Reviving Japan's Economy: Problems and Prescriptions (review)

This edited volume, with contributions by recognized academic specialists, is a convenient and authoritative one-stop-shopping source for analytical descriptions of the Japanese economy, covering the most recent decade or two of economic and policy developments. Most chapters present a snapshot of the many problems facing policymakers and offer recommendations to deal with the issues.

The detailed policy recommendations are useful compilations of expert thinking as well as benchmarks for judging policy choices. Several of the prescriptions, offered forcefully and frequently by these authors and others, influenced government policies, even though the adopted policies deviated from the specifications and speed urged by the writers.

The introductory piece by Takatoshi Ito and Hugh Patrick reviews the nation's economic problems and summarizes the individual chapters. This introduction, by itself, could be used as a short summary of recent economic affairs. However, a sense of being overtaken by events appears on the first page and runs throughout the book. Pessimism about the recovery in progress at the time of writing is used to justify the need for this policy-centered book: "it seems unlikely that the recovery will be sufficiently strong or durable to get back onto the path of sustained growth" (p. 1). This rationale for the book is repeated several pages later; a slowdown in 2004 prompted the writers to declare that the "stalled economic performance for the rest of 2004 is indicative of the reality that major economic problems persist" (p. 12).

The list of problems was, indeed, long and serious. Aggregate demand remained inadequate; deflation persisted and land prices continued their almost-15-year decline; corporate, financial, and public-sector restructuring was incomplete; and labor and capital were underutilized and misallocated. However, despite their pessimism, the economic expansion turned out to be the longest in the post-1945 period, and the problems listed by Ito and Patrick were ameliorated or even disappeared in the short span of two years.

Japan's monetary policy described by Ito and Frederic Mishkin is one of the best summaries of this topic available. Their dismissal of the arguments for "good deflation" (falling prices arising from technology or more competition) should be assigned to every economics undergraduate; they describe the problem as a confusion between relative price changes and changes of prices taken as a whole—the proper concern of monetary authorities. Their cogently argued policy recommendations call for price-level targeting until deflation ends, and inflation targeting thereafter. In addition, vigorous, public commitment by the central bank to achieve the price targets is an essential part of the policy, something the Bank of Japan (BOJ) willfully ignored until 2003. However, the authors acknowledge that no central bank has yet to adopt a price-level target as part of its armory of policy tools, and neither did the BOJ.

One reason for aiming at a specified higher price level is to strengthen the balance sheets of firms burdened by excessive debt. However, by 2006, firms' interest-bearing debt had fallen below 1987 values, and the debt-to-asset ratio had dropped to the 1979 level. Debt of the smallest firms, specifically noted as problematic, is below 1994 levels according to the corporate financial statistics of the Ministry of Finance. Therefore, part of the justification for price-level targeting has been weakened by subsequent events. Moreover, the BOJ's zero-interest-rate policy, rapid growth of the monetary base through the supply of large amounts of excess reserves, and a commitment to maintain these policies until deflation ended helped achieve modest consumer price increases in 2006.

The explicitly comparative analysis by James Harrigan and Kenneth Kuttner provides additional insight into Japan's monetary policy. American central bankers were following events in Japan closely and learned from mistakes in Tokyo. The Federal Reserve sponsored a study of the Japanese experience, the main lesson of which was to avoid deflation...