Makin’s optimism stems from the recent decision by the Bank of Japan (the BOJ is Japan’s Federal Reserve) to ease credit until inflation, now virtually nonexistent, reaches 1 percent. If successful, the BOJ would end periodic bouts of deflation — falling prices — that, Makin and other economists contend, hobbled the economy. Falling prices cause people to postpone purchases, expecting items to become cheaper. Deflation also deters borrowing, because debts have to be repaid in more expensive currency.
The BOJ’s decision, made Feb. 14, might reverse these trends. To generate higher inflation, the BOJ would inject money into the economy. Some extra cash would go into consumer spending; some would go into the stock market. Lastly, higher inflation could cause the yen to depreciate, reviving exports by making them cheaper. Combined with rebuilding after last year’s devastating earthquake, all this would revive the economy. That’s the theory.
Japan’s experience has relevance for America’s tepid recovery. How much can fiscal policy (government budget policy) and monetary policy (interest rates, credit conditions) compensate for underlying structural problems? Since the early 1990s, Japan has run loose monetary policies and large budget deficits. They haven’t fully resuscitated the economy. Some economists argue that these policies were always too little, too late; others contend that there are limits to what textbook economic policies can do.
“Japan has a political system that looks disturbingly like the United States’,” says economist Marcus Noland of the Peterson Institute. “The elected political elites seem unable to formulate compromises that redound (positively) on the economy.” He cites lagging reconstruction of the Tohoku region that was hit by the earthquake.
Japan faces three major structural problems — and, interestingly, there’s an American counterpart for each.
First, the country’s basic economic model is broken. That model was export-led growth. It worked well until the mid-1980s when the yen’s rising value made exports much more expensive. Japan has yet to create an adequate substitute. The U.S. counterpart is consumption-led economic growth. From the 1980s to 2007, Americans went on a shopping spree; they skimped on saving and borrowed against rising home values and stock portfolios. The loss of much of that wealth has now dampened consumer spending. It’s unclear whether a new engine of growth will emerge — and what it might be.