Japan’s Lost Decade: Causes and Remedies

Abstract

Japan has suffered from sluggish economic growth and recession since the 1990s, a period dubbed “Japan’s Lost Decade.” The People’s Republic of China, many countries in the eurozone, and the United States may face similar problems in the future, and they have been concerned by Japan’s long-term recession. This chapter will address why Japan’s economy has stagnated since the bursting of its economic bubble. Our empirical analysis challenges the beliefs of some western economists, such as Paul Krugman, that the Japanese economy is in a liquidity trap. We argue that Japan’s economic stagnation stems from a vertical investment–saving curve rather than a liquidity trap. The impact of fiscal policy has declined drastically, and the Japanese economy is facing structural problems rather than a temporary downturn. These structural problems have many causes: an aging demographic (a problem that is frequently overlooked), local governments’ overreliance on transfers from the central government, and Basel capital requirements that have made Japanese banks reluctant to lend money to startup businesses and small and medium-sized enterprises. This latter issue has discouraged Japanese innovation and technological progress. The chapter will address all these issues empirically and theoretically and will provide some remedies for Japan’s long-lasting recession.