OECD Economic Outlook, Volume 2025 Issue 2

Japan

After growing robustly at 1.3% in 2025, real GDP growth is projected to slow to 0.9% per annum in 2026-27. Domestic demand will be the main driver of growth, with external demand exerting a slight drag on activity, reflecting the US tariffs. Private consumption will be supported by wage gains pushing up real disposable incomes. Robust corporate profits and government subsidies will support business investment. The new fiscal stimulus package will support public consumption and investment. Headline consumer price inflation will slow down to around the 2% target in 2026-27, following the easing of food inflation.

A gradual withdrawal of monetary accommodation is appropriate, given projections of sustained inflation around the 2% target and solid wage growth. The projected temporary easing in the fiscal stance in 2026 reflects the new fiscal stimulus package and the corresponding supplementary budget, which should be restricted to periods of large-scale shocks. Designing and implementing a medium-term fiscal consolidation path, with concrete revenue and expenditure measures, is needed for medium-term fiscal sustainability. Reducing the complexity of regulations, by streamlining requirements for businesses through enhanced digitalisation of public services, would boost firm entry and productivity growth.

The economy remains relatively resilient amid global headwinds

Real GDP grew in the first half of 2025, reflecting robust domestic demand and front-loading of exports to the United States, before contracting by 0.4% in the third quarter. This fall was driven by weaker exports and a temporary decline in housing investment due to policy factors, with private consumption and business investment remaining resilient. Labour shortages remain in many sectors, which will further support wage increases and investment in labour-saving technologies. Nominal wage growth has gained momentum, with robust summer bonuses and the strong results of the Shunto wage negotiations for FY2025, with the largest union announcing they will seek similar wage increases of 5% for FY2026. Headline consumer price inflation has eased, mainly due to energy subsidies but remains above the 2% target, at 3.0% in October. According to the Bank of Japan’s September Tankan Survey, business sentiment, profit expectations and investment plans for FY2025 remain solid.

According to the July agreement with the United States, which is applicable from early August, Japanese exports are subject to a flat tariff rate of 15%. Despite some volatility due to front-loading, total exports and industrial production have been supported by robust exports to non-US destinations. Exports to the United States have been declining even though automobile exporters have absorbed most of the tariffs by lowering export prices. The growth of inbound tourism has eased somewhat but remains elevated, with spending by tourists up by 11.1% from the previous year in the third quarter of 2025.

Japan 1

1. The diffusion index subtracts the number of firms responding “unfavourable” from those responding “favourable” to questions on business conditions at their firm.

Source: Bank of Japan; and OECD calculations.

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Japan: Demand, output and prices

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Japan 2

1. Contractual cash earnings, excluding bonuses. Nominal values are divided by the headline consumer price index.

Source: Ministry of Health, Labour, and Welfare; Ministry of Internal Affairs and OECD calculations.

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Monetary policy is projected to be tighter, while fiscal policy will support growth in 2026

The policy interest rate has been around 0.5% since January. The Bank of Japan has been reducing its monthly purchases of Japanese government bonds (JGBs) by around JPY 400 billion each quarter since July 2024. The pace of reduction will change to JPY 200 billion from April 2026, resulting in roughly a 16-17% reduction in JGB holdings by March 2027. In September, the Bank of Japan decided to gradually sell its holdings of exchange-traded funds and Japan real estate investment trusts, a further step in its monetary policy normalisation. Firms expect stable inflation above the target, at 2.4% for all horizons up to five years, according to the September Tankan Survey, and the breakeven inflation rate on 10-year JGBs has been trending up and was 1.57% at the end of October. Given inflation and wage developments, monetary accommodation should continue to be withdrawn gradually, with the policy rate projected to reach 2% at the end of 2027.

The fiscal stance is temporarily expansionary in 2026, reflecting the large fiscal stimulus package announced in November, before turning contractionary in 2027, assuming no supplementary budget in FY2026. The overall fiscal stance between 2025 and 2027 will be broadly neutral. The fiscal package includes measures to support medium-term investment in several areas (JPY 7.2 trillion, 1.1% of GDP), such as artificial intelligence and semiconductors and to strengthen defence capabilities and diplomatic effectiveness (JPY 1.7 trillion, 0.3% of GDP). To moderate the impact of high prices, the package also has cash handouts to households with children and support for households through local governments (JPY 2.4 trillion, 0.4% of GDP) and subsidies for electricity, city gas and gasoline (JPY 1.5 trillion, 0.3% of GDP). The latter will be switched to a permanent tax cut in January. The higher income deduction in the personal income tax from FY2025 will reduce tax revenues (JPY 1.2 trillion, 0.2% of GDP). OECD projections also assume an increase in public investment to mitigate the impact of future disasters by 0.2% of GDP in FY2026, and additional spending on high school tuition assistance (0.1% of GDP). A special corporate tax surcharge of 4% for tax liabilities exceeding JPY 5 million will be introduced in April 2026 to partly finance the increase in the defence budget. The gross public debt‑to‑GDP ratio is projected to decrease from 222% in 2024 to 203% in 2027, as nominal growth currently remains higher than debt servicing costs.

Domestic demand will drive growth

Real GDP is projected to moderate to 0.9% in 2026 and 2027. Growth will be mainly driven by domestic demand, with a negative contribution from net exports over the projection period. Business investment is projected to remain robust, reflecting solid corporate profits and historically high order backlogs in machinery and construction, and supported by government subsidies. High corporate profits will enable continued wage growth, which together with easing inflation, will support private consumption. The new fiscal package will support public consumption and investment. Headline consumer price inflation is projected to moderate towards the 2% target as food inflation eases.

The main downside risk is weaker-than-expected external demand due to geopolitical tensions. Sharp movements in bond and equity prices could destabilise financial markets and hurt the balance sheets of financial institutions and the government. 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. Stickier food inflation could delay the recovery of private consumption. On the upside, a faster‑than‑expected reconstruction of global supply chains and the development of new export channels could further boost exports and support growth.

Rebuilding fiscal buffers and boosting potential growth are priorities

With rising government bond yields and mounting expenditure pressures from health and long-term care in an ageing society, ensuring medium-term fiscal sustainability should be prioritised. A clear medium-term fiscal framework, underpinned by concrete revenue and expenditure measures, would increase fiscal buffers. The use of unscheduled supplementary budgets should be restricted to large-scale shocks, which should be well-defined. Addressing demographic headwinds requires further increasing labour supply and reinvigorating productivity growth. Reducing labour market dualism between regular and non-regular workers would raise the labour participation of female and older workers. Raising the pension eligibility age beyond 65, in line with rising life expectancy, would strengthen work incentives among the elderly and help contain fiscal costs. Simplifying business regulations, such as reducing the number of procedures required to register new firms, would foster business entry and inward foreign direct investment. Streamlined permitting processes are needed to increase the share of renewables in electricity production, boosting energy security.