Japan’s announcement Monday of new measures to turn around its flagging economy were not enough to rally investors’ confidence, nor may it be enough to pull the country out of its decades long stagnation. The plan involves expanding loans available to banks and a 900 billion yen ($10.8 billion) stimulus package.
“That’s peanuts,” said Martin Eichenbaum, a professor of economics at Northwestern University. “The numbers are really telling here,” he added. “Ten billion dollars is a rounding error” on an $4.9 trillion economy.
The other part of the package—the loan expansions—may be equally ineffectual. Monetary policy has been of little use to Japan since interest rates have been at or near zero for the last fifteen years. With their backs against a wall, Japan’s central bankers will sometimes use announcements to “stir up expectations,” said Sergio Rebelo, a professor of finance at the Kellogg School of Management. “Sometimes they raise interest rates by a quarter percent without telling anyone, and then they announce with great fanfare that they’re going to lower it again by 25 basis points. They’re playing this game to try to impact expectations.”
The market can easily ignore such talk. Economists and central bankers then have to use other tactics such as government spending. Japan has done exactly that on numerous occasions, but none have jump-started their economy into robust growth. Part of the problem may be their timing.
Japan’s current tepid reaction echoes its past missteps. When the bubble burst in the late 1980s and early 1990s, Japan’s government and central bank were both in denial about the depth of the problem, Eichenbaum said. It took Japan years to drop interest rates to zero, and early rate adjustments were poorly timed with early stimulus packages.
Between August 1992 and September 1993, the Japanese government rolled out three stimulus plans that totaled six percent of GDP—a very large amount. Yet over that same time period, the central bank only lowered interest rates from 3.25 percent to 2.5 percent. Government stimulus only returns about 80 cents in GDP for ever dollar in spent when interest rates remain well above zero. But when interest rates are stuck near zero, government spending can boost GDP by up to $2.50 for every stimulus dollar spent, according to research by Eichenbaum, Rebelo, and their co-author Lawrence Christiano, a professor of economics at Northwestern. With high interest rates and low inflation in the early 1990s, it’s likely Japan’s stimulus packages did not benefit from any large government spending multiplier.
With Japan’s interest rate at 0.1 percent, the current stimulus plan may see some sort of multiplier effect, but it may not be enough. Even with Eichenbaum, Rebelo, and Christiano’s most optimistic estimate of the multiplier, Japan’s current package would only add $25 billion to GDP, or about half a percent.
Rebelo points out that Japan has not slipped into a major recession since its troubles began, but the country’s slow growth has dragged on for so long that Eichenbaum wonders if “the problem of Japan is cyclical or do some countries have deep seated problems that you can’t solve magically?”
Photo by Jesse Braun.