IMF Executive Board Concludes 2026 Article IV Consultation with Japan
The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Japan.
The Japanese economy has displayed impressive resilience in the face of global shocks and output is growing above potential. Domestic demand has been robust and unemployment remains low. After three decades of near-zero inflation, prices grew faster than the BOJ’s target for over three and a half years before moderating in January. While nominal wages are rising at a historic pace, there are persistent concerns about the cost of living as high inflation erodes household purchasing power.
Growth is projected to remain strong in 2026, but to moderate to 0.8 percent due to weaker external demand and the impact from the conflict in the Middle East. Private investment and consumption are expected to remain strong, the latter supported by a gradual rise in real wages as inflation eases and labor shortages persist. From 1.3 percent y/y in February, inflation is expected to rise in 2026 before converging to the BOJ’s target in 2027. Risks to the outlook and inflation are broadly balanced.
Recent fiscal performance has exceeded expectations, but the deficit is expected to widen in 2026 and spending on interest and health and long-term care for the aging population will continue to rise, eventually leading to an increase in the debt-to-GDP ratio from 2035. Fiscal prudence is needed, including a plan to keep debt-to-GDP on a firmly downward path. Monetary policy accommodation is appropriately being withdrawn, and gradual hikes should continue to move the policy rate toward a neutral setting.
Executive Board Assessment
Executive Directors commended Japan’s strong economic resilience in the face of global shocks. Directors concurred that the war in the Middle East poses significant new risks to the outlook. Going forward, they underscored the need to continue rebuilding fiscal buffers, proceed with monetary policy normalization, and advance labor market reforms to support sustained real wage gains.
Directors welcomed Japan’s post-pandemic fiscal consolidation. They agreed that a more neutral fiscal stance in the near term and growth-friendly fiscal adjustments in the medium term, underpinned by a credible fiscal framework, are needed to place public debt firmly on a downward path and preserve market confidence, given the expected long-term spending pressures from the interest bill as well as health and long-term care. Noting the authorities’ discussions on temporarily suspending the consumption tax on food and beverage items while reforming the taxation system to improve social support, Directors emphasized that any measures should be targeted to vulnerable households and firms, temporary, and budget neutral. They also recommended improving expenditure efficiency and advancing durable revenue mobilization measures.
Directors agreed that the Bank of Japan (BOJ) is appropriately withdrawing monetary accommodation. They noted that as underlying inflation converges toward the BOJ’s target, gradual rate hikes toward neutral should continue. Directors supported a flexible, well‑communicated, and data-dependent approach, given heightened uncertainty about external conditions and the neutral rate. They commended the BOJ for the smooth implementation of its balance sheet reduction and encouraged continued monitoring of the Japanese Government Bond market functioning. Directors stressed the importance of maintaining a flexible exchange rate as a credible shock absorber.
Directors concurred that Japan’s financial system remains broadly resilient. They encouraged continued vigilance given potential vulnerabilities, including from foreign exchange exposures, structural challenges in some regional banks, valuation risks in commercial real estate, and growing participation of non-bank financial institutions.
Continued implementation of the 2024 Financial Sector Assessment Program’s recommendations, particularly on the macroprudential framework, financial sector oversight, and systemic risk monitoring, is also important.
Directors encouraged reforms to enhance labor market flexibility and mobility, including through reskilling and upskilling to address AI-related labor displacement, and to remove distortions discouraging labor supply to sustain real wage growth. They welcomed Japan’s continued support for IMF activities and commitment to multilateral economic cooperation, stressed the importance of pursuing deeper trade integration, and recommended that industrial policies be narrowly targeted, time-bound, and subject to cost‑benefit analysis.
Norbert Gehrke
