Several notable economists prognosticated on what Japan should do to get out of their malaise in the 1990s but none of them understood the problem or the options available to the sovereign government. They all gave poor advice. The way Japan recovered after that decade of poor economic outcomes was through fiscal policy. Monetary policy had little to do with it, as Richard Koo has demonstrated in
his recent book on the country.
Let's eliminate a few misconceptions. Japanese households do not fund the deficit. A government default is not possible (unless Japan chooses to do it, which I suppose they could do as they are pretty clueless).We learned that interest rates do not sky-rocket and inflation does not accelerate when deficits and debt issuance are on-going and huge – quite the opposite. If the BOJ should want to increase the money supply, devotees of the money multiplier model (including numerous Nobel Prize winners) would have the BOJ purchase securities. When the BOJ buys securities reserves are added to the system. However, the money multiplier model fails to recognize that the added reserves in excess of required reserves drive the funds rate to zero, since reserve requirements do not change until the following accounting period. That forces the central bank to sell securities, i.e., drain the excess reserves just added, to maintain the funds rate above zero. If, on the other hand, the BOJ wants to decrease money supply, taking reserves out of the system when there are no excess reserves places some banks at risk of not meeting their reserve requirements. The BOJ has no choice but to add reserves back into the banking system, to keep the funds rate from going, theoretically, to infinity.
In either case, the money supply remains unchanged by the BOJ's action. The multiplier is properly thought of as simply the ratio of the money supply to the monetary base (m = M/MB). Changes in the money supply cause changes in the monetary base, not vice versa. The money multiplier is more accurately thought of as a divisor (MB = M/m).
Their export model is dead, the Chinese are eating their lunch, so the Japanese have to switch to a domestic consumption based model. How do you do that without spurring lots of unemployment in the absence of government spending?
It is clear to me that the neo-liberal period in Japan has devastated the security of the middle class which accounted for more than 80 per cent of the population. A person could rely on retaining full-time employment on good wages for life as long as they completed secondary school. The 1991 recession which followed the real estate collapse and poor investments by the financial sector led to the "lost decade".
