Macroeconomic Policy Options for Japan Warwick J McKibbin Economics Division RSPAS/APSEM

Economic Problems in Japan Poor macroeconomic management Structural rigidities in non traded sectors Banking system bad debts

Is it Feasible for Macroeconomic Policy to work in Japan? Shorter term –Monetary Policy –Fiscal Policy –Trade Policy Longer term –Kyoto Protocol –Demographic transition

What can be done Monetary Policy –Announce an inflation target –Pursue expansionary monetary policy by first having the BoJ print yen to buy government debt then purchase as many assets as possible until inflationary expectations rise

What can be done Fiscal Policy –Announce a substantial phased fiscal consolidation financed by cutting government expenditure –Cuts of 5% of GDP phased over 3 year –Abolish the consumption tax immediately and reintroduce in 1 year

What will happen? Monetary stimulus will raise output through – a fall in real interest rates ( a rise in expected inflation) –A depreciation of the yen

What will happen? Credible fiscal contraction will initially lower output but raise it in future years through –Lower long term real interest rates and –A depreciation of the Yen Temporary cut in consumption tax will make current consumption attractive

Some results from “Macroeconomic Policy in Japan” paper presented to Harvard Asian Economic Panel September 2001

Will this work? If no effect of inflation target as some would argue then might as well try If big effect of inflation target as I and others argue then might as well try The fiscal adjustment is critical to do now given the demographic transition

What else is needed? A variety of policies –Structural reform –Banking reform –Trade Liberalization –Not the Kyoto Protocol But none of these will work well without sensible macroeconomic policies

Will this Happen? Probably not without a serious crisis A serious economic crisis need not occur in Japan for a very long time

Background papers