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

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:

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, The Japanese economy grew at an annual rate of 6% during the 3 decades following 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

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, 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”

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, During the 1980s the Nikkei 225 soared, reaching nearly 39,000 at year-end 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, ,000 20,000 30,000 40,000 0 Nikkei 225 Index

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, Real GDP growth in Japan averaged 5% annually during the 1980s, but only 1% during Growth during has remained sluggish. Change in Japanese Real GDP (%)

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, The unemployment rate in Japan is quite low, but there has been an upward trend since 1992 Japanese Rate of Unemployment (%)

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

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

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, During the 1990s, government spending in Japan expanded, soaring to nearly 40% of GDP during Japanese Government Expenditures as a Share of GDP (%)

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, 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 (%)

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, 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 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 (%)

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

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 deflation was often present. Japanese Monetary Policy

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, 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 Annual Percentage Change in Japanese M2 Money Supply (%)

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, The general level of prices changed little during the 1990s. Deflation was present during 5 of the 8 years between Annual Percentage Change in Japanese Consumer Price Index (%)

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

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 % 17.3% 23.1% Share of Japanese Population

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 will grow rapidly, but the growth will be a little slower than was the case in Japan from % 16.1% 19.3% Share of U.S. Population

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

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

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

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 , 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.

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.

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?

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

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

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 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?

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 % of GDP Federal SpendingTotal Government Spending

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 , 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 (%) Federal Govt.Total Govt.Federal Govt.Total Govt.

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

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 , compared to only 1.5% during 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

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 After the budgetary policy shift, unemployment fell from 9.6% in 1996 to 7.6% in By it had fallen to 6%. Total employment in Canada expanded at an annual rate twice that of the U.S. during Canadian Unemployment Rate (%)

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

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

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 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?

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