Paul Krugman: The Japan Story

The Japan Story:

Dean Baker is annoyed at Robert Samuelson, not for the first time, and with reason. The idea of invoking Japan, of all places, to justify fears that stimulus leads to inflation or asset bubbles is just bizarre….

[W]hat remains true is that Japan has run budget deficits for many years while delivering what appears on the surface to be very disappointing economic performance. What’s the story there?… First, you should never make comments on Japanese growth or lack thereof without taking demography into account…. [T]here were two long periods of depressed output relative to trend, one in the mid-1990s and another, much worse, between 1997 and 2007. And one other thing: Japanese monetary policy was still up against the zero lower bound in 2007, leaving it no room to counter the Great Recession, and hence leaving Japan open to a deep slump when exports plunged.

So how do we think about this problem? Here’s my take. Japan has pretty much spent the past 20 years in a liquidity trap… the amount that people would want to save at full employment exceeds the amount they would be willing to invest, also at full employment…. A debt overhang from the 1980s bubble surely started the process; but surely it’s reasonable to suggest that the demography also contributes…. What you need in this situation is a negative real interest rate — which means that you need some expected inflation, because nominal rates face the zero lower bound. But Japanese policy has never sought to achieve this. Deficit spending has put part, but only part, of the excess desired private saving to work; this has mitigated the slump, but not produced a booming economy….

Japan’s experience is perfectly consistent with an IS-LM type story, with nothing in there to suggest that fiscal stimulus has somehow backfired; stimulus has done exactly what you’d expect given its limited size and the refusal to take the opportunity to break out of the liquidity trap.

What Abenomics seems to be is an attempt, finally, to do what should have been done long ago: combine temporary fiscal stimulus with a real effort to move inflation up.

Oh, and what about the US relevance? We are, for the time being, in the same situation…. [B]ecause we don’t share Japan’s demographic challenge, our liquidity trap is probably temporary… so… fiscal stimulus is much more likely to serve as a bridge to a revived era of normal macroeconomics. That said, I welcome efforts by the Fed to modestly raise inflation expectations, and would like to see more. So, is Japan a cautionary tale? Yes, but not the tale everyone tells. Its performance isn’t that bad given the shortage of Japanese; and it’s a tale of fiscal and monetary policy that have been too cautious, not of stimulus that failed.