In Search of a Prescription for the
Japanese Economy
Joseph E. Stiglitz
Keynote Address
April 14, 2003
Tokyo
Symptoms of an underlying problem
1.
2.
3.
Slow growth for more than a decade, slipping in and
out of recession
Rising unemployment –but still low by international
standards
Overall: under performing potential, a sense of
malaise
2
Competing Diagnoses (I)
1.
Lack of aggregate demand
2.
Structural problems
3
Competing Diagnoses (II)
a.
Both are present, and the two are intertwined
b.
Much harder to solve structural problems when
economy is in recession
c.
Much harder to solve aggregate demand problems,
given the structural problems
d.
But structural problems relate to economy’s long run
productivity growth
4
Competing Diagnoses (III)
•
There is a short run aggregate demand
problem, and this needs to be addressed much
before much progress can be made on
structural issues
–
Attacking some of the structural problems (e.g. in
finance) in the wrong way could exacerbate
aggregate demand problems and be self-defeating
5
Competing theories of lack of aggregate
demand (I)
1.
2.
Keynes: downward price and wage rigidities
Fisher: debt-deflation theory
a.
b.
c.
‘Updated’ by modern theory of capital markets,
based on asymmetric information and incomplete
contracts, by Greenwald and Stiglitz
Focuses on balance sheet effects on households,
banks, and firms resulting from inflation and large
changes in asset prices (breaking of bubble)
Ability and willingness of firms to invest and banks
to lend are both affected
6
Competing theories of lack of aggregate
demand (II)
d.
e.
f.
Helps explain why some structural reforms can worsen
aggregate demand problem: attempts to ‘clean up’ banks can
lead to reduced credit supply (as in US), exacerbating economic
downturn –and making bank balance sheets even worse
Even redistributive changes (some people gain, some people
lose) can have large real effects
Falling prices implies that even with low nominal interest rates,
real interest rates are high
DEBT DEFLATION THEORIES PROVIDE A BETTER
DESCRIPTION OF JAPAN’S SITUATION, AND MANY
OTHERS
7
Prescription (I)
1.
2.
Theory suggests focus on balance sheets
Shifting from deflation to inflation may help balance sheets –
undoing damage that deflation has done in increasing real value of
debt
3.
But some institutions with a maturity mismatch may find their
balance sheet hurt –may need to have inflation or interest rate puts
4.
Shifting from deflation to inflation may lead to lower real interest
rates
8
Prescription (II)
On average, devaluation will also improve Japan’s
balance sheet, given its large creditor status
And will help to reduce deflation
This is in addition to normal trade benefits from
devaluation
Conventional way of correcting bank balance sheet shifts
problem from banks to government
5.
6.
7.
8.
a.
But there are unconventional ways which provide as accurate a
picture of the true change in government’s position as
conventional method
9
Specific policies: limited efficacy of
standard keynesian instruments (I)
Income tax cuts may be ineffective, if individuals think
they are temporary
Or even if they are believed to be permanent, they may
simply be used to ‘restore’ balance sheet
Temporary consumption tax cut more likely to be
effective, since the fact that it is temporary is more
incredible than the claim that the income tax is
permanent, and such a tax has an intertemporal
substitution effect
1.
2.
3.
a.
But still may have limited effect
10
Specific policies: limited efficacy of
standard keynesian instruments (II)
4.
Spending financed by borrowing
stimulates the economy
a.
b.
c.
d.
But leaves the country in debt
Worsening government’s balance sheet
Could set in motion bad dynamic
Households may worry about the future tax increases
11
Key Questions
1.
How to devalue, how to reverse deflation?
•
Possible solution: Financing some of deficit spending by printing
money
2.
No evidence of discontinuity: moderate amount will not set off
rampant inflation
3.
Advantage over debt finance: not treated as a liability
4.
Can be used to help recapitalize banks, enabling them to lend
more
5.
Strategy was tried in Sweden in Great Depression - worked
12
Important Lesson
1.
Even if this prescription works, it will not address Japan’s
longer run problems
2.
Failure to use innovations in manufacturing elsewhere in the
economy, especially in the service sector
3.
Unless, however, Japan does something about the continuing
short run lack of aggregate demand, there is a real risk of
exacerbating long run problem, as financial problems mount
and investments in new technology wane.
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