A Third Decade of Low Growth? Lessons from Japan on Financial Management and Economic Growth

Abstract

Economic growth rates have fallen in a substantial number of countries in the last five years, compared to the previous five years. This was partly triggered by the financial crisis, but also occurred in countries that had not directly experienced a financial crisis, such as in Asia. There is now an increasing fear that we might enter a phase of very low global growth. In 2008 I warned of the threat of nominal GDP contraction and deflation as a result of the banking crisis, if the right policies were not adopted. A debate has since arisen about the scenario of “zero growth”. Japan has already experienced two decades of low growth and is possibly entering the beginning of a third decade. What are the lessons for the world? I will first briefly discuss the demand management policies that have been adopted in Japan from the beginning of the slowdown in the early 1990s. Their failure has been a puzzle for conventional demand-side economics. As a result, policy-makers turned to supply-side policies, but these equally failed, increasing the puzzle. To solve it, we will revisit the demand-side argument, specifically the connection between the financial part of the economy and the real economy. And I will use a tool developed in the early 1990s, called the Quantity Theory of Credit (Werner, 1992, 1997, 2005, 2013). This theory has stood the test of time well, and unlike others has not been contradicted by the empirical record. Instead, it has a superior forecasting track record, and a growing body of work supports it (see the survey in Werner, 2012).