The government economic outlook for FY2026 forecasts the growth rate of the real Gross Domestic Product (GDP) to be 1.3%. The figure is considerably higher than a potential growth rate of around 0.5%, but as is well known, government economic forecasts generally tend to be biased upward.
Overly optimistic outlooks have become the norm not only during abnormal periods like the COVID-19 crisis but also in normal times, and actual performance has repeatedly failed to reach expectations. In recent years, it has become common practice to formulate large-scale economic policy packages based on supplementary budgets prior to compiling the budget for the following fiscal year, and estimations for the expected macroeconomic effects of the package are published. In the case of the recent economic package, the estimated effect was an annual increase of 1.4% of the real GDP for the coming three years. This type of practice is likely a contributor to the bias observed in government forecasts.
The Japanese economy is moving away from long-term abnormalities of long-lasting deflation and the zero-interest rate policy and is returning to a normal situation where prices increase and positive interest rate exists. With the deflationary gap closed and the labor shortage increasing in severity, the necessary economic policies are not demand-creation measures but policies that raise productivity and the potential growth rate.
The Sanae Takaichi Cabinet newly inaugurated the "Japan Growth Strategy Council," launching efforts such as promoting innovation and developing human resources to build a "Strong Japanese Economy." The policy direction of increasing supply capacity is justified, but unlike demand-stimulus, visible effects will take long time to materialize. Steady and persistent effort is required.
Generally, growth strategies present policy options for enhancing economic growth rates, but they often overlook the perspective of eliminating factors that lower growth. Examples of such factors include government regulations. Nearly 20% of total labor hours are spent on ensuring compliance with regulations and rules including taxation and social security systems. The number of permits or approvals was increasing by 2% to 3% annually, centered on so-called social regulations, and this is lowering the potential growth rate. The easing of the regulations on working hours is being discussed, but if labor input that does not contribute to increasing supply capacity can be reduced, it will be possible to increase the effective labor supply. Such a policy would be supported both by companies and workers.
Another example is government debt, which has long been in an abnormal state. The aforementioned optimistic economic forecasts are also a factor behind the increasing debt. There is no consensus among economists about what influence the government debt exerts on economic growth rates, but many studies show that excessive government debt and the risk of fiscal collapse depress economic growth rates. In an environment of increasing interest rates, high-level government debt is highly likely to crowd out private investment and thwart the growth strategy.
Various explanations have been offered to explain why Japan’s public finances have not collapsed despite its enormous debt. Naturally, low interest rates have been one of the major factors. Under a low-interest-rate environment, there was room to expand government spending without increasing tax, but that situation is becoming a thing of the past.
According to the results of a survey on people's subjective perception of risks, the average perceived probability of fiscal collapse occurring within 10 years was approximately 20%, the same level as the risk of resource- and energy-supply disruptions. The government needs to address not only economic security risks but also risks that arise domestically from within. It is important to at least restore the primary fiscal surplus in ordinary times in order to avoid any potential sudden shocks and to increase supply capacity.
>> Original text in Japanese
* Translated by RIETI.
January 16, 2026 - Published in Nihon Keizai Shimbun's "Economist 360° Perspective"
