Japan’s New Monetary Policy

CAMBRIDGE: The economic world breathed easier when the Bank of Japan announced that it would expand Japan’s money supply in order to boost demand. Japan’s stock market soared nearly 10%, though it has fallen a bit since. Worries about Japan – the world’s second-largest economy, gripped by stagnation for years – are high. Unless its monetary policy really changes, both America and Japan could fall into recession simultaneously, with risks for all the world.

In the 1980s, Japan’s economy could do no wrong. Its economy grew 4% annually, much faster than America’s annual 3% growth. In the 1990s, however, Japanese growth averaged less than half of the annual 3.4% growth of the US.

Two usual explanations exist for Japan’s poor economic performance. One is that Japan still suffers from the collapse of a financial bubble in the late 1980s. Steep decline in Japan’s stock and real estate markets at the end of the 1980s and early 1990s left many financial bankruptcies and a weak banking system filled with bad loans. Japan’s Government has been rather ineffective in cleaning up the mess, for example by delaying for nearly a decade the re-capitalization of Japanese banks.

A second explanation is that Japan’s economic structure became rigid because vested interests, especially in construction and services, prevented structural changes. Political paralysis also contributed to the lack of structural change.