The sudden announcement by Prime Minister Yasuo Fukuda on September 1 that he is stepping down is bound to heighten the uncertainty about prospects for the Japanese economy. At the end of August the government put together a package of measures to support the economy in the face of rising prices, but the psychological impact of the package was sapped by the political upset, which means that the start of the upcoming Diet session (which must approve the added spending) will probably be delayed until late September or thereafter. And it is unclear how much effect the measures will have even if they are implemented, since the size of the package is relatively modest: The stimulus amounts to ¥11.7 trillion in total, of which just ¥2 trillion is to be in the form of additional spending by the national government.

Consumer spending has been holding up recently thanks to the demand resulting from the unusually hot summer in much of the country, and there is no sign of an increase in the pace of deceleration. Exports have also avoided an extended downturn; sales to China and other East Asian markets and to Europe, which had been weakening, have picked up again. But the overall trend in overseas economies is toward slower growth, which is liable to have a negative impact on Japan. Furthermore, the rise in bankruptcies, particularly in the construction and real estate industries, may set off a negative cycle of rising unemployment and declining consumption. In August both the government and the Bank of Japan effectively recognized that the economy has entered a downturn; it may or may not be possible to pull it back from the brink of a sharp fall.

In the United States, the slowdown has remained only gradual thanks to the effects of tax refunds and of increased exports, but the risk of a sharper loss of speed during the remainder of the year has been increasing. Many observers expect the next upturn to start in the second half of 2009; if the decline in house prices continues, the upturn could be delayed, but the chances of it coming sooner seem remote.

In Britain, meanwhile, the chancellor of the exchequer has called economic conditions the worst in 60 years; as in the United States, the economy is suffering from rising inflation and the bursting of the housing bubble.

The downturn in the euro zone has been deepening recently, particularly in major economies like France and Germany; rising inflation is causing consumer spending to weaken, and exports to the emerging economies have started to lag. In addition, the north-south gap within the area has been widening because of differences in economies' abilities to withstand the impact of the euro's appreciation and higher interest rates. Some are now suggesting that the southern "PIGS"—Portugal, Italy, Greece, and Spain—may face a structural slowdown in their growth.

The current account for the euro zone as a whole is basically balanced, but Portugal, Greece, and Spain are running current account deficits that have swollen to 9%–13% of gross domestic product. Ordinarily such countries might devalue their currencies in order to make their exports more competitive, but this is virtually impossible for members of the common European currency. Stuck with policy interest rates that are high relative to their domestic economic conditions, the PIGS countries will have to address the situation not through devaluation but with structural adjustments, such as cutbacks in employment, production capacity, and borrowing.

People are wondering how the Chinese economy will fare now that the Beijing Olympics are over. The chance of a serious post-Olympic sag, such as seen in previous host countries like Spain and Australia, seems slight in China's case. The more serious risk at this point is that of asset deflation, which is showing signs of emerging in response to the tight monetary policy that the authorities have been applying; stock prices have been trending downward since early this year (due in part also to deteriorating business performance and the effects of the subprime crisis), and in some parts of Guangdong land prices have peaked and started to decline.

Leading Indicators of Business Conditions, Major Economies

Source: Organization for Economic Cooperation and Development.

(Soichi Okuda, September 3, 2008)