OECD Economic Outlook, Volume 2025 Issue 1

Japan

Real GDP growth is projected at 0.7% in 2025, despite significant headwinds, before reverting towards potential in 2026, at 0.4%. Domestic demand will be the main driver of growth. Private consumption is set to increase as robust wage growth boosts households’ disposable income. Expanding profits and government subsidies, especially for green and digital investment, will support business investment, despite higher uncertainty. External demand will exert a drag on growth, reflecting the higher US tariffs. A surge in food prices will slightly raise headline consumer price inflation in 2025, before it eases towards the 2% target in 2026.

Inflation above target over the past three years and robust wage growth warrant continued gradual policy interest rate increases, but high uncertainty calls for close monitoring and a data-driven pace. The primary fiscal balance is projected to improve absent additional supplementary budgets, which should be limited to large shocks. To increase fiscal buffers to address shocks and ensure medium-term fiscal sustainability, a medium-term fiscal consolidation path is needed amid rising debt servicing costs. Structural reforms to boost productivity, including labour-saving and labour-augmenting investment, and employment are key to address demographic headwinds and raise potential growth.

Robust profits and wage growth are supporting domestic demand

While GDP contracted in the first quarter of 2025, domestic demand grew robustly. Business investment increased, supported by high corporate profits, and the order backlog of machinery rose to record highs. The Bank of Japan’s March Tankan Survey, which did not fully factor in the impact of US tariffs, pointed to robust future investment plans. Consumption remained flat in the first quarter of 2025, reflecting declining consumer confidence amidst high inflation, despite rising nominal wages and strong labour market performance. Annual headline consumer price inflation was 3.6% in April, due to sticky food inflation, despite the resumption of electricity and city gas subsidies between January and March. The outcome of the ongoing annual wage negotiations for FY2025, with a 3.8% base pay increase as of 2 May, is stronger than last year.

Japan 1

1. As of 2 May. The horizontal axis shows fiscal years.

Source: Japanese Trade Union Confederation; Ministry of Internal Affairs and Communications; and OECD calculations.

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Japan: Demand, output and prices

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Japan 2

1. The underlying primary balance in 2024-26 is estimated or projected.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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The United States, Japan’s main export destination at 20% of total goods exports in 2024, has imposed tariffs on steel and aluminium products, and automobiles and auto parts, as well as an additional flat tariff of 10% as of mid-April 2025. The impact on the Japanese economy will be direct, as for example automobile exports to the United Stares are high at 6% of total exports, and indirect through higher uncertainty and lower global growth. The projections assume no trade policy retaliation by Japan. Imports and inventories grew strongly in the first quarter of 2025, reflecting precautionary behaviour by firms in the face of higher trade uncertainty. Inbound tourism has expanded robustly, driven primarily by tourists from China.

Macroeconomic support is projected to gradually decrease

In January, the Bank of Japan (BoJ) raised the policy interest rate from around 0.25% to around 0.5%, the highest level in 17 years. The BoJ’s reduction of its monthly purchases of Japanese Government Bonds (JGBs) by around JPY 400 billion each quarter, targeting about JPY 3 trillion by the first quarter of 2026 and roughly a 7-8% reduction in JGB holdings by March 2026, has been proceeding smoothly. Corporate inflation expectations have risen moderately to 2.5%, 2.4%, and 2.3% at the one-, three-, and five-year horizons, respectively, according to the Tankan Survey. Given inflation and wage developments, monetary accommodation should continue to be withdrawn gradually, with the policy rate projected to reach 1¼ per cent during the latter half of 2026. High uncertainty calls for close monitoring and a data-driven pace to monetary policy normalisation.

The underlying primary deficit is projected to decrease from 1.5% of GDP in 2024 to 0.6% in 2026, assuming no supplementary budgets in FY2025 and FY2026, helped by fiscal consolidation in both years. OECD projections assume an increase in public investment to mitigate the impact of future disasters by 0.2% of GDP in FY2026, and additional expenditures on high school tuition assistance by 0.1% of GDP and defence spending by 0.2% of GDP in FY2025-2026. On the other hand, the corporate tax rate will be increased by 4 percentage points in April 2026 to partly finance increased defence spending. Subsidies for electricity and city gas bills will be resumed between July and September 2025. Given lower oil prices, the projections assume that the gasoline price subsidy will be phased out at the end of 2025. The gross public debt-to-GDP ratio is projected to decrease from 227% in 2023 to 213% in 2026, as nominal growth surpasses debt servicing costs.

Domestic demand will drive growth but faces significant risks

Real GDP is projected to grow by 0.7% and 0.4% in 2025 and 2026, respectively, driven by domestic demand. Strong wage growth will support private consumption. Despite headwinds from uncertainty, business investment is projected to remain robust in 2025, reflecting high corporate profits, a large order backlog in machinery and government subsidies. Higher trade restrictions, weaker global demand and elevated uncertainty about trading partner trade policies will weigh on exports, moderating growth. Headline consumer price inflation is projected to edge up to 2.8% in 2025, before converging to the 2% target in 2026 as food inflation slows.

Risks are tilted to the downside. Weaker-than-expected external demand and abrupt changes in financial markets would lower growth. A large and rapid appreciation of the yen could reduce corporate profits and wage increases, leading to lower-than-projected private consumption and investment. Abrupt changes in bond and equity prices could destabilise financial markets and hurt the balance sheets of private financial institutions, the government, and the public pension funds. Interest rates on long-dated Japanese government bonds have already surged to record highs in May. A loss of confidence in Japan’s fiscal sustainability and an increase in the sovereign risk premium could also adversely affect the financial sector and the real economy. The main upside risk is higher-than-projected exports due to a rapid reconstruction of international supply chains, the establishment of new export channels or an agreement with the United States on tariffs.

Rebuilding fiscal buffers and boosting potential growth are priorities

A higher interest bill and expenditure pressures related to spending on health and long-term care for an ageing population will exacerbate medium-term fiscal sustainability challenges. A medium-term fiscal consolidation path needs to be spelled out and adhered to, underpinned by concrete revenue and expenditure measures. Supplementary budgets should only be used in the event of large shocks. Additional potential support against the high cost-of-living or tariffs could derail fiscal consolidation and, if implemented, should be targeted and temporary. Misallocation of capital and labour and population ageing have weighed on investment and total factor productivity growth during the past decade. Reforms to improve the innovation framework and incentives for start-ups, such as redesigning the R&D tax credit and strengthening the links between universities and SMEs, would boost productivity growth and investment in new technologies and digitalisation. Investing in labour-saving and labour-augmenting technologies, as well as re-skilling and upskilling to address changing skill needs, are also key. Higher labour mobility can also boost knowledge transfer and productivity growth. Reforms to boost the labour supply of older, female, and migrant workers should also be continued to address demographic headwinds.