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Part - III

Japan has used both fiscal and monetary policy to get out of this rut. But it has failed miserably. During the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed in its purpose. What these spending sprees have achieved is that they have put the government in poor fiscal shape. The public debt has exceeded 100% of GDP, the highest in the G7. Japan has also followed an expansionary monetary policy. From the high of 6%, the discount rate was lowered to 4.5% in 1991, 3.25% in 1992, 1.75% during 1993-94, and 0.5% during 1995-2000. This drastic easing of interest rates has not been able to pull the Japanese economy out of trouble. Over this period Japan has been experiencing deflation. Coupled with low nominal rates of interest, this makes the real rate of interest higher than the nominal. Given that nominal rates of interest cannot fall below zero, inflation is the only way to generate negative real rates of interest that are needed to reverse the liquidity trap that Japan finds itself in.

Excessive savings is Japan's Problem, in contrast to the United States! Even nominal interest rates of cloze to zero have proved to be insufficient to get investors to make use of unspent incomes. The only way out was to depreciate the yen so that it will become worthless if not spent. Another thing this would achieve is to boost the export demand, which has been the case with Chinese demand for Japanese exports soaring with the dragon on a path of explosive growth. This is the thing which has saved Japan from falling into an abyss.

Then what is the problem. Why has the above mentioned monetary policy not worked? The answer lies in the credibility problem facing the Bank of Japan. It needed to adopt an overtly inflationary policy, which it did, to have the desired effect. The problem is that people would expect that, once the emergency was over, the central bank would revert and stabilize the prices. Central banks worldwide have a policy - explicit or implicit - of being tough on inflation. If people expect that the emergency policy would be discontinued once the emergency was over, than they will not spend their savings, and hence the problem will not be over.

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* Contributed by -
Ravi Birhman, B.E. (Computer Science), BITS, Pilani,
Kshitij Goel, B.Tech. (Mechanical), IIT Guwahati,
Post Graduate Diploma in Management (First Year),
Indian Institute of Management, Calcutta.