New policies needed for Japan's economic problems

Comments on Richard Katz “Inflation targeting will not work on Japan’s deflation problem”, 24/03/2010, http://www.eastasiaforum.org/2010/03/24/inflation-targeting-will-not-work-on-japans-deflation-problem/

It seems that the Japanese case has some uniqueness and consequently any policy for dealing with the Japanese economy will have to address the causes underlying that uniqueness.

In my view, the economic experience Japan has had since the late 1980s or early 1990s has been different from any financial and economic problems the world leading economies have had, including the great depression of the 1930s.

There are two main differences. One is that Japan has been experiencing population aging, and in danger of declining. This has implications for social burden or the so called dependent ratio. Clearly the dependent ratio has been expected to rise and people will live longer, including more years after retirement.

The second is that Japan has had relatively high productivity. The implication of this is that it is difficult to expect that significant advances in productivity from Japan if it is on the world production frontier.

Thirdly, Japan, as similar to other East Asian countries, has had high saving rates.

While there can be other uniqueness, but the combination of these three factors can be very serious and indeed deadly, especially following the serious balance sheet recession that occurred in the early 1990s.

People’s expectations have been formed under these factors. They had realised that the past rapid economic growth was over; that their assets values have permanently decreased and cannot increase much; their income from work was also limited by being already high and on the world productivity frontier; that they will need more savings for their retirement.

Conventional fiscal policies, whether they are in the form of government investment in infrastructure or giving people spending power may be ineffective, because it can be regarded as purely wasteful rather than productive. Conventional monetary policies are ineffective when they came to liquidity trap, that is zero or near zero interest rates.

It is likely that any policies will have to be credible to change the underlying behaviours out of those concerns. They need to shape people's “rational expectations”, so people can see a credible way to increase their current consumptions and still be able to live in retirement comfortably, due to the implementation of those policies