The Japan quandary

Scott Sumner has done a post on Krugman´s latest “Japan Story”. I just tried to elaborate a bit.

This from Krugman:

But what remains true is that Japan has run budget deficits for many years while delivering what appears on the surface to be very disappointing economic performance. What’s the story there?

My answer would run in two parts.

First, you should never make comments on Japanese growth or lack thereof without taking demography into account. Japan has low fertility and low immigration; this has translated into a dramatically aging population and a declining working-age population. So what does Japan’s performance look like if you calculate real GDP per working-age adult? (In the picture below I define working-age as 15-64; this is one case in which you DO NOT WANT to look at FRED, which defines working age as 16+ and therefore takes no account of aging).

Japan Story_1

I’ve used a log scale, so you can view vertical distances as percentage changes. If we look at growth from the early 1990s to the business cycle peak in 2007, we have growth of about 1.2% per year. That’s actually not bad; you can argue that demographically adjusted, the whole tale of Japanese stagnation is a myth.

Why is Japan in this situation? A debt overhang from the 1980s bubble surely started the process; but surely it’s reasonable to suggest that the demography also contributes, since a declining working-age population depresses the demand for investment.

Is that so? I reproduce Krugman´s chart, only this time comparing Japan and Sweden. That´s because Sweden also has ‘demographic issues’ and also had a debt overhang from the bursting of a property bubble in 1990.

Japan Story_2

It shows that, contrary to Krugman´s assertion that it´s ‘not bad’, relative to Sweden it´s much worse! And we must ask why in Sweden the ‘debt overhang’ was followed by a ‘robust revival’?

The following charts show how output per working age person has evolved over a long span of time in both Japan and Sweden. See the ‘robust Swedish revival’? And how the ‘modest revival’ in Japan in the second half of the 1980s was ‘aborted’ about 1990?

Japan Story_3

 

Japan Story_4

Krugman talks about deficits and how they have not been ‘enough’. Let´s take a look. The charts show that there really was a lot of deficit in Japan, but interestingly when monetary policy became consistently expansionary for a period (QE), growth went up at the same time that deficits were reduced!

Japan Story_5

 

Japan Story_6

And we can look at Sweden to see that despite deficits turning into surpluses, growth was significant (while inflation was contained).

Japan Story_7

 

Japan Story_8

It appears that ‘fiscal stimuli , or lack thereof, is not the reason for Japan´s ‘underperformance’. So let´s compare monetary policy in the two countries, viewed through an NGDP perspective.

Japan Story_9

Riddle solved!

Krugman more or less concludes his post with:

What Abenomics seems to be is an attempt, finally, to do what should have been done long ago: combine temporary fiscal stimulus with a real effort to move inflation up.

You can drop his temporary ‘fiscal stimulus’ and change the ‘real effort to move inflation up’ to ‘real effort to increase aggregate spending’.

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11 thoughts on “The Japan quandary

  1. Completly off topic,

    I know you don’t talk much about Brazil, but Brazilian NGDP is 10% below 2000-crises trend.

    Don’t you think this is interesting in some way? I know because our NGDP growth is quite large, we should be able to take shocks better than developed countries. But isn’t it strange that growth is slowing along with NGDP? IPCA is up, but the deflator not so much. Employment is going very well.

    The story usually is that we reached full employment and government policies depress productivity grow. Do the rates of long term inflation protected bonds are down? I haven’t had time to check.

    Our situation seems to resemble that of UK. I still can’t figure out what is happening exactly. I even start considering indexing as the problem, something that I always thought was an excuse for the past failures in inflation fighting, although I still do not put high probability on it

      • Just thought of something. It makes sense, but I think it won’t fit the data. I’ll try to look into it still today.

        If there was a external demand shock, and the central bank partially offset it, we could get declining or decelerating productivity, full employment, rising inflation, and slow growth.

        My priors are that the exports are not that great to make such difference, and demand for Brazilian exports didn’t fell much, or with the right timing. But if exports and investment fell or decelerated compared to the other demand things, and exports intensive sectors, I guess agriculture and extractive industries, but I’ll check, fell or decelerated compared to other supply things, I guess i could be part of it.

  2. To Arthur,

    I believe the brazilian economy is facing a supply side problem created by the government, the market realized that this government is more tolerant towards rising inflation, because most prices are adjusted at given intervals (sticky), this rising inflation expectations affects how firms sets their prices today, so if inflation expectations are rising because of uncertainty about the inflation target this will be like a negative supply shock. At least I think this is the most probable cause for the low RGDP growth and rising IPCA.

    • I just find it strange that this is happening simultaneously with a demand shock.

      It seems to me that the government supply side bad policies are not that big to cause that effect, especially with a demand shock happening.

      I’m not so sure if inflation expectations are rising that much also. I’ll need to check.

  3. Pingback: Thursday, Jan 7 – Daily Reading List

  4. I’m not convinced that monetary policy and demographics are truly independent.

    Firstly, we know elderly pensioners hate inflation.

    But, and perhaps more importantly, tight money leads to fewer children. The lags are long and variable — at least nine months!

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