8% (at annual rate) after +6.1% during the first three months of this year. Compared to the second quarter of 2013 growth is at 0%. Carry over at the end of the first semester is 0.5% for 2014.

The first chart presents the Japanese GDP profile since 2000. The red line is a trend calculated from 2000 to Q2 2008. At the end of the second quarter of 2014 the gap between the GDP level and the trend is -8.7%. The GDP level is 8.7% below the trend.

On the second chart I show contributions to GDP quarterly growth

The impact of the VAT rate hike on consumption has been spectacular (blue bar), investment had a negative contribution and the positive contribution from net exports results mainly on lower imports (exports also dropped but marginally compared to imports). Higher inventories match a stock reduction during the first quarter.

The main question is the depth of the shock. To answer this question the third chart shows the internal demand contribution to GDP quarterly growth since 1980.

In Q2 the contribution was negative at -13.6%. It is the deepest drop since 1980. It’s more important than the 1997 former VAT rate hike and than Fukushima events in 2011.

In 1997 households’ consumption contribution was negative by -7.7%, this year the contribution is -11.3%. The break is clearly more important this year.

This comparison is not sufficient as households have anticipated the VAT hike. We have to compare the first semester of 2014 to the second semester of 2013. We can do the same for 1997. In 1997, GDP was up by 1% following this comparison. In 2014 it is just 0.6%. For households’ consumption, numbers are 0.9% for 1997 and -0.4% for 2014. Internal demand was up by 0.5% in 1997 and by 0.2% in 2014. Whatever the comparison the shock was stronger this year than in the previous VAT rate hike in 1997.

In 1997 the economy felt in recession after the fiscal measure. Except in Q3 1997, growth rates were negative in Q and Q4 1997 and in Q1 and Q2 1998.

To avoid such a negative sequence that would save the Abenomics, we are impatient to hear from Shinzo Abe all the measures that has to be taken to counterbalance this deep negative shock. The question is to know if the Japanese economy has the capacity to absorb such a shock. I don’t think so as monetary policy is already very accommodative. The probability of a long-lasting recession is far from 0.

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Everything is very open with a very clear description of the issues.

It was really informative. Your site is extremely helpful.

Thank you for sharing!

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