The Heisei Recession: An Overview

The prolonged recession in recent Japan continues much longer than a decade. One observes exciting policy-related discussions over the diagnosis and the effective prescriptions to the problem. Gradually, academic economists have been accumulating scientific investigations into the nature and the causes of this "great" recession. Economic theory faces a test of its applicability in the light of the novel situation, unobserved in the world economy at least after World War II, where the price is falling, the short-term interest approaches virtually the zero limit, and the demand for money is insatiable. This paper in an attempt to relate the ongoing policy discussions to economic theory and some empirical results. The causes of this long recession certain include real factors such as the slowing down of the capacity growth, and difficulty of the adjustment of the Japanese institutions to changing environment. At the same time, one cannot neglect the effect of abrupt monetary contraction in the early 1990s, and resulting collapses of asset bubbles, which triggered the inefficacy of financial intermediation. However, since the most acute symptom of this recession is continuing recession, the first-hand remedies should be sought in monetary policy. The traditional interest policy or the policy to increase base money is limited. Purchase of long-term government bonds, and interventions in the exchange market are still effective policies to solve the situation. Moreover, inflation targeting or price-level targeting will be the most appropriate po licy prescription in Japan where the liquidity trap persists because of a kind of liquidity trap. The paper concludes with the political economy question. The reason why appropriate policies are not adopted is certainly because of the vested interests. Is the situation not, at least partly, attributable to the mere lack of understanding in simple economic logic on the part of politicians, of policy makers and even of economists? The Heisei Recession: An Overview Koichi Hamada Yale University