Japan’s Experience with Fiscal Policy in the 1990s in the Aftermath of the Bubble Economy

Abstract

Nakao examines the evolution of Japanese fiscal policy in the Nineties and its current challenges. His account begins with an analysis of the collapse of the financial bubble at the beginning of the Nineties. He argues that the prolonged economic slump of the last decade largely depends on the effects of wealth losses on consumption and investment decisions and on balance sheet problems of financial and non-financial corporations. These problems were exacerbated by several structural factors, ranging from population ageing to the inflexibility of labour market and corporate governance. Nakao notes that Japanese authorities took an active approach. Many large fiscal packages were introduced to boost the economy determining a sizeable increase in public capital expenditure. Interest rates were reduced. Wide-ranging structural reforms were promoted. However, fiscal expansion did not succeed in reviving the economy. The multiplier effect of public works decreased. Public debt accumulation may have determined expectations of future tax increases; the productivity of the additional public works may have been rather limited. Nakao considers that policies that merely support demand cannot improve economic expectations. He advocates radical structural reforms and a rationalisation of public expenditure, including a better selection of capital projects. An increase of revenues, now relatively low as a ratio to GDP, may also be helpful in improving the budget balance. The author concludes that Japanese technology, saving ratio and well-educated labour force indicate that the country can successfully overcome its current problems.