Commentary #

2
Japans Debts Crisis

Mihir Khubchandani
/29/2011

Dwelling deeper into the costs of rebuilding Japan after its disastrous affects, and
understanding how Japan can help increase demand to stimulate an economy in debt.
Related Syllabus Coverage:
1. Demand Side Policies
2. Economic Growth
3. Inflation
With Reference to Bloomberg BusinessWeek (Magazine)
Article of the week 21st-27th March 2011 Issue
Article Titled: Financing the Reconstruction
Written by Aki Ito, Keiko Ujikane and Mayumi Otsuma
Available Online at http://www.businessweek.com/magazine/content/11_13/b4221020108140.htm

After the devastating earthquake and tsunamis caused an almost irreversible

extrogenous supply shock, pushing the countrys potential output back (figure 1),
Japan faces a bill of $235 billion to rebuild the country, as well as a debt of 200%
of the GDP caused by a deflationary gap it earlier faced.

This report will look closely at demand side policies for Japan, which are a form of
government intervention used to alter the aggregate demand and GDP of the
country. This is done via monetary policy, using interest rates set by the national
bank, or using taxes and government spending under the fiscal policy.
Japans demand side policy is solely a fiscal policy, as the current interest rate is
0% and the monetary policy is as such irrelevant, due to the problem of deflation
Japan faced. The interim solution used of increasing supply of money will simply
help pay for immediate rebuilding, but in future will contribute to inflation over
the long term.
An expansionary fiscal policy will have to be used, led by government spending,
as a change in taxes may have adverse effect on the economy. Japan needs
funding to pay for rebuilding and also to furnish the debts and so needs to
increase tax revenue. However, if taxes are increased, firms and households will
find that the spending income (or real profits) will decline. This will mean that the
investments and consumption expenditure will fall, and this will reduce GDP.

A loose fiscal policy led by

government spending will help
increase real GDP (figure 3). At the
same time, government can
incentivize the people to spend more in the country, by offering to all the people
in the affected areas that can be claimed in exchange for products that are
needed. This will help boost the aggregate demand, as seen in figure 3 and will
help close up the deflationary gap. Moreover, provision of goods and services in
this way will improve standard of living for those who were affected by the
disasters.
In the short term, the increased government spending will have a positive
impact. The money will help provide relief for the victims, and will help increase
standard of living, thus yielding higher GDP in the coming months. The change in
costs of production and the supply side policy will be slower to implement, but as
soon as it is, the aggregate demand will rise due to more spending power. This
will further increase the aggregate demand in the short term.
However, in the long term this could be adverse. First, the excess supply of
money in the market will make the Yen depreciate. Also, the governments
budget deficit means it may not be able to afford increased expenditure.
Furthermore, increased costs of production will prevent foreign firms from setting
up in Japan, thus hampering future growth. On the plus side though, using
vouchers and increased consumption expenses for households will result in the
multiplier effect. This will allow for more and more money to flow through the
circular flow model, and therefore increase GDP in the long run too.
In all, due to the fact that monetary policy cannot be used in Japan and due to
the adverse side effects of changes in tax policies, sole use of demand side
policy is unfeasible. Therefore, it appears that in the short term the best solution
is government spending, which can only be used in the interim due to large
debts. In the medium to long term, incentivizing household expenditure will
increase demand and raise GDP, and may help remove the save more culture,
and therefore enable Japans growth to the future.
Judging by the Japanese economy prior to this earthquake, Japans lack of GDP
and output will result in further slowing growth in future. This means that Japan

could come to a stage of debt crisis, since output has slowed after the
earthquake. Immediate government intervention appears to be the only solution,
to increase GDP.

Total Word Count (Inclusive of diagrams and textboxes): 750 words only.

Bibliography:

Trading Economics, 14/6/2011Japan Interest Rate, viewed on 27/07/2011

<http://www.tradingeconomics.com/japan/interest-rate>

Economics Help, 7/2/2011, List of National Debt by Country, viewed on

24/7/2011 <http://www.economicshelp.org/blog/economics/list-of-nationaldebt-by-country/>

The Week, 22/3/2011, Rebuilding Japan: By The Numbers, viewed on

28/7/2011 <http://theweek.com/article/index/213405/rebuilding-japan-bythe-numbers>