Keynesian Economics Didn't Work in Japan

Douglas French wrote about the economic history of Japan over the last two decades.  It started with a real estate bubble bursting and has continued with bailouts, stimulus, quantitative easing, zero percent interest rates, tax rate cuts, and no spending cuts. 

Does any of that sound familiar? 

Do you suppose that the results are any good?

When that doozy of a bubble popped, the supposedly halfhearted BOJ transformed the world’s healthiest OECD country in 1990 into a country with a public debt of 240% of GDP. Bill Bonner quips, “The Japanese tried to cure an alcoholic with heroin. Now they’re addicted to it.”

Japan’s monetary policy aggressively lowered rates to 0.5% between 1991-1995 and has operated a zero interest rate policy virtually ever since.

The Japanese government didn’t just leave matters to the monetary authorities. Between 1992-1995, it tried six stimulus plans totaling 65.5 trillion yen and even cut tax rates in 1994. It tried cutting taxes again in 1998, but government spending was never cut.

In 1998, another stimulus package of 16.7 trillion yen was rolled out, nearly half of which was for public works projects. Later in the same year, another stimulus package was announced, totaling 23.9 trillion yen. The very next year, an 18 trillion yen stimulus was tried, and in October 2000, another stimulus of 11 trillion yen was announced.
During the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession.

In spring 2001, the BOJ switched to a policy of quantitative easing — targeting the growth of the money supply, instead of nominal interest rates — in order to engineer a rebound in demand growth.

The BOJ’s quantitative easing and large increase in liquidity stopped the fall in land prices by 2003. Japan’s central bank held interest rates at zero until early 2007, when it boosted its discount rate back to 0.5% in two steps by midyear. But the BOJ quickly reverted back to its zero interest rate policy.

In August 2008, the Japanese government unveiled an 11.5 trillion yen stimulus. The package, which included 1.8 trillion yen in new spending and nearly 10 trillion yen in government loans and credit guarantees, was in response to news that the Japanese economy the previous month suffered its biggest contraction in seven years and inflation had topped 2% for the first time in a decade.

In December 2009, Reuters reported, “The Bank of Japan reinforced its commitment to maintain very low interest rates on Friday and set the scene for a further easing of monetary policy to fight deflation. The bank said that it would not tolerate zero inflation or falling prices.”

In a paper for the International Monetary Fund entitled Bank of Japan’s Monetary Easing Measures: Are They Powerful and Comprehensive?, W. Raphael Lam wrote that the BOJ had “expanded its tool kit through a series of monetary easing measures since early 2009.” The BOJ instituted new asset purchase programs allowing the central bank to purchase corporate bonds, commercial paper, exchange-traded funds (ETFs), and real estate investment trusts (REITs).

According to Lam’s work, the BOJ bought 134.8 trillion yen worth of government and corporate paper between December 2008 and August 2011. Lam described the impact of these purchases as “broad-based and comprehensive,” but it failed to impact “inflation expectations.”

For more than two decades, the Japanese central bank and government have emptied the Keynesian tool chest looking for anything that would slay the deflation dragon. Reading the hysterics of the financial press and Japanese central bankers, one would think prices are plunging. Or that borrowers cannot repay loans and the economy is not just at a standstill, but in a tailspin. Tokyo must be one big soup line.

Why would doing all of those things here give us better results than the Japanese got?

Do you want to know what the American economy will look like in the next few years?  Have a look at Japan's new normal.