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Issues in Money, Banking & Finance - Essay Example

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Japan’s unsuccessful struggle with deflation over the last twenty years has shown how costly deflation could be for any economy, especially if economic conditions at the time are unfavourable. Nishizaki et al (2014: p27) note that while price levels do decline temporarily in…
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Issues in Money, Banking & Finance
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Download file to see previous pages Some of the treatments that Japan has attempted in combating deflation are fiscal expansion, reduction of interest rates, depreciating the Yen, bank restructuring, two rounds of quantitative easing, and Abenomics. However, with the exception of the last measure whose effect is yet unclear, the situation has not changed much with a continuous economic recession reflected by its balance sheet (Botman et al, 2015: p32). This paper will explore the reasons why monetary and fiscal policy measures, as well as economic restructuring measures by Japan, have failed to end the deflationary pressures on its economy.
As Japan’s consumption rate tax increased in 1997 followed by an economic recession and a deflationary spiral, Krugman (1999b: p1) stated that Japan had entered into a liquidity trap, in which the demand for currency was increasing dramatically, while resulting increases in the supply of currency failed to effect any changes in interest rates. This assertion was an extension of liquidity trap theory advanced by Keynes, where an economy’s general demand continues to decline despite a reduction of nominal interest rates to zero with production capability being higher than the general demand. Therefore, this definition would attribute Japan’s deflationary spiral to inadequate effective demand in relation to consumption and investment. Although Japan kept its interest rates low, this was still not enough to stimulate consumption and investment, while expansion of currency supply by the Bank of Japan was equally ineffective (Murota & Ono, 2012: p344).
Krugman (1999c: p1) attributes this phenomenon to the fact that the Japanese public was more likely to save due to uncertainty about the country’s economic future, as well as fears that their income would reduce, despite having stable liquidity preference at the interest rates critical point. Therefore, the underlying factor driving this ...Download file to see next pagesRead More
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