Japan's prime minister dissolved the lower house of parliament Friday to avoid a disastrous freeze in government spending, triggering elections that could result in more aggressive policies to stimulate the country's economy.
Prime Minister Yoshihiko Noda's move, made under pressure from the main opposition Liberal Democrat Party, allows Japan to head off its own "fiscal cliff". In exchange for fresh elections, the LDP gave its support for bonds to be issued to finance government operations for the rest of the year, ending a long-running impasse.
But even with that short-term fiscal crisis averted, Japan still faces substantial challenges as the country seeks to recover from the tsunami and nuclear disasters that rocked the world's third-largest economy last year.
The Japanese economy contracted at an annual rate of 3.5% from July to September, a faster rate than economists had expected. One more quarter of negative growth, deemed likely by analysts, and the economy will be in recession.
Policymakers have limited options for combating the economic malaise. The country's debt-to-GDP ratio is the highest in the world. And much like in the United States, its leaders do not agree on the path most likely to restore growth.
Fitch, the ratings agency, said this week that it remains concerned about the "leisurely pace" of fiscal consolidation in Japan -- and political dysfunction.
"Further political volatility would increase concerns about the ability of the Japanese political system to deliver policies geared toward fiscal sustainability," the agency said in a statement.
Indeed, based on current forecasts in Japan, neither of the two main parties is likely to secure enough votes in the election to form a majority government. The LDP is led by Shinzo Abe, a former prime minister who stepped down citing health reasons in 2007 after only a year in office.
Still, investors appear to be betting on a return to power for Abe, pushing up Japanese stocks and selling the yen this week on signs that he would push the Bank of Japan to relax monetary policy and adopt a higher target for inflation.
A new government may pursue fiscal stimulus as well. Analysts at Nomura said the chances of a supplementary budget for early next year had increased -- and could boost growth in 2013.
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