The Japanese Economy : Breaking Out of the Crisis

ABSTRACT

There is a growing risk that the Japanese economy will fall into a deflationary spiral marked by a continuous pattern of lower prices and demand. The demand-supply gap currently stands at approximately 40 trillion yen, and this is causing significant deflationary pressure. Given the trade-off relationship between the rate of price increases and unemployment (Phillip's Curve), there is a very strong possibility that consumer prices will continue to fall in the future.

The main cause of the financial crisis was that banks were no longer able to function sufficiently as financial intermediaries due to increased bad debt. Restructuring the banking industry and eliminating financial instability should be set as the highest priorities. In addition, in order to avoid a deflationary spiral, there is an increasing need to implement new banking and financial policies.

It is not clear whether or not the so-called controlled inflation policy would have a significant impact on demand. However, the Bank of Japan should support and reinforce its strategy of loose monetary policy to guarantee that government fiscal policies are positive and effective in order to create an environment in which Japanese banks are able to dispose of bad debt smoothly.

At present, drastic reforms of the income and resident tax structures are the most needed government fiscal policy measures. Such measures would stimulate the economy in the short term, and would increase work motivation and innovation in the medium and long term. Specifically, the maximum tax rate should be decreased to 40%, and the tax system should be simplified into four tax rate categories. At the same time, the government must dispel the people's insecurity about the future by constructing an improved tax structure (balance of direct and indirect taxes), and by establishing measures to guarantee financial resources as well a vision for the incremental transition of these future systems and structures.