CAMBRIDGE – In April 2014, Japan’s consumption-tax rate is set to rise from 5% to 8% in an effort to address the long-term problem of high public debt. But will the resulting loss in purchasing power bring an end to the Japanese economy’s fragile recovery, as many fear?
The question is reminiscent of April 1997. Larry Summers, who was then Deputy Secretary of the United States Treasury, repeatedly warned the Japanese government that if it proceeded with a scheduled consumption-tax hike, Japan’s economy would slide back into recession. I was in the US government at the time. As the date drew near, I asked Summers why he persisted in offering Japan’s leaders this unwanted advice, given that they were clearly locked in politically. Summers told me that he knew he was unlikely to change anyone’s mind, but that he wanted to be sure that Japanese officials recognized their mistake when they went ahead with the increase. Sadly, his prediction proved correct.