Japan’s Lost Decade

Japan has suffered from sluggish economic growth and recession since the 1990s, a period dubbed “Japan’s Lost Decade.” The People’s Republic of China, many countries in the eurozone, and the United States may face similar problems in the future, and they have been concerned by Japan’s long-term recession. This chapter will address why Japan’s economy has stagnated since the bursting of its economic bubble. Our empirical analysis challenges the beliefs of some western economists, such as Paul Krugman, that the Japanese economy is in a liquidity trap. We argue that Japan’s economic stagnation stems from a vertical investment–saving curve rather than a liquidity trap. The impact of fiscal policy has declined drastically, and the Japanese economy is facing structural problems rather than a temporary downturn. These structural problems have many causes: an aging demographic (a problem that is frequently overlooked), local governments’ overreliance on transfers from the central government, and Basel capital requirements that have made Japanese banks reluctant to lend money to startup businesses and small and medium-sized enterprises. This latter issue has discouraged Japanese innovation and technological progress. The chapter will address all these issues empirically and theoretically and will provide some remedies for Japan’s long-lasting recession.

This chapter analyzes the economic effect of infrastructure, focusing on the productivity effect of public investment, and discusses how to promote the private sector investment in infrastructure by enhancing the rate of return to investors by utilizing part of spillover effects from the infrastructure. Traditional highway or railway investment relies on toll fees or train fees, which are often regulated to keep the price low. Private investors find it difficult to obtain an adequate rate of return. This chapter proposes the incremental tax revenues along the highway or railway should contribute a certain fraction of tax revenues (say 30%) to investors in infrastructure.

The important factors for further promoting the use of private sector resources in infrastructure development include (i) government involvement in high-risk infrastructure projects and risk sharing between government and the private sector, (ii) an earnings structure that appropriately reflects the spillover effect of infrastructure (e.g., return of some spillover tax revenues to infrastructure investors), and (iii) systems designed to increase incentives for infrastructure-operating entities.

Japan’s debt-to-gross domestic product (GDP) ratio is the highest among Organisation for Economic Co-operation and Development (OECD) countries. This chapter will answer the question of whether Japanese government debt is sustainable. While the Domar condition and Bohn’s condition are often used in the literature to check whether a government’s debt situation is in a dangerous zone, this chapter will show that the Domar condition is obtained only from the government budget constraint (namely the supply of government bonds) and does not take into account the demand for government bonds. A simple comparison of the interest rate and the growth rate of an economy using the Domar condition is not adequate to check the stability of a government’s budget deficit. Both the interest rate and the growth rate of the economy are determined endogenously in the model. This chapter shows that Bohn’s condition satisfies the stability of the government budget in the long run by imposing constraints on the primary balance. However, Bohn’s condition does not achieve economic stability—even if the condition is satisfied, the recovery of the economy may not be achieved. This chapter will propose a new condition that satisfies both the stability of the government budget and the recovery of the economy. The chapter will shed light on these issues both theoretically and empirically. The empirical findings declare that in order to achieve fiscal sustainability based on the optimal fiscal policy rule provided in this chapter, both sides of the Japanese government budget (expenditure and revenue) need to be adjusted simultaneously. Moreover, the results show that the decrease in government expenditure must be more than the increase in tax revenue.

This chapter applies Bayesian estimation to an open-economy dynamic stochastic general equilibrium (DSGE) model of Japan to assess the effects of expanding government debt on interest rates, real exchange-rate dynamics, and real sector performance. We find that the emergence of even a small risk premium on will trigger considerable instability in the real and nominal variables. We show that a switch to an exchange-rate rule for monetary policy would considerably moderate the instability induced by a rising risk premium.

This brief chapter investigates postwar Japanese monetary policies through the lens of the Taylor equation and the associated Taylor rule. We break from previous studies in extending the investigation back to the early postwar period and by examining the stability of the Taylor specification in various subperiods. In general, we find little support for the Taylor equation in the Japan case. A possible exception is the period from 1980–1997, but this was a period of the “bubble economy” and subsequent “Lost Decade.” We see this as setting the stage for a more detailed description and assessment of Japan’s postwar monetary policies.

Since the oil price shocks of the 1970s, several studies have found significant impacts of oil prices on macro variables. However, it is particularly crucial to know how each micro sector in an economy, such as the residential, transport, industrial, and nonenergy sectors, respond to oil price impulses. In this research, we try to shed light on the impact of crude oil price volatility on each sector in Japan, the world’s third-largest crude oil consumer. To do so, we apply a vector auto regression model and perform impulse response analysis by using quarterly data from 1990Q1 to 2014Q1. The findings indicate that some economic sectors, such as the residential sector, did not have significant sensitivity to the sharp oil price fluctuations. In contrast, some other sectors, like the commercial, industrial, and transport sectors, were strongly sensitive to the drastic oil price fluctuations. Moreover, our findings show that after the Fukushima disaster in 2011, which led to the shutdown of nuclear power plants in Japan and increased the country’s reliance on oil imports, the sensitivity of most sectors to oil price volatility declined.

“Abenomics” refers to the economic policies advocated by Prime Minister Shinzo Abe, who became Prime Minister of Japan for a second time when his party, the Liberal Democratic Party, won an overwhelming majority at the general election in December 2012. Abenomics is distinguished by sets of policies that comprise “three arrows”: (i) an aggressive monetary policy, (ii) fiscal consolidation, and (iii) a growth strategy. The Japanese economy faces an aging population and expanding social welfare expenses. No other country has experienced Japan’s rapid growth of retired people. In this chapter we will explain these three aspects of Abenomics and the current state of the Japanese economy and examine what further remedies may be required if Japan is to recover from its long-term deflation. Among remedies we will highlight hometown investment trust (HIT) funds, as a new way of financing start-up businesses and SMEs. The sector that dominates the Japanese economic output and employment.

In April 2013, the Bank of Japan (BOJ) introduced an inflation target of 2% with the aim of overcoming deflation and achieving sustainable economic growth. But due to lower international oil prices it was unable to achieve this target and was forced to take further measures. Hence, in February 2016, the BOJ adopted a negative interest rate policy by massively increasing the money supply through purchasing long-term Japanese government bonds (JGB). Previously the BOJ only purchased short-term government bonds. This policy has flattened the yield curve of JGBs. One the one hand, banks reduced the numbers of government bonds because short-term bond yields had become negative, and even the interest rates of long-term government bonds up to 17 years became negative. On the other hand, bank loans to the corporate sector did not increase, due to the Japanese economy’s vertical investment–saving (IS) curve. This chapter firstly explains why, in the view of the authors, the BOJ must reduce its 2% inflation target in the present low oil price era. Secondly, it argues that Japan cannot make a sustainable recovery from its long-lasting recession and tackle its long-standing deflation problem by means of its current monetary policy, and its negative interest rate policy in particular. It is of key importance to make the IS curve downward sloping rather than vertical. That means the rate of return on investment must be positive and companies must be willing to invest if interest rates are lowered. Japan’s long-term recession is due to structural problems that cannot be solved by its current monetary policy. The last section reports the results of our simulation of tackling Japan’s aging population by introducing a productivity-based wage rate and postponement of the retirement age, which will help the recovery of the Japanese economy.