1. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson To Accompany: “Economics: Private and Public Choice, 14th ed.” James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson Slides authored and animated by: James Gwartney & Charles Skipton Full Length Text — Macro Only Text — Part: 6 Special Topic: 7 Lessons from Japan and Canada

2. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The Boom and Bust of Japanese Asset Prices: 1985-1992

3. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The Boom and Bust of Japanese Asset Prices, 1985-1992 The Japanese economy grew at an annual rate of 6% during the 3 decades following 1960. By 1990, per-capita income in Japan was similar to the high-income countries of Western Europe & North America. In the late 1980s, real estate and stock prices in Japan soared, much like housing prices in the U.S. during 2001-2005

4. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The Boom and Bust of Japanese Asset Prices, 1985-1992 Like the housing boom in the U.S., Japan’s stock and real estate price boom was followed by a bust in the early 1990s This price collapse led to a surge in loan defaults, troubles in the banking sector, and a sharp slowdown in the growth of the Japanese economy in the early 1990s This sluggishness persisted and the 1990s are now known as Japan’s “lost decade”

5. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japanese Stock Market, 1984-2008 During the 1980s the Nikkei 225 soared, reaching nearly 39,000 at year-end 1989. But it fell by 46% during the first 9 months of 1990 and has never recovered. By January 2002, it had fallen below 10,000, approximately a quarter of the 1989 level At year-end 2008 the index stood at 8,860. 1984198819901998199420001986199219962004200620022008 10,000 20,000 30,000 40,000 0 Nikkei 225 Index 1984-2008

6. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Change in Real GDP, 1987-2008 Real GDP growth in Japan averaged 5% annually during the 1980s, but only 1% during 1992-2001. Growth during 2002-2008 has remained sluggish. Change in Japanese Real GDP (%) 1987-2008 19871991199320011997200319891995 1999 3.8 6.8 5.3 20072005 5.2 3.4 1.0 0.2 1.1 2.0 2.7 1.6 -2.0 -0.1 2.9 0.2 0.3 1.4 2.7 1.9 2.4 2.1 0.3

7. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japanese Unemployment, 1987-2008 The unemployment rate in Japan is quite low, but there has been an upward trend since 1992 Japanese Rate of Unemployment (%) 1987-2008 198719911993200119972003198919951999 2.9 2.5 2.2 20072005 2.1 2.2 2.9 3.2 3.4 4.8 5.2 4.7 4.4 4.1 3.9 4.1 3.4 4.1 4.7 5.4 5.0

8. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japanese Policy Responses During the 1990s

9. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japan responded to the downturn with several “stimulus” programs that substantially increased spending on roads, bridges, and other infrastructure. Government spending rose from a little more than 30% of GDP in the early 1990s to nearly 40% in the latter part of the decade. The increased spending was financed with budget deficits. Japanese Fiscal Policy

10. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Government Expenditures, 1987-2002 During the 1990s, government spending in Japan expanded, soaring to nearly 40% of GDP during 1999-2002 Japanese Government Expenditures as a Share of GDP (%) 1987-2002 19871991199320011997198919951999 31.7 31.1 30.5 32.1 31.8 32.8 34.7 35.1 36.1 36.6 35.4 36.5 38.1 38.6 38.0 38.6

11. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japanese Budget Deficits, 1987-2002 Japan’s increased government spending was financed by borrowing. Japan began running budget deficits in 1993, and they became larger and larger during the decade that followed. Japanese Budget Deficits as a Share of GDP (%) 1987-2002 19871991199320011997198919951999 0.3 -2.4 1.1 1.8 2.0 1.8 0.8 -3.7 -4.7 -5.0 -3.8 -5.5 -7.2 -7.4 -6.1 -7.1 19881992199420021998199019962000

12. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Net Debt of Japan, 1987-2008 Measured as a share of GDP, the net debt of the Japanese Central Government was 14% in 1992, but it rose to 60% in 2000 and 88% in 2008. Japan’s fiscal policy response was highly expansionary – an increase in government spending, larger budget deficits & an increase in debt. But the economy continued to stagnate. Net Debt of Japanese Government as a Share of GDP (%) 1987-2008 10 50 19871991199320011997200319891995199920072005 20 30 40 0 90 60 70 80

13. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japan’s fiscal policy response was highly expansionary Government spending as a share of GDP increased Budget deficits were large Net government debt soared But the economy continued to stagnate Japanese Fiscal Response Summary

14. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson In contrast with fiscal policy, Japanese monetary policy was restrictive during the 1990s. The money supply grew slowly and during 1995-2002 deflation was often present. Japanese Monetary Policy

15. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japanese Monetary Policy, 1987-2002 The broad measure of the money supply (M2) increased at double-digit rates during the late 1980s. But M2 grew at an average rate of only 2.5% from 1991-2002. Annual Percentage Change in Japanese M2 Money Supply (%) 1987-2002 19871991199320011997198919951999 11.5 10.4 10.6 8.5 2.0 -0.4 1.4 2.9 3.2 2.9 3.8 3.9 2.6 2.0 3.4 2.1

16. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Japanese Inflation, 1987-2002 The general level of prices changed little during the 1990s. Deflation was present during 5 of the 8 years between 1995-2002. Annual Percentage Change in Japanese Consumer Price Index (%) 1987-2002 19871991199320011997198919951999 0.1 1.3 0.7 2.3 3.1 3.2 1.7 0.7 -0.1 1.7 0.7 -0.3 -0.7 -0.9 19881992199420021998199019962000 0.1

17. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The Aging Population of Japan in the 1990s and the United States Today

18. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Aging of the Japanese Population The share of the Japanese population aged 65+ nearly doubled from 1990-2010. 15.3% 17.3% 23.1% Share of Japanese Population 65+ 1990 2000 2010

19. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Aging of the U.S. Population The elderly population in the U.S. during 2010-2030 will grow rapidly, but the growth will be a little slower than was the case in Japan from 1990-2010. 13.0% 16.1% 19.3% Share of U.S. Population 65+ 1990 2000 2010

20. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Growth of the elderly population as a share of the total, will tend to reduce productivity and lead to higher taxes for the finance of retirement benefits and health care for the elderly. This slowed economic growth in Japan during the 1990s, and it is likely to do so in the U.S. in the decade ahead. Impact of Aging Population

21. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Lessons From the Japanese Experience

22. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Expansionary fiscal policy is unlikely to be very effective in promoting recovery from a severe recession generated by reductions in asset prices and wealth. Restrictive monetary policy will tend to delay and complicate recovery. Growth of the elderly population as a share of the total is likely to place upward pressure on taxes, reduce productivity, and slow long-term growth. Lessons from the Japanese Experience

23. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson While there are many similarities between the Japanese economic crisis of 1990 and that of the U.S. in 2008-2009, there is one major difference: monetary policy. If monetary policy exerts a strong impact, the U.S. experience in the decade ahead may differ substantially from that of Japan during the 1990s. Difference Between Policy Response of Japan and U.S.

24. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Even if expansionary monetary policy does lead to a robust recovery, the long and variable lags will make it difficult for the Fed to both promote recovery and then shift back to restraint in a manner that will lead to stability in the decade ahead. We are in the midst of a very interesting “experiment” in macroeconomics Difference Between Policy Response of Japan and U.S.

25. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Questions for Thought: 1.What were the underlying factors that caused the Japanese economic crisis of the 1990s? Were they similar to the 2008 U.S. crisis? 2.How did policymakers in Japan respond to the crisis? In what ways have the responses of the U.S. policymakers been similar? In what ways have they been different? 3.What are the important lessons from the Japanese experience for the United States?

26. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The Experience of the Canadian Economy

27. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson During the 1970s and 1980s, the government expenditures of Canada grew rapidly and budget deficits were large. By the mid 1990s, conditions in Canada were similar to those of the United States and western Europe today. Government spending was approximately 50% of GDP. Budget deficits were large and total government debt (federal plus provincial) had soared to more than 100 percent of GDP. Real GDP was growing slowly and the unemployment rate exceeded 10 percent. The spending on entitlement programs was unsustainable and the rating agencies had downgraded Canadian bonds. Canada in the mid-1990s

28. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson How did Canada respond to the crisis conditions of the mid-90s? Government spending was cut substantially. Measured as a share of GDP, total government spending was cut from 46.6% in 1996 to 44.3% in 1997 and 41.1% in 2000. The budget cuts were broad and they included reform of the Canadian pension (social security) system. The government budget was shifted from deficits to surpluses. Government debt was reduced as a share of the economy at both the federal and provincial levels. How did Canada Respond to the Crisis Conditions of the mid-1990s?

29. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Government Spending as a Share of GDP (in Canada) Government spending rose as a share of GDP during the 1970s & ‘80s, but beginning in the mid’90s, it was reduced (substantially) as a share of the economy. Note that government spending was reduced at both the federal and provincial levels during 1996-2008. 1990199419962000199219982004200220082006 10 20 30 40 0 50 % of GDP Federal SpendingTotal Government Spending

30. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Budget Deficits and Government Debt Prior to 1996, Canada ran large budget deficits and government debt increased to more than 100% of GDP. In 1996, Canada reversed course. During 1997- 2008, Canada ran budget surpluses and govt. debt fell sharply as a share of the economy. By 2008… total government debt had declined to about 60% of GDP, half the 1996 level. federal debt was only 22% of GDP, less than a third of the 1996 level. Surplus (+) or Deficit (-) as a Share of GDP (%) Net Debt a Share of GDP (%) 1990199419962000199219982004200220082006 19951999199720032001200720051993 - 8 50 - 6 - 4 - 2 - 10 +2+2 +4+4 20 100 40 60 80 0 120 Federal Govt.Total Govt.Federal Govt.Total Govt.

31. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson What impact did the cuts in government spending and shift of the budget to a surplus have on the Canadian economy? Did it reduce aggregate demand and lead the Canadian economy to slower growth and higher unemployment as the Keynesian model implies? Let’s consider the evidence. Impact of the Spending Cuts and Shift of Budget to Surplus

32. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Impact of the Spending Cuts and Shift of Budget to Surplus Canadian real GDP grew at an annual rate of 3.1% during 1997-2008, compared to only 1.5% during 1990-1996. During the decade following the policy shift, the growth rate of the Canadian economy was the fastest among the large high-income industrial economies. 1.5% 3.1% Real Growth Rate (%) of Canadian Economy 1990-1996 1997-2008

33. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The Canadian Unemployment Rate Note that Canada’s rate of unemployment soared to double-digit levels during 1991-1994. After the budgetary policy shift, unemployment fell from 9.6% in 1996 to 7.6% in 1999. By 2007-2008 it had fallen to 6%. Total employment in Canada expanded at an annual rate twice that of the U.S. during 1997-2008. Canadian Unemployment Rate (%) 8.1 1990199419962000199219982004200220082006 10.3 11.2 11.4 10.3 9.4 9.6 9.1 8.3 7.6 6.8 7.3 7.7 7.6 7.2 6.7 6.3 6.0 6.1

34. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The Canadian response to slow growth and high unemployment during the mid-1990s was the opposite of the response of Japan to its crisis during the early 1990s. While Japan chose the Keynesian prescription of increases in government spending financed by borrowing, Canada reduced govt. spending and shifted the government budget to a surplus. The results following the policy shifts were also dramatically different – while the Japanese economy stagnated, economic growth in Canada accelerated and unemployment declined. Lessons From the Canadian Experience

35. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson The U.S. policy response to the crisis of 2008 was similar to that of Japan: increases in government spending financed with large budget deficits. Like Japan, the recovery of the United States was anemic during the first 2 years following the end of the recession. The contrasting experiences of Japan and Canada should cause both economists and policy makers to re-consider whether increases in government spending, large budget deficits, and growth of outstanding debt provide the proper recipe for a rapid recovery. Lessons From the Canadian Experience

36. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 14 th edition Gwartney-Stroup Sobel-Macpherson Questions for Thought: 1.Indicate the similarities in the conditions of … (a) government finance, (b) unemployment, and, (c) growth of real GDP … for Canada in the mid1990s and the United States in 2008-10. How did Canadians respond to their troublesome economic conditions and how effective was their response? How has the U.S responded to the recent economic crisis? How do the results achieved by the United States compare with those of Canada?

37. Copyright ©2013 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page End of Special Topic 7