South-Western College Publishing - Economics  
The Paradox of Thrift, Japanese Style
Subject Fiscal Policy
Topic International Finance/Taxes, Spending, and Deficits
Key Words Savings, Interest Rates, Debt, Deficit, Investment
News Story

Even though Japan has always had a reputation as a nation of savers, the Japanese economy may soon be able to claim the title as number one on the debtor list. As the Japanese economy floundered in recession that started in 1992, Japan, at the urging of the U.S., starting spending at a feverish pace in order to stimulate the economy into recovery. As a consequence of the spending and recession, annual budget deficits grew and total debt has almost doubled. Although there are some signs that the economy is recovering, forecasts are for the debt to continue to build up. The debt buildup has already caused Japan's credit rating to be downgraded by Moody's Investors Service. Rising debt levels tend to produce higher long-term interest rates which would affect the development of many Asian economies.

The deterioration in Japan's finances has been very swift. Annual budget deficits are currently 10 to 13 percent of gross domestic product (GDP) and total debt is 116 percent of GDP. By contrast, the U.S. debt to GDP ratio is 59 percent and Germany's is 61 percent. Of the major industrial nations, only Italy has a higher debt to GDP ratio, 119 percent, and Japan's ratio is expected to surpass Italy's this year. The International Monetary Fund estimates Japan's debt to GDP ratio to rise to 138 percent by 2003. Given the problems Japan is having with its banking system, postal savings loans and railroad debt, some analysts believe Japan's debt to GDP ratio could rise to 170 or 180 percent.

The increased debt has created some problems. Long-term interest rates are nearly 60 times the level of short-term rates. Interest payments on the debt are an ever-increasing portion of the annual budget. Local governments in Japan have also amassed large debts and have had to declare fiscal emergencies and lay off workers. Even with these problems there is little Japan can do to improve its finances. An increase in taxes is politically taboo. Reducing spending, it is feared, will cause recession to return.

(Updated October 1, 1999)

Questions
1. Using an aggregate supply/aggregate demand diagram, illustrate the current position of Japan's economy. Carefully label the curves and the axes. On your diagram show the recessionary gap.
2. Suppose that the Japanese government were to cut back on their expenditures. What would be the effect of this change on the price level and level of real GDP?
3. Suppose instead that Japanese consumers decided to decrease their savings and increase their consumption. What impact would this have on the economy?
4. How does the increase in Japan's debt affect its long-term interest rates?
Source Sheryl WuDunn and Nicholas D. Kristof, "Though Japanese Save Diligently, The Nation Sinks Deeper in Debt," The New York Times, September 1, 1999.

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