Japan, Revisted

I haven’t had a chance to comment on the recent debate regarding Japan’s lost decades, so I am coming to the party a bit late.   A view is forming that the situation is not as dire as many believe.  Paul Krugman notes:

This picture suggests that the Japanese economy was indeed depressed for about 16 years, and deeply so after the slump of the late 1990s. But it may have returned to more or less potential output on the eve of the current crisis.

Just to be clear, this is not a picture of policy success; it is, in fact, a picture of enormous waste. But the condition wasn’t permanent.

Yes, the lost years surely indicate a policy failure. But arguably there is some success.  On one hand, we can see this as vindication of massive deficit spending.  But is this really success?  Because on the other hand, there is no end in sight of such deficit spending.  On Japan’s 2012 budget, via the FT:

Even by current grim international fiscal standards, Japan’s budget for the year from April 1 makes scary reading.

For the fourth year in a row, government revenue from bond issuance is set to exceed that from all taxes. Outstanding government debt is expected to hit an extraordinary Y937tn.

I don’t intend to go down the “Japan’s bond market is about to collapse” path.   But what I am wondering about is Krugman’s description of the condition as not permanent. Do we need to see a reversal of debt to GDP ratios to declare victory?  Well, even on that metric it looks like there was some hope heading into the recent downturn:


But such hopes have since been dashed.

Where does this leave me?  Yes, fiscal policy can work – it can back fill missing demand.  But we haven’t seen enough activity in Japan to really jump start the economy to a point that fiscal policy is no longer an economic necessity.  And I am not sure we can expect such a jump start without more explicit help from the central bank.  In which case, Japan has not truly “recovered.”  Thus, we cannot yet conclude their condition is not permanent.

In short, before we can declare recovery in Japan, we need to define what a successful recovery should look like. Is it just about returning to potential output (adjusted, in this case, for demographics), or should it be recovery to the point that deficit spending is no longer necessary to support that output?

This post originally appeared at Tim Duy’s Fed Watch and is posted with permission.