Japanese fiscal policy in the 1990s
Paul Krugman recommends this chapter by Adam Posen, which gives a good overview of the history. The piece argues at length that the Japanese didn’t try much expansionary fiscal policy during their downturn of the 1990s. On p.49 comes the evidence that fiscal policy works, at least as it was tried in 1995:
In the end, the September 1995 stimulus package did add significantly to economic growth in 1996. Not only was the actual real GDP growth of 3.6 significantly higher than the 0.9 percent recorded in 1995, it was at least 0.9 percent higher than the growth forecasted for 1996 by all of the major international institutions and the financial consensus…This stimulative effect can largely be attributed to the fiscal package, although the decline in the yen also stemmed the decline in net exports (by -1 percent of GDP in 1995 and by -0.4 percent in 1996)…There was actually no other source of positive impetus to the Japanese economy in late 1995 and early 1996 that can be identified except discretionary fiscal policy.
A few observations:
1. This is a piece of evidence in favor of fiscal stimulus and so we should take it seriously.
2. It is, quite literally, only a single data point.
3. In November 1994 there was a big cut in personal income taxes and that may be responsible for some of the increase in economic growth in 1995-6. (There was also reconstruction from the 1995 Kobe earthquake, as one reader notes in the comments.)
4. Japan was much weaker automatic stabilizers than does the United States. Some of the fiscal policy boost was to strengthen those economic stabilizers. The case for doing that is indeed much stronger than the case for initiating new government expenditures in the form of specific projects.
5. The history is fully consistent with an alternative interpretation, as I have discussed in my post on the fetishization of measured gdp. Namely, the Japanese spent more money putting unemployed resources to work on construction projects. Measured gdp went up, but the Japanese didn’t get much of value for their money. (Japanese construction projects from this era are notoriously ugly, wasteful, and unpopular.) The spending also didn’t set off any kind of lasting recovery. It was the proverbial ditch digging without much in the way of later-order benefits or multipliers. In these circumstances a boost in measured, temporary GDP is very different from an economic recovery.
6. There is a deeper question of why governments so often back away from aggressive fiscal stimulus, if that policy indeed will bring so much recovery and thus bring in so many votes and so much revenue. Posen in his chaper suggests that ideology is at fault but I am not convinced. After all Japan is not ruled by Grover Norquist. The alternative null hypothesis is simply that governments see the fiscal stimulus is not working.
Anyway, that is the evidence we are being asked to spend $600-700 billion on — or $2 trillion for some –so I thought you should see it.
Addendum: Here are very good comments from Greg Mankiw’s blog.