Paul Krugman comments on Japan in the New York Times and makes a remark that I find very interesting. Two actually that have always kept me a bit worried when Bill Mitchell points out that constant, relatively high deficits, and a high debt-to-GDP ratio are not unsustainable and will not lead to inflation. The first is in connection to GDP growth, which never looks very impressive for Japan in the last decades:
First, you should never make comments on Japanese growth or lack thereof without taking demography into account. Japan has low fertility and low immigration; this has translated into a dramatically aging population and a declining working-age population. So what does Japan’s performance look like if you calculate real GDP per working-age adult? (In the picture below I define working-age as 15-64; this is one case in which you DO NOT WANT to look at FRED, which defines working age as 16+ and therefore takes no account of aging).
I’ve used a log scale, so you can view vertical distances as percentage changes. If we look at growth from the early 1990s to the business cycle peak in 2007, we have growth of about 1.2% per year. That’s actually not bad; you can argue that demographically adjusted, the whole tale of Japanese stagnation is a myth.
The second remark has to do with the on-going deflation:
What is true is that there 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; as I’ve been explaining for years, one way to understand such traps is that they happen when, even at a zero real interest rate, the amount that people would want to save at full employment exceeds the amount they would be willing to invest, also at full employment[.]
Why is Japan in this situation? A debt overhang from the 1980s bubble surely started the process; but surely it’s reasonable to suggest that the demography also contributes, since a declining working-age population depresses the demand for investment.
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, except perhaps briefly circa 2007. And the Bank of Japan has always pulled back on monetary policy when the economy looks better, instead of doing what it should, which is to keep the pedal to the metal until the inflation rate is solidly into positive territory.
I don’t know how valid those two points are but they offer a way of thinking about why Japan, even though it is closer than the other “industrialized” countries to working with stimulus and deficit spending, is not experiencing stronger, sustained growth. There are other aspects, such as that an export-oriented economy is very reliant on trading partners doing well, which they currently don’t.
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.
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.
Wonder whether European austerians will listen?