U.S. Hears Echo of Japan’s Woes

By MARTIN FACKLER and STEVE LOHR
NYT

TOKYO — In the annals of economic policy blunders, the one in which Hiroshi Kato played a hand in early 1997 ranks among the biggest in recent Japanese history.

Mr. Kato led a government advisory committee that concluded that the economy, which was then finally starting to rebound from the collapse of its 1980s land and stock bubbles, was healthy enough to raise the national consumption tax to 5 percent from 3 percent.

Aimed at reducing deficits, the tax increase instead quickly snuffed out the fragile recovery, pushing Japan to the brink of a financial meltdown and thrusting the nation deeper into the economic morass from which it has yet to emerge even today.

“Our sins are large,” Mr. Kato, now president of Kaetsu University in Tokyo, said ruefully. “I hope the rest of the world can learn from this mistake.”

And indeed, the lessons of Japan’s long stagnation are well known to American policy makers like the treasury secretary, Timothy F. Geithner, and the chairman of the Federal Reserve, Ben S. Bernanke, who have studied Japan’s policy missteps.

(More here. Here's Paul Krugman's commentary on the above article:)

The Moral Equivalent of Stagflation

NYT

Martin Fackler and Steve Lohr have a good article this morning on parallels between the United States and Japan; regular leaders know that I’ve been on this for more than two years. And the possibility of such a parallel was the main theme of the original version of The Return of Depression Economics, which I wrote way back in 1999. Domo arigato, Bernanke-san.

What I don’t think is fully appreciated yet — and may never be, for reasons I’ll explain in a bit — is what this American remake of The Bad Sleep Well should be telling us about economic theory and policy.

Let me offer a parallel: the stagflation of the 1970s.

Stagflation had a huge impact on economic thinking. Why? Mainly because it was predicted: the Friedman-Phelps natural rate hypothesis said that the apparent positive tradeoff between inflation and unemployment would prove only temporary, and that once inflation had gone on for a while, disinflation would involve a period of both high inflation and high unemployment.

So when that condition actually materialized, it gave huge prestige to the whole program of grounding macroeconomic models in microeconomic foundations. When I was in graduate school, which was just when the saltwater-freshwater divide was beginning to widen, I remember some of my classmates arguing that we should believe what the Chicago guys were saying — after all, they’d been right so far.

(Continued here.)

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