Back in the day, there was a popular TV program on TV Asahi called Sunday Project, hosted by Soichiro Tahara. It was the premier arena for fierce debates between experts on political and economic issues. Looking back, the 1990s and early 2000s were a whirlwind of shifting theories as Japan’s “economic miracle” began to fade.
The Era of Pessimists vs. Optimists
After the bubble burst in 1991, the loss of momentum was undeniable. Real GDP growth fell for three consecutive years, hitting negative territory in 1993. On Sunday Project, the debate pitted optimists like Yoshio Suzuki (Nomura Research Institute) against pessimists like Masaru Takagi (Fuji Research Institute). Yet, even the “pessimists” of that time never imagined Japan would endure nearly 30 years of stagnation. Inflation was still a given back then; it wasn’t even a point of contention.
By the mid-90s, the focus shifted from growth forecasts to the “bad debt” crisis. Major financial institutions began to collapse, and a sense of unease lingered despite moderate GDP growth. Then came the fateful year of 1997. The “double punch” of the Hashimoto tax hike and the Asian Financial Crisis sent the economy into an abyss.
The Great Intellectual Divide
As the economy cratered, two camps emerged:
- Structural Reformers: Led by figures like Heizo Takenaka, they advocated for market-driven overhauls. At the time, I consider myself a market fundamentalist and agreed with them.
- Fiscal Activists: Figures like Richard Koo and Shizuka Kamei argued for aggressive government spending. They were often dismissed as advocates for “pork-barrel” spending.
Richard Koo, in particular, was the pioneer of the “Balance Sheet Recession” theory. He argued that when asset prices collapse, businesses and households stop spending to repair their finances. If the government also cuts spending due to falling tax revenue, you get a “fallacy of composition”—where rational individual actions lead to a macro-disaster. Looking back, Koo was the one talking sense from the very beginning.
The Rise and Limits of Reflationism
When deflation became entrenched in the 2000s, the “Reflationists” (Reflationary school) rose to prominence. They argued that non-traditional monetary policy—like Quantitative Easing (QE)—could change public expectations and spark inflation. This camp included heavyweights like Kikuo Iwata and Nobel laureate Koichi Hamada.
I agree that QE helps lower long-term rates, boost asset prices, and weaken the yen. However, the Reflationist obsession with “inflation expectations” changing consumer psychology never quite materialized in the way they promised. Why? Because fiscal policy kept getting in the way. The 2014 and 2019 tax hikes neutralized the effects of monetary easing.
Former BoJ Governor Kuroda seemed never to grasp this (or perhaps he pretended not to, given his Ministry of Finance roots). He was so desperate to avoid increasing the fiscal deficit that he resorted to complex tools like negative interest rates and Yield Curve Control (YCC). It is baffling: how can one prove that the BoJ can create money out of thin air, yet still fret over the “fiscal deficit” while trying to raise inflation?
A Belated Handshake
Fortunately, as the limits of monetary policy became clear, some Reflationists began joining forces with Fiscal Activists. This is a welcome development. Stripping away the jargon, both camps share a core realization: the government has an unlimited capacity to supply currency.
It is tragic that these two camps spent years attacking each other. Reflationists mocked fiscal policy as “outdated,” while fiscal activists criticized the BoJ’s experiments. If they had cooperated from the start—using monetary policy first, then bringing in the “heavy artillery” of fiscal spending when that failed—Japan might have recovered much sooner.
Conclusion
Non-traditional monetary policy as a tool against deflation had some effect, but it also created many distortions. We should have capped interest rate cuts at 0% (or 0.1%) and relied primarily on fiscal policy thereafter.
Conversely, monetary policy is exceptionally effective at stopping inflation. Central banks can raise rates every month if necessary, and there is no “ceiling” on how high rates can go. Fiscal policy, on the other hand, is too slow and politically difficult (tax hikes are never popular) to react nimbly to rising prices.
In short: Use monetary policy to kill inflation, and fiscal policy to kill deflation.
(Note) Some argue that BoJ’s currency issuance is a “liability” on the balance sheet. While technically true in accounting, a liability that never has to be repaid is essentially equity. If it were coins instead of bills, it would be recorded as a government asset from the start. The distinction is academic, not functional.
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