Significance: Japan was widely expected to show poor growth for the third quarter of this year, but instead the economy was boosted by household spending.

Implications: The data show the importance of government policies in stimulating domestic spending, despite bad fundamentals such as high unemployment.

Outlook: A downward correction to consumption appears likely in the coming quarters, as the government's pro-spending policies expire.

Japan's first release of national income accounts data for the third quarter show that the economy grew at a 3.9% pace (quarter-on-quarter, seasonally adjusted at annual rate). This was much higher than expected, especially given the deceleration seen in the first two quarters of this year and the weakening global economy. It should, however, be noted that the three previous quarters' growth were revised upward, by 0.5–1.5 percentage points; had these data been available earlier, the forecasts for the third quarter of 2010 would have been higher.

Consumption and More

Private consumption has never been a major growth driver in Japan, and in fact the data for the second quarter showed only marginal gains. But the third quarter saw a sharp rise in real household spending. Given the slow economy, both domestically and abroad, and relatively high unemployment, this rise would seem anomalous. But the gain makes more sense in light of government policies. Tax incentives for the purchases of consumer goods are set to expire soon, so the third-quarter surge may simply represent consumers' last chance to take advantage of lower prices. In addition, taxes on tobacco rose in November, so that, too, would have encouraged increased spending—for hoarding purposes—in the third quarter.

The gains in the third quarter were, however, not exclusively driven by consumer spending. Exports also posted gains—the lowest in six quarters, but higher than the rise in imports, so net external demand was a net contributor to growth. Capital expenditures also rose modestly, showing that firms were not overly pessimistic regarding the near-term outlook. There was also a gain in inventory investment, although it is unclear whether this was an intentional increase by optimistic firms or the result of an unexpected drop in sales—although the latter appears unlikely due to the gains in domestic and overseas purchases. Lastly, the effect of government spending was neutral: government consumption rose but was offset by an equal decrease in government investment (public works) spending.

Outlook and Implications

Assuming the consumption rise in the third quarter was driven by policy change—namely, tax incentives ending or tax hikes beginning—then it seems logical to expect a decline in consumer spending in the fourth quarter and thereafter. There is, however, considerable uncertainty about future household spending. That is, the good third-quarter performance may have boosted wages, which would encourage future spending. On the other hand, government incentives have been in effect for over a year, so it is possible that households have now become sated with regards to personal expenditures; if that is the case, then the third-quarter surge will be the "last hurrah" for Japanese consumption, to be followed by flat—or declining—personal spending in the near term. This would once again leave the economy dependent on exports to drive growth, an increasingly difficult situation as more global competitors arise to take market share away from Japan.