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The federal government and the Federal Reserve are attempting to reverse the current economic downturn with aggressive fiscal deficits and severely reduced interest rates. Nearly 20 years ago, Japan tried the same approach, but with scant success. What happened in Japan’s “lost decade” provides an insight into what Americans may expect in the coming years.
After a credit-induced boom in the late 1980s, Japan’s stock and real estate markets tumbled. From a high in December 1989, the Nikkei Index fell in less than a year by 46 percent. Within two years it had fallen by 59 percent. Following the crash, loan defaults soared—sound familiar?—and Japan’s Urban Land Price Index began an unbroken decline which has continued to this day. As of the latest measure, 2008, the index was well under half its 1991 level. At the same time, annual per capita growth stalled to an average of less than one percent for 1991 to 1999—going negative in 1993, 1998, and 1999. The rate of unemployment doubled during the 1990s and has never recovered.
The Japanese government responded with a succession of deficit-driven stimulus policies, alongside a similarly aggressive monetary policy from the Bank of Japan. As American leaders are doing now, Japan brought in temporary tax cuts, but the primary emphasis was on increased spending on infrastructure projects. The seaside town of Hamada, as just one example, gained their own bridge to nowhere, along with a new highway, university, prison, and art museum, among an array of government-funded projects. Although not always so extreme, rural Japan is littered with recently built infrastructure, warranted by hopes of job creation, not necessarily constituent need.
Consequently, the government’s surplus in 1990, equal to 2 percent of GDP, plunged to a string of deficits, only getting larger as the forgettable decade wore on, equal to 7.4 percent of GDP by the year 2000. Also getting larger during that period was the size of government expenditures relative to the economy, rising from 30.5 percent in 1990 to 38.6 percent in 2000.
The Bank of Japan’s strategy was to simply lower interest rates, and to continue doing so, holding to 1 percent or less for most of the 1990s. (In fact, Japan’s central bank discount rate still sits at 0.1 percent, as it has remained for almost a decade.) However, confidence in the Japanese economy had fallen to such a large degree that the cuts to the interest rate had no apparent effect on employment or economic activity. Few people were willing to borrow yen, certainly not enough to have the intended stimulatory outcome, and Japan found conventional monetary policy to be ineffectual. Despite interest rates close to zero, Japan was and continues to be dogged with price deflation.
By the end of the 1990s, Japan’s economy was in even worse shape than it was after the crash in 1990, and the lost decade looks set to be remembered as the lost two decades. The only prize the strategy achieved for Japan was the largest national debt, 200 percent of the entire economy, in the developed world.
Click to enlarge chart. Data Sources: Japanese Debt: International Monetary Fund (World Economic Outlook Database), Nikkei 225 Index: Finance.Yahoo.com (supplied by Commodity Systems Incorporated)
The United States stands in a similar economic position to Japan of the early 1990s, and the federal government’s and Federal Reserve’s overarching response also matches that of Japan, in both magnitude and substance. If anything, American leaders are being more aggressive with their response. The Obama administration’s projected deficits for the next ten years, $9.1 trillion, would be more than 5 percent of economic activity for the entire decade, while Japan’s was 4 percent for the decade following the 1990 collapse. On the monetary side, the cost of borrowing the U.S. dollar is now even cheaper than the yen ever was in the 1990s, although both sit at close to 0 percent, with little room to go any lower.
In addition to comparable declines in employment and economic activity, America’s population is also aging, although not as rapidly as Japan's. Perhaps the main advantage the United States has in dealing with that problem is a more flexible workforce, in which workers can transfer more swiftly to productive placements.
If one is to go by the Japanese experience, Americans should expect little from the current stimulus policies. Even a prominent proponent and architect of the Japanese approach, Richard Koo (chief economist of Nomura Research Institute, Tokyo, and a former New York Fed economist), has argued that avoidance of a more severe recession is the best American leaders can hope for, so a limp and drawn out recovery is most likely. At the same time, if America follows Japan’s deficits and growth of government, which did not come for free, an expanded debt and interest burden will be unavoidable.
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