Japans Lost Decade Essays - Public Finance, Monetary Economics

Japan had been the model economy of the world, envied by countries around the globe, and was one to be emulated during the 1980?s (Farnham, P. 2010). Japan?s rapid and sustained growth in GDP after WWII was due to innovative manufacturing processes using ?statistical quality control ? methods and many other investments in infrastructure and technology. The Japanese economy today, even after a decade of economic set-back, is still the second largest economy in the world with over $7 trillion in annual GDP (Farnham, P. 2010). In any event, the ?lost decade? has been studied by economist to determine why Japan?s fiscal and monetary policies did not work quickly. Specifically, the US wishes to avoid a similar period of stagnation. The reasons leading up to Japans economic ?bubble? crash, and subsequent recession from 1990 through 2000 appear to be generally agreed upon by economist. After decades of very strong growth in GDP subsequent to WWII, Japan?s economy came to an abrupt halt in 1990, and was followed by a decade of stagnation; dropping land prices, financial banking dysfunction, and a falling stock market (Powell, B. 2002). The central catalyst to the crash, most economists agree, is that the government attempted to offset the stronger yen in the late 80?s by easing monetary policy between January 1986 and February 1987. During this period, the Bank of Japan (BOJ) instituted an expansionary monetary policy whereby the discount rate was cut in half from 5 percent to 2.5 percent (Powell, B. 2002). Due to the stimulus created by the monetary policy, asset prices in the real estate and stock markets inflated, creating one of the biggest financial bubbles in history. The Bank of Japan (BOJ) responded by con tracting monetary policy. The BOJ raised interest rates five times, up to 6 percent in 1989 and 1990. After these increases in interest rates, the market collapsed (Powell, B. 2002). Before discussing Japans specific attempts to stimulate their economy, a brief discussion of fiscal and monetary policies is necessary. Fiscal policy generally refers to a governments spending of revenue and expenses. Revenues are typically generated through taxes, and expenses are normally focused on spending for required government services. There are three possible stances of fiscal policy; neutral, expansionary, and contractionary. A neutral policy would mean that the government is spending equal to revenue. An expansionary policy means that the government is spending more than it is collecting, e.g. deficit spending. Contractionary policy means that the government is spending less than it is collecting, e.g. a budget surplus (Farnham, P. 2010). Monetary policy is considered the government?s central banks control over the money supply, specifically interest rates and available bank cash surpluses. Easy money, or expansionary monetary policy is one in which the central bank creates a favorable investment environment by keeping interest rates low, and cash reserves high. Contractionary monetary policy refers to the central bank raising interest rates and lowering banking surpluses. The central bank?s primary tools for controlling monetary policy are open market operations and the discount rate. The central bank is able to manipulate the money supply and interest rates by buying and selling government securities in the open market, and by directly cutting the discount rate, which is the rate that the central banks charges to member banks for borrowed cash reserves. The most common and powerful tool the central bank uses are open market transactions, which as mentioned, is the buying and selling of government securities, which c auses the federal funds rate to change, and effects overall interest rates in an economy (Farnham, P. 2010). Japan appears to have attempted all types of monetary and fiscal policies during its ?lost decade? (Reynolds 2009). Japans nominal interest rate was kept very low during the 1990?s. There were a total of 10 Japanese ?fiscal stimulus? packages in the 90?s alone, focused on government spending. Government consumption, mainly public payrolls, rose from 5.9% GDP in 1991, to 7.5% in 2003. Yet, total employment did not increase at all during this decade. Japan has suffered major shocks to the prospective productivity of labor and capital which are arguably a consequence of a very high corporate tax rate. Plus, harmful new taxes on land, capital gains, and household consumption