Japan by comparison already has a public sector deficit of 218% this year and a predicted deficit of 246% by 2014.
Japan has a real problem in the unprecedented scale of its fiscal deficit. It also has a real problem with deflation. Japanese consumer prices fell 2.4% in September, the largest on record.
Exports have fallen 31% after the great recession and a rapid appreciation of the Yen.
Demographics are working against Japan. The workforce is contracting due to low population growth and an ageing population. The Japanese economy has stagnated (grown below potential) ever since its 1980s bubble burst.
The economic situation is dire. The immediate policy response should be to end deflation. Japan desperately needs a positive rate of inflation. This will help prevent real debt burden rising. Inflation will reduce the value of the Yen, making exports more competitive.
Combined with a loosening of monetary policy, Japan will be able to start tackling its budget deficit. Yet, the Bank of Japan has already indicated that it will end its limited policy of quantitative easing meaning there are no real policies to deal with the deflationary pressures. It seems Japan doesn't have the political will to deal with the problems it faces; it is almost as if it is waiting for a real crisis. (Perhaps when markets start to worry over extent of Japanese debt)
Why has Huge Budget Deficits failed to boost Growth in Japan?Increasing government debt, during a period of deflation does not really help. Budget deficits can provide a boost to aggregate demand, if combined with positive money supply growth.
Also, budget deficits need to be a temporary affair, not a permanent two decade fiscal expansion. The deficit also reflects the structural weaknesses of the economy - pension requirements growing in an ageing population.
Lessons for UK and US.The lessons for the UK and US from Japan are:
- Avoid Deflation at all Costs. Don't implement timid policies claiming you are frightened at the prospect of inflation.
- Avoid Government debt rising for two decades.
- If necessary monetary policy will have to take slack from fiscal tightening, when the time is right.
- Avoid having a very strong currency when your economy is in recession and exporters are suffering.
- Make sure the economy remains dynamic and productive through incentives to be more efficient.