South-Western College Publishing - Economics  
Interest in Japan is on the Rise
Subject Budgets, Deficits and Public Policy
Topic International Finance
Key Words Budget Deficit, Budget Surplus, GDP
News Story

Japan's economy is in its worst recession in the postwar period. For eight years the government has been trying to revive Japan's economy. During the course of this economic stagnation, Japan's policy makers have tried a variety of measures, including tax cuts and spending programs, to stimulate the economy. As a consequence of a large-scale bank bailout, a $200 billion spending and lending program and a series of tax cuts, Japan's budget deficit has grown to almost 10 percent of Gross Domestic Product (GDP). Its accumulated debt is almost the size of its GDP. Economic analysts fear that this pressure on credit markets will cause interest rates to rise and choke off the recovery that these measures are aimed at.

Government bond yields in Japan are still low by world standards, but they have nearly tripled since October. The yield on a 10-year bond was about 2.44 percent early this month, having increased from slightly more than seven-tenths of one percent in October. The government's large debt will require Japan to raise approximately $535 billion for the fiscal year starting April 1. In addition, the government must redeem almost $900 billion in postal savings deposits that will come due in 2000 and 2001. The combination of the debt and the need to redeem postal savings deposits will put extraordinary pressure on Japan's credit markets. Many analysts fear that this pressure will cause further increases in interest rates.

The risk for the economy is that the increase in interest rates will come at a time when the economy is just starting to recover and choke economic growth. Some analysts argue that the increase in interest rates would be temporary - higher rates would bring forth additional savings that would then depress rates. If this were the case, there would be some shock to Japan's economy but no permanent damage.

(Updated April 1, 1999)

1. Draw an aggregate demand/ aggregate supply diagram illustrating an economy with a contractionary gap. Label equilibrium real GDP and the price level.
2. Illustrate on your diagram how fiscal policy measures such as increased government spending and tax cuts could be employed to reduce the contractionary gap.
3. Illustrate on your diagram how monetary policy could be used to correct a contractionary gap.
4. In the context of fiscal policy, what does the term "crowding out" mean?
Source Sheryl WuDunn, "An Unlikely Fear for Japan: Stiflingly High Interest Rates", The New York Times, February 3, 1999.

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