Sorry for the delay, real life intervened.
Well, after the bursting of the Japanese commercial real estate bubble in the late ’80s and early ’90s, the Bank of Japan (after a brief brainfart of raising rates) knocked its interest rates down to effectively zero. Under normal circumstances, this would have led to increased economic activity, since businesses could theoretically borrow money for free.
However, because of the banking crisis going on at the same time, there was actually less lending. Banks held onto their bad loans (toxic assets) and were essentially allowed to continue operating in a technically insolvent state.
So Japan turned to stimulus spending. Their stimulus packages focused on road-building and other infrastructure projects, often in rural areas. As we know now, these stimulus plans didn’t really work very well, as Japan stayed in stagnation for an extended period. So what went wrong?
First, the ruling Liberal Democratic Party (don’t be fooled by the name, they’re ultraconservative) used these projects to essentially buy votes in the rural prefectures. There are dozens of bridges to nowhere, and pretty much every town has its own local history museum (usually empty).
Second, the stimuli were applied unevenly, and in a stop-and-go fashion. Many projects required followup money from prefectural governments that never came, so the money was never spent. In 1997, the stimulus was reversed — spending was cut and taxes were raised — and that caused another drop in GDP.
Third, the banking problem was never really fixed, either by a bailout or by temporary nationalization (regulatory takeover a la the FDIC). It was dragged out over the years, sort of healed over time through mergers (there are a smaller number of regional banks, and two national megabanks now), and even now many toxic assets are still on the books.
Fourth, and this is a little controversial, the stimulus might have been too small. This is Nobel Prize-winning economist Paul Krugman’s idea, based on Keynesian theory. The idea is to provide a large enough stimulus to shock the system back to life. The Japanese stimuli were on the order of 1.0 to 1.5% of GDP annually (when they weren’t reversing them). Krugman estimates a stimulus of 3-5% would have been signficantly more effective.
So, in the fourth and hopefully final part of this series, I’ll go over the successes and failures of the Japanese policies. Also, where the US in 2009 is similar to Japan in the ’90s, and where we differ. Stay tuned (but don’t hold your breath)!