Outlook of the Global Economy
and the Japanese Economy for
the New Year

SummaryIn 2017, the global economy expanded steadily despite increased geopolitical risks.
In 2018, the global economy is expected to maintain modest growth, while manyrisk factors also continue.
The New Year marks the milestone of the 150th anniversary of the Meiji
Restoration. Japan must take a big step toward opening a new era.

1. Reviewing Year 2017 :1. Global Economy : Return of the Great Moderation
At the start of 2017, there was widespread anxiety surrounding the global economy.
Western countries were facing growing uncertainties that the United States may turn tohardline protectionism policies under the Trump administration. Another risk was that thegaps may widen among EU countries depending on the outcome of the French presidentialelection. Trend towards an inward-looking policy seemed to have prevailed in manycountries.
In conclusion, however, the global economy remained strong, supported by theexpectations of the US tax cuts and China's economic stimulus policies.
The year-to-year real GDP growth rate of the global economy in 2017 is estimated to be+3.6% according to the IMF, which is higher than +3.2% of 2016*1. Since the volatility of
the growth rate continues to be small, corporations and investors can afford to be moreaggressive in taking various risks.
Some economists view and describe the current stable expansion as the return of “GreatModeration”.

2. Financial Markets : Bullish Sentiment Continues to Overcome
Uncertainties
Under the strong economy, the risk appetite of investors has strengthened in the financialmarkets.
The US Dow Jones Industrial Average surpassed the 24,000 level, reaching an all-time high.
The Nikkei average also hit its high for the first time in 26 years. Although the uncertainties,
such as policy management of the United States and the Brexit negotiation at EU, remained
high, bullish moves for aggressive risk taking surpassed risk-aversive moves in the financial
markets in 2017.
The factors that supported the continued bullish behavior of the investors include: (1)Expectations of the US tax cut, (2) Confidence that the normalization of monetary policyby the US Federal Reserve will proceed at a slow but steady pace and (3) Expectations forhigh growth in the IT sector. In particular, in addition to the US companies referred to as“GAFA,”*2 Chinese IT companies such as Tencent and Alibaba also performed well in themarket. Competition among major platformers in the digital era is getting tougher mainly inthe United States and China.

*1 IMF “World Economic Outlook Database, October 2017”.
*2 An acronym created by taking the initial letters of Google, Apple, Facebook, and Amazon.

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23. United States : The Trump Administration Remains Popularamong Consistent Supporters in the Republican Party, despite
its Unconventional Policy Management,
The Trump administration failed to deliver during its first year many policies it hascommitted. A large number of vacancies in key positions remain unfilled, and theadministration often faced conflict even within the Republican Party. As a result, major
policy plans including repealing of the Obamacare and the large scale investments in thesocial infrastructure have yet to be implemented. The tax reform bill barely got through at
the end of 2017.
Despite the disappointing record in policy management, the support rate for the Trumpadministration remained high, which is comparable to the Reagan administration, helped by
the consistent supporters within the Republican Party. While the national unemployment
rate has improved to the lowest level since 2000, the labor-participation rate of breadwinners (i.e. males, ranging 35-44 years old), still remained at a low level. These “negativehistorical effects”*3 and continued disparities in the labor market are the major backgroundof the wide gaps embedded in the US society. The Trump administration has been firmly
supported by those groups who feel they have been neglected.

4. China : Aiming for “Center Stage” as a Major Global PowerIn 2017, China stepped further aiming for center stage as a major global power to replace
the United States, which has been taking an inward-looking direction.
At the 19th National Congress of the Communist Party of China in the autumn of 2017,
President Xi Jinping positioned himself as the “core of the party center.” On the economic
policies, Xi explained his determination for stronger “guidance and leadership by the Party”
to establish a solid “modernized socialist power” by the 100th anniversary of the foundingof the country (2049). He intends to have China lead the world in not only economy but
also politics, culture, and the living standard.
Aspiration for a “great revival of the Chinese” people is the key momentum pushing China
to aim for “Center stage.” Throughout the 4,000-year history of China, it was only the 150years after the Opium War that she was classified as a small economy.
During the Ming Dynasty and Qing Dynasty eras, China kept 30 percent share in the globalGDP. After decreasing momentarily to 5% in 1950, the ratio has recovered to 25% in 2016.
*4The Xi administration now looks to be more confident in setting the “great revival ofthe Chinese people” as an achievable target.

5. Trade : Japan Promotes Free Trade in contrast to Protectionism
trend of the US
In the global trade arena, while the United States has been inclined to protectionism, Japanhas promoted free trade. The United States pushed through drastic measures such as*3 Workers who lost their jobs in a large-scale recession, such as 2008 financial crisis, tend to face difficulties in getting back to theirjobs even after the economy recovers. Due to lack of opportunities to build skills during the recession, these workers are forced intolong periods of unemployment or working under low wages.
*4 Calculated by Mitsubishi Research Institute based on Angus Maddison: “Historical Statistics of the World Economy” and IMF: “WorldEconomic Outlook Database, October 2017” (data for 2016 only)

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withdrawal from TPP and re-negotiation of NAFTA. If the US eventually withdraws fromNAFTA, the proportion of the US trade with countries under FTA may reduce to 10% ofthe total amount of the US trade.
In the meantime, Japan concluded an EPA with the EU and managed to reach a basic TPP
agreement among 11 countries excluding the United States. As a result, the proportion ofJapanese trade with countries under FTA is expected to increase to 33%. Based on theestimates by our GTAP model*5, ASEAN countries will benefit significantly from TPP
even without the United States. Japan is now expected to play an increased role as afacilitator for free trade.

2. Outlook for 2018 :1. Global Economy in 2018 : Sustained Growth Expected against
Wide Range of Risk Factors
Our main scenario for the global economy is that the Great Moderation will continue in2018. Stronger domestic demand bolstered by improved employment and householdincome is prevailing worldwide. With the implementation of US tax cuts serving as anadditional tailwind, we expect the global economy to maintain its growth at the same rate as
in 2017. At the same time, however, the positive impacts of the economic stimulus in China
will gradually fade out and monetary control in the United States and other westerncountries is expected to be more conservative. Thus, the effect of expansionary economic
and monetary policy will gradually weaken through 2018.
In addition, political and geopolitical risks are widespread in many corners of the world,
implying serious negative impact on the sustained growth scenario. Possible regime changes
in major European countries, growing military tension in the Korean Peninsula, and further
turmoil in the Middle East are examples of the risk factors to change the market sentiment
abruptly towards bearish. A volatile market will inevitably put downward pressure on theglobal economy.

2. US Economy : Tax Cuts will Sustain Stable Economy
With the rocky passing of the tax reform bill, the risk of corporations and households
losing confidence, which has been a major concern, may have been avoided. The US will
most likely sustain stable economy in 2018.The centerpiece of the latest tax reform is thereduction of the corporate tax rate to be implemented for the first time since the Reaganadministration.
The effective corporate tax rate in the United States was the highest among the G7
countries, but now it has become the second lowest after the UK. It remains unclear
whether the reduction of the corporate tax rate would lead to capital investment. However,there is also tax reduction on dividends from overseas subsidiaries. So through share buybacks, corporations can enjoy high share price. Economic benefits from these tax cuts,
including personal income tax reduction may amount to +0.7% points of the GDP.
*5 GTAP is a model for determining the medium- to long-term equilibrium conditions of the economy, referred to as a computable
general equilibrium (CGE) model. Economic effects are calculated by comparing the state where the economy has undergone
structural adjustment (such as the relocation of capital and labor) due to changes in the tariff rate with the state of the economy
before the adjustment.

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3. US Monetary Policy : The Steering of the Monetary Policy
Towards Normalization is in the hands of the Incoming
Chairman of the Fed
Another point of interest concerning the US economy in 2018 is the normalization ofmonetary policy. Jerome Powell, the next Fed chairman, who is scheduled to beinaugurated in February, must lead this task.
The Fed will use two policy tools. The government securities held by the Fed should
decrease from $4.4 trillion to $3.1 trillion over the next three years if we do not encounter
problems. Increases in interest rates, on the other hand, will be dealt in a flexible mannerwith both economy and inflation in mind.
The US core inflation forecast for 2018 is +1.8% from the previous year. Although anincrease of nearly 2% is expected, the decrease in the inflation rate expected in thehousehold sector has weighed down the overall price increase. The increases in interest
rates in 2018 will likely be gradual at 0.25% per six months.

4. Global Inflation Environment : Tug-of-War Continues Between
Positive/Negative Factors
Although the GDP gaps among Japan, the United States, and the eurozone are expected toturn positive for the first time in 11 years, there are differences in their respective outlookof their inflation rates*6. While the United States expects an inflation rate of nearly 2%, theeurozone expects it to be +1.3%, and Japan +0.7%. They all fall short of their central
banks’ 2% targets.
There are various reasons for the low inflation. While a high unemployment rate exceeding
the natural unemployment rate continues in the eurozone, the pace of wage hikes remains
slow in Japan despite the tight labor supply-demand situation. There are views that the
expected inflation rates have fallen structurally, including also the United States. The
inflation environments in various countries will be the key point in understanding theirrespective monetary policies in 2018.

5. International Finance : Will the normalization of US monetary
policy affect emerging economies?
As the United States promotes normalization of its monetary policy, it is necessary to pay
attention to the risk of funds flowing out from emerging market. Will there be a recurrenceof the Bernanke shock*7 of 2013?
As a conclusion, the possibility of a wide-area currency crisis occurring in emerging markets
in 2018 is small. In addition to the likelihood that the increase in interest rates in the US
will remain moderate, the emerging economies with Asia at their center have enhanced
their competitiveness in the international market and their basic economic has beenstrengthened.

*6 Core inflation rate excluding both food and energy*7 Global financial markets were upset in 2013 when FRB Chairman Bernanke suggested slowing-down of quantitative easing.

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Furthermore, we have also seen development of safety nets to prevent outflow of funds
such as the Chiang Mai Initiative.
However, there is a possibility that funds will flow out selectively from countries whose
economy is vulnerable and the dollar-denominated debt ratio is high such as Turkey andRussia.

6. Chinese Economy : What is the direction of the Chinese
economy under the strengthened Xi regime?
In China, at the National Congress of the Communist Party of China (CPC), the Party has
expressed its intention to further strengthen its intervention in economic activities. As aresult, the risk of a sharp downturn in Chinese economy due to structural adjustments inthe market has reduced in the short term. Though in 2018, a slowdown in growth due tothe diminishing effect of the economic stimulus measures cannot be avoided, the Chinese
economy is still expected to maintain a steady growth of around mid-6%.
In particular, China's progress in the field of cutting-edge technologies has been remarkable.
China is also strengthening its competitiveness in the market of high-value-added productsthat has been dominated by developed countries. Converting weakness to strength, China isexpected to take advantage of its underdeveloped social infrastructure and promote
implementation of advanced technologies such as AI and self-driving cars.
Meanwhile, the excessive debt problem is still an issue for the Chinese economy. Though
there is optimism that China’s non-financial sector debt (considered to be about $30trillion) will decrease over time under party leadership, a fundamental solution has yet to bepresented. Whether the risk of hard landing can be avoided through structural adjustmentof the market and achieve soft landing will depend on the ability of the Xi administration.

7. European Economy : Unclear Future of EU Integration andPolitics in Each Country
The European economy is expected to continue its moderate recovery. However, theweakening of the political foundations of the ruling parties of each country is the largest
risk factor. In Germany, which is the cornerstone of EU, Chancellor Merkel’s grasp ofleadership has declined, and there is a possibility of another election in the first half of 2018.
In Italy, where a general election is scheduled by May, there is a high possibility that noneof the parties will gain majority and talks on forming a coalition will face difficulty.
Each country must give priority to recovering their domestic political bases, and it is likelythat the move toward EU integration will be stalled. The de facto deadline of UK’s Brexit
negotiation is the end of October 2018. Though the condition for the exit has been agreed
upon, depending on the outcome of the trade negotiation that will follow, UK may face aneconomic turmoil.

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8. Japanese Economy : Can Japan Enhance Economic GrowthAutonomously?
The Japanese economy will be entering the sixth year of economic recovery. According to
the “Regional Economic Report (Sakura Report)” released by the Bank of Japan, three ofthe nine regions have achieved recovery, and the other six regions have expanded.
Economic recovery has penetrated into regional areas. The real GDP growth rate in 2018
(calendar year) is projected at +1.2% over the previous year, with the economy continuing
to grow centering on domestic demand as the engine. If economic recovery continues until
the end of the year, it will become the longest postwar expansion.
Recovery in employment during the initial period of Abenomics centered on part time
workers, but it appears to have spread to full time employees around 2016. Though thewheels of the economic expansion have started spinning in the right direction, bothincrease in wages and consumption in the household sector, are the keys to turn this into a
more autonomous cycle.

9. Japanese Economy : Will there be Expansion of the Forwardlooking Movement of Companies to Develop New Markets?
Improvement in corporate productivity is indispensable to achieve sustainable wage
increases. Since there is limit to improve business operations in the existing market, it isimportant to develop new growth market. Unfortunately, however, according toDevelopment Bank of Japan survey*8, companies that are “working on developing newgrowth markets” are mere 30% of the whole.
However, these 30% that are positive about new market development have been
accelerating their efforts toward the fourth industrial revolution. It is hoped that thepositive moves of these 30% will spread to the remaining 70% in 2018.

10. Achieving a Prosperous Society by Co-Creating the Future
Through Innovation
True innovation will enrich the society. For example, if the shared use of self-driving
electric vehicles (EV) becomes widespread, a society that is safe and environment friendly
will be realized. It will become possible for the seniors who find it challenging to drive canmove around freely. Becoming free from driving, people will be able to use the freed up
time to conduct other value added activities and hence achieve affluence.

The New Year will mark the 150th anniversary of the Meiji Restoration. It is hoped that
this will become a year for Japan to take a big step toward co-creating the future throughinnovation.

*8 Development Bank of Japan: “Survey on Planned Capital Spending” (Conducted in June 2017)

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Outlook of the Global Economy andthe Japanese Economy for the New Year

Outlook of the Global Economy andthe Japanese Economy for the New Year
Issue：February.2018.Ver.1
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