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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 Fig 3a: Real Effects on Japan of a Credible 3% Inflation Target 1 %GDP deviation from baseline 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 0 1 2 3 GDP 4 5 6 Consumption 7 8 Investment 9 10 11 Fig 6a: Real Effects on Japan of a Phased Fiscal Consolidation of 5% of GDP in Japan 4 %GDP deviation from baseline 3.5 3 2.5 2 1.5 1 0.5 0 -0.5 0 1 2 3 4 5 6 7 8 -1 -1.5 GDP Consumption Investment 9 10 11 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 WWW.SENSIBLEPOLICY.COM WWW.NOTWRONG.COM