Comments and Discussion

Since the persistence of Japan's economic stagnation first became apparent, the Japanese government has been offered a flood of advice from macroeconomic policy analysis. Much of this advice emanated from the official sector, most prominently from the U.S. Treasury and the International Monetary Fund (IMF), but a host of academics were likewise generous in their recommendations.¹ Yet both the degree to which Japan has followed this advice and the effects of the macroeconomic policies undertaken remain in dispute. Economic commentators and other observers of Japan have split over whether standard Keynesian policies were tried and failed, whether the policies implemented had the expected effects but were offset by other factors, or whether some of the recommended policies (monetary expansion, in particular) never were seriously tried at all.

After the longest period of below-potential growth for any developed economy since World War II—what we and others have termed the Great Recession—with no end in sight, it is worth asking what lessons there are for macroeconomic policy from Japan. Japan's experience since the burst of its stock market bubble in December 1989 constitutes a critical experiment for the effectiveness of macroeconomic policy on several grounds. First and foremost, Japan's unprecedentedly persistent shortfall of demand raises the obvious question of whether countercyclical policies had any beneficial effects, if such policies were implemented and Japan has not yet recovered. Second, the argument has often been made, although not by macroeconomists, that the Japanese economic system is somehow special, not subject to the same rules and economic logic as Western economies; if largely the same macroeconomic policy prescriptions are to be offered universally, whether or not they work in Japan is an important test case. Third, the unvarying nature of Japan's institutional structures (a topic of much criticism from advocates of structural reform) provides a unique opportunity to assess the impact of monetary and fiscal policies in the absence of other major changes in the economic environment.

On more specific issues there are also questions of real concern. As has often been observed, monetary policy in Japan today confronts a disabled banking system, the zero bound on nominal interest rates, and arguably a liquidity trap, forcing us to reexamine the efficacy of the quantity channels of monetary policy transmission. As for fiscal policy, Japan in the last decade can be seen as a case in which fiscal stimulus should have been either very effective or largely ineffective: effective because of the relatively closed economy, the reluctance of savers to move money abroad, and the vast quantities of private household savings available; ineffective because of the wastefulness of public works projects, the looming demographic threat posed by an aging population, and the rapid and obvious rise in public debt. Thus Japan represents a crucial test of the Ricardian versus the Keynesian approach to fiscal policy. Finally, that same disabled banking system, which has now limped along for a decade without resolution of its bad loans, allows us to consider the nonmonetary effects of financial fragility on the real economy when banks are not allowed to fail outright.

Thus the purpose of this paper is to establish the record and assess empirically the effects of macroeconomic policies undertaken in Japan in response to the Great Recession. Discussions of Japan's macroeconomic policies have all too often suffered from lack of empirical rigor. Some have been based on simplistic, uncontrolled analyses, observing, for example, that the economy has faltered despite growing fiscal deficits, and concluding from this that fiscal stimulus has failed. Others have relied on comparisons with other countries' experiences, for example in discussing what a central bank might do if faced with a liquidity trap, or simply appealed to abstract (and untested) economic principles. Very little empirical research has looked both directly and rigorously at what policies Japan has undertaken, with what effect, and what this experience implies for the efficacy of policy. We attempt to fill this void by applying modern but off-the-shelf empirical techniques (developed using U.S. data) to assess...