Fiscal Stimulus and Japanese Stagnation in Early 1990 Crisis - Research Paper Example

Your Prof Did the fiscal stimulus work during the Japanese Stagnation in early 1990 crisis? Introduction Following strong economic growth in the eighties extending until 1991, the Japanese economy began its long run of stagnation so much so that during the entire decade from 1992 to 2002, Japan saw its real GDP growth rise more than 2% in only 2 of the 10 years. Due to this severe economic stagnation, this period is also known as the “Lost Decade” of Japan. While it would not be correct to say that the Japanese government did nothing to spur growth during this period, strictly taking into account the resultant GDP, it does seem that whatever the government did was probably not enough. Indeed, the government introduced several fiscal stimuli, they were, however, not effective enough to bring back the growth that the Japanese economy had earlier witnessed. Opinions on the effectiveness of the fiscal stimulus abound in literature written by economists with some arguing that the fiscal stimulus was not successful and actually degraded the economic growth due to the crowding out effect; while others arguing that the fiscal stimulus prevented worsening of the economy and should therefore be considered “successful”. In my opinion, however, the fiscal stimulus did not work and the reason for this, in part, is due to the fact that most fiscal stimulus when actually implemented/applied by the Japanese government was seldom close to what the government actually promised to implement/apply. Therefore, the fiscal stimulus failed to work because whatever stimulus was actually applied was never enough. Following the September 1985 Plaza Accord, the Japanese Yen started to appreciate which led to Japan’s export sector getting badly hit. To counter this appreciation of the Yen, the Bank of Japan drastically eased its monetary policy reducing the interest rate from 5% in January 1986 to 2.5% in February 1987. Soon, the real estate and financial markets began to expand rapidly as a result of this monetary easing, creating a huge financial asset bubble. In response to this, the government increased its interest rate to 6% in 1989-90. The sudden tightening of the money supply led the markets to collapse and thus began the onset of a long period of stagnant economic growth in Japan. The real GDP increased from 428,826 billion Yen in 1990 was to a mere 469,480 billion Yen by the end of 2000 (Powell). Statistical evidence of poor performance of fiscal stimulus The discussion about fiscal stimulus and the Japanese 1990s crisis finds root in the Keynesian economic principles. Keynesian economists preach that during a cyclical trough, discretionary fiscal policies can help the economy emerge from the trough. That is, when the economy goes down due to cyclical factors, the government by introducing fiscal expansionary policy (applying fiscal stimulus) can help the economy maintain emerge from the downturn faster. The Japanese economy in the 1980s saw rapid expansion and large building up of asset bubbles. Accordingly and cyclically, when the bubbles burst, the economy started to cool down. However, this time the trough was not due to a business cyclical downturn; the economy had lost steam due to asset bubble burst. Keynesians argue that by applying large fiscal stimulus under such situations, the government can reinvigorate growth. The Japanese government did apply several fiscal stimulus programs but was unsuccessful in spurring growth or controlling other macroeconomic indicators either. Figure 1 below puts into perspective the state of the Japanese economy during the crisis. It shows the real GDP growth rates for Japan and for the US from 1985 to 2002. Figure 1: Comparison of Real GDP growth in Japan and US from 1985 to 2002 From Figure 1, we see that Japan enjoyed high economic growth from 1985 to 1991 where after the economy was more or less stagnant until 2002 except in 1996 (2.6%) and in 2000 (2.9%) where the economic growth was >2% but still well below that of US. As illustrated in Figure 2, during this time, the unemployment continued to increase and inflation reached close to zero and was even negative for some years. The unemployment rates increased from a low of 2.1% in 1991 to 5.4% in 2002, continuously increasing during the entire period. Inflation touched below zero at -0.1% in 1995 and again reached below zero in 199 where after it stayed below zero until 2002. In fact, it continued to stay below zero until 2005. Clearly, with the GDP not increasing, unemployment rising, and inflation reaching near and below zero, the Japanese economy showed no signs of improvements – this further proves the inutility of fiscal stimulus applied by the Japanese government during the 1990s crisis. No counter-cyclical fiscal stimulus can be considered effective if it does not help the economy spur back to growth, or prevent increasing unemployment, or prevent deflation. Figure 2: Inflation and Unemployment in Japan from 1985 to 2002 It can thus be generally accepted that the economic policies of the Japanese government did little to improve the Japanese economy. We must now look at the quality and the quantity of the fiscal policies to ascertain whether enough was done to spur growth. Significant size of the fiscal stimulus During the period 1991 to 2000, the government undertook several initiatives for fiscal stimulus. The total national debt as a percentage of GDP for Japan increased from 67.6% in 1985 to 161% in 2002. In absolute terms, the net debt for Japan increased from 66.7 trillion Yen in 1990 to 356.8 trillion Yen in 2002. Figure 3 shows the evolution of net debt. In effect, the net debt increased by nearly 290 trillion Yen from 1990 to 2002. Clearly then, the near 6 fold increase in net debt shows that the government did introduce several fiscal stimulus during this period. Until 1990, the Japanese government maintained the net debt around 70% of the GDP where after, from 1991 to 1999, each year the net debt increased by at least 13% in absolute terms with the highest increase coming in 1997 (30% increase). The total debt reached 100% of the GDP in 1996. The trend of increase in public debt shows that the fiscal policy was increasing gradually and in no year, there was a “huge” stimulus provided. Figure 3: Evolution of Japanese government Net debt from 1985 to 2002 Most increase in this debt was used for providing fiscal stimulus to the economy. Figure 4 shows the details of the fiscal stimulus programs launched by the Japanese government from 1992 onwards. Of the total fiscal stimulus, 22.6 trillion Yen was spent in personal tax cuts – 15 Trillion Yen were spent in ad hoc tax cuts provided from 1994 to April 1998 and finally in Nov 1998, a permanent tax cut was introduced which was worth 6 trillion yen. Government spending on infrastructure accounted for 70 trillion Yen from 1992 to 2002. It included mostly spending on public works involving central government (38.2 trillion Yen). Other than this, the key ingredient of the fiscal stimulus was government lending to small and medium enterprises worth 44 trillion Yen during this period. Interestingly, employment support was started only in 1998 and amounted to only 5 trillion Yen from 1992 to 2002. Figure 4: Fiscal Stimulus Packages in Japan since 1990s Poor implementation of the fiscal stimulus The Japanese government was increasing its fiscal spending during the years yet the economy responded poorly to the stimulus. Therefore, we now turn to details of how much of the stimulus was actually implemented and pumped into the economy. According to a report from IIE, the actual implemented fiscal stimulus was far short of the fiscal stimulus that the Japanese government announced in the early 1990s. According to them, several claims and data suggest that 65 to 75 trillion Yen were spent by the government on fiscal stimulus between 1991 and 1995. In fact, the government did increase its debt by this amount but the actual amount injected into the economy was only 23 trillion Yen, one third of the amount announced. Table 1 below shows the details of the announced fiscal stimulus plans and the actual implemented program details. Clearly, this seems to suggest that either the government was making too many promises and not very active in implementing them, or while the central government took on debt to inject the fiscal stimulus into the economy, the local governments were not able to implement the fiscal stimulus packages properly leading to a half-hearted effort in deploying the fiscal expansionary policy. Had the full announced packages been implemented, the effect could possibly have been much more positive than what Japan saw. Table 1: Comparison of announced and implemented amount of fiscal stimulus in early 1990s (Figures are in billions of Yen) It is interesting to note that the actual amount injected in to the economy was roughly 1/3rd of what was announced by the government. It seems that the local government set-up failed to effectively implement the fiscal stimulus. Ishii & Wada suggest that from 1992 to 1996, the local governments actually spent 10 trillion Yen less than what the central government had projected (25 trillion Yen from 1992 to 1996). The local governments spent 3.6 trillion Yen less than the initial budget meaning that not only did they fail to spend the 6 trillion Yen in additional stimulus, they also spent less than the initial budget (excluding fiscal stimulus). Thus, while the government had taken on the debt to implement the fiscal stimulus programs, ineffectiveness at local implementation levels meant that the actual stimulus reaching the economy was far lower than the debt. Non-Committal Fiscal Stimulus Next, another important aspect of the fiscal stimulus to be noted is that while there was some fiscal stimulus applied from 1992 to 1995, there was none in 1996 and 1997 thereby undermining the effects of previous stimuli as well (Bruckner & Tuladhar). Figure 5 below shows the details of stimulus package size, fiscal balance and GDP growth from 1990 to 2000. We observe that there were no discretionary fiscal policies applied in 1996 and 1997; just when the economy had started to show positive growth. It could be said that the GDP growth in 1995 from 1997 was driven by the effect of fiscal stimulus applied in the previous years from 1992 to 1995, but due to no further impetus, this growth eventually died out leading to negative GDP growth in 1997. Thereafter, 1998 saw a huge increase in fiscal stimulus and then some more in 1999 and 2000, which led to a positive growth again in 2000. We could therefore conclude that while the fiscal stimulus was helping to bring the economy back to positive, due to the non-committal and “start-stop-start” nature of fiscal packages by the Japanese government, the net effect was that the fiscal expansionary policy proved near ineffective. Figure 5: Fiscal stimulus packages applied in Japan from 1990 to 2000 Conclusion Japan witnessed long and depressive economic conditions during the 1990s. During this period, the Japanese government used discretionary fiscal policy to overcome the trough but they did little to alleviate the problems. The reasons lie probably not in the fundamental use of fiscal stimulus to spur economic growth but more in the way they fiscal stimulus was implemented. There were many other factors at play that reduced the effect that the fiscal stimulus could have potentially generated. These factors included partial implementation of announced packages by the central government, inefficient allocation of packages, and further insufficient injection of the packages into the economy by local governments. Had the implementation issues been taken care of, the fiscal stimulus could well have brought the Japanese economy back to growth. However, as it stands, one could conclude that the fiscal stimulus applied by the government did not work during the Japanese stagnation in the 1990s crisis. References Bruckner, markus and Anita Tuladhar. "Public investment as a fiscal stimulus: Evidence from Japan's regional spending during the 1990s." IMF Working Paper. 2010. IIE. "Fiscal Policy Works When It Is Tried." 1996. IMF. Report for Selected Countries and Subjects: Japan. 2011. 10 October 2011 . indexmundi. Japan GDP - real growth rate. 2011. 10 October 2011 . —. United States GDP - real growth rate. 2011. 10 October 2011 . Ishii, Hiroko and Erika Wada. "Local Government Spending: Solving the Mystery of Japanese Fiscal Packages." 1998. Ministry of Internal Affairs and Communication. Chapter 22: Prices. 2011. 10 October 2011 . Powell, Benjamin. Explaining Japan's Recession. 19 November 2002. 10 October 2011 . Read More