The Truth About Japan

I would highly recommend that you take a look at Adam Pozen’s talk “The Realities and Relevance of Japan’s Great Recession — Neither Ran nor Rashomon. His point is that poor Japanese economic performance, though of course not unrelated to the bursting of asset bubbles, was fundamentally caused by policy errors and that when better policies were implemented growth became strong:

What was necessary was the clean-up and recapitalization of the banking system, the further loosening of monetary policy (to the extent possible given that interest rates were at zero), and the avoidance of any further premature fiscal tightening, as I set out in Posen (1998, 1999a, and 2001b). This was obviously not a simple list, economically or politically. Yet, it was also not a list of the impossible, it emphasized demand side factors, and was a list that seemed all the more plausible when Japanese policymakers recognized that Japan was not doomed to a permanently low trend growth rate — a belief that had bedevilled both fiscal and monetary policy decisions in Japan for much of the 1990s.

Japan’s new economic leadership in the early 2000s, Prime Minister Junichiro Koizumi, Cabinet Office and later Financial Services Minister Heizo Takenaka, and Bank of Japan Governor Toshihiko Fukui, turned matters around. They reversed monetary policies that contributed to deflation, turned the fiscal impulse to average net zero (see figure 5), and forced bad loan write- offs and recapitalization by the Japanese banks (figure 6).10 What few seem to appreciate, either inside or outside of Japan, is just how strong the resulting Japanese recovery from 2002–2008 was. It was the longest unbroken recovery of Japan’s postwar history, and, while not as strong as pre-bubble Japanese performance, was in fact stronger than the growth in comparable economies even when fuelled by their own bubbles.

People can get confused about Koizumi-era Japan’s economic performance because demographics were driving a pretty rapid reduction in the number of workers. That drags down overall output. But even though China’s GDP is much larger than Switzerland, Switzerland is still much richer and its workers are much more productive.


Posen’s piece is important, because I fear that historical evidence of poor economic performance in the wake of asset price bubbles bursting is creating a mood of dangerous complacency. You can read that as evidence that we’re destined to experience an extended period of poor growth, but you can also read it as evidence that what normally happens after a bust is that policymakers implement an ineffective response. And as Posen argues, accepting the view that slow growth is inevitable is a major cause of ineffective policy and becomes self-fulfilling. Japan started growing once it got some policymakers who believed it was possible for Japan to grow, and thus that they would try pro-growth things and try them on a large scale.