Lessons From Japan

Abstract

We argue that Japan’s experience with fiscal policy over the period 1990-2009 confirms the rational expectations and new classical position that fiscal policy, particularly when it is not accompanied by an accommodating monetary policy, is ineffective. We show that Japan’s combination of a loose fiscal policy, together with a tight monetary policy has given them the worst of all possible worlds over the past twenty years; i.e. slow growth, deflation, rising unemployment, and a huge increase in their national debt burden. We argue that the Obama administration should be careful not to fall into the same trap the Japanese have been floundering in for the past twenty years.