Scott Sumner has a comment on Japan’s ”lost decades” and the importance of fiscal policy in Japan. Scott acknowledges based on comments from Paul Krugman and Tim Duy that in fact Japan has not had two lost decades. Scott also discusses whether fiscal policy has been helpful in reviving growth in the past decade in Japan.
I have two main conclusions in these comments:
1) Japan only had one “lost decade” and not two. The 1990s obviously was a disaster, but over the past decade Japan has grown in line with other large developed economies when real GDP growth is adjust for population growth. (And yes, 2008 was a disaster in Japan as well).
2) Monetary policy is at the centre of these developments. Once the Bank of Japan introduced Quantitative Easing Japan pulled out of the slump (Until BoJ once again in 2007 gave up QE and allowed Japan to slip back to deflation). Se especially my post “Japan shows QE works”.
This graph of GDP/capita in the G7 proves the first point.
Second my method of decomposition of demand and supply inflation – the so-called Quasi-Real Price Index – shows that once Bank of Japan in 2001 introduced QE Japanese demand deflation eased and from 2004 to 2007 the deflation in Japan only reflected supply deflation while demand inflation was slightly positive or zero. This coincided with Japanese growth being revived. The graph below illustrates this.
Obviously the Bank of Japan’s policies during the past decades have been far from optimal, but the experience clearly shows that monetary policy is very powerful and even BoJ’s meagre QE program was enough to at least bring back growth to the Japanese economy.
Furthermore, it is clear that Japan’s extremely weak fiscal position to a large extent can be explained by the fact that BoJ de facto has been targeting 0% NGDP growth rather than for example 3% or 5% NGDP growth. I basically don’t think that there is a problem with a 0% NGDP growth path target if you start out with a totally unleveraged economy – one can hardly say Japan did that. The problem is that BoJ changed its de facto NGDP target during the 1990s. As a result public debt ratios exploded. This is similar to what we see in Europe today.
So yes, it is obvious that Japan can’t not afford “fiscal stimulus” – as it today is the case for the euro zone countries. But that discussion in my view is totally irrelevant! As I recently argued, there is no such thing as fiscal policy in the sense Keynesians claim. Only monetary policy can impact nominal spending and I strongly believe that fiscal policy has very little impact on the Japanese growth pattern over the last two decades.
Above I have basically added nothing new to the discussion about Japan’s lost decade (not decades!) and fiscal and monetary policy in Japan, but since Scott brought up the issue I thought it was an opportunity to remind my readers (including Scott) that I think that the Japanese story is pretty simple, but also that it is wrong that we keep on talking about Japan’s lost decades. The Japanese story tells us basically nothing new about fiscal policy (but reminds us that debt ratios explode when NGDP drops), but the experience shows that monetary policy is terribly important.
PS I feel pretty sure that if the Bank of Japan and the ECB tomorrow announced that they would target an increase in NGDP of 10 or 15% over the coming two years and thereafter would target a 4% NGDP growth path then all talk of “lost decades”, the New Normal and fiscal crisis would disappear very fast. Well, the same would of course be true for the US.