South-Western College Publishing - Economics  
Japan's Remedy for Recession: Inflation?
Subject Inflation
Topic International Finance
Key Words Inflation, Depreciation, Recession, Federal Deficit
News Story

Japan's economy is in the deepest recession in its recent history. Policy makers have suggested the traditional remedies to revive the economy - tax cuts, increases in government spending, and incentives to encourage private spending. So far these measures have had little success. Japan's latest measure is to increase its money supply. Japan is hoping to lower its already low interest rates. By increasing the money supply, it will have to contend with increased inflation.

The Japanese economy seems to be mired in a recession, and current projections call for a further decline of 2 percent this year. Measures such as public works projects, gift vouchers provided by the government, and tax cuts have not stimulated Japanese consumer spending. The government, faced with a large deficit and a gigantic bank debt problem, began printing more yen and pumping more money into the Japanese banking system. Decision-makers have concluded that only the threat of higher prices tomorrow resulting from the increased money supply will scare Japanese consumers into spending today.

This policy is not without consequences. The dollar has already appreciated relative to the yen. The dollar was up to 121 yen from 112 yen a few weeks ago. An appreciation of the dollar will likely increase the near record $65 billion U.S. trade deficit with Japan. The weakness in the yen will put pressure on other Asian currencies to devalue in order to remain competitive and increase the U.S. trade deficit with other Asian countries. Japan may also have trouble keeping inflation to a moderate level. A little inflation may provide a stimulus; a lot of inflation may be counterproductive.

(Updated April 1, 1999)

1. Assume that a government has a deficit. How can that deficit be financed?
2. Suppose that an economy is in a recession. What fiscal policy measures could be applied to revive the economy?
3. What monetary policy measures could be applied to revive the economy?
4. What are the relative advantages and disadvantages of monetary and fiscal policy measures?
Source Jim Hoagland, "Japan's Inflation Experiment", The Washington Post, March 4, 1999.

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