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).

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.

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?

 

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!

 

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

 

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.

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’.