Krugman Argues That Japan Really Did Have A Lost Decade

Paul Krugman used Japan's lost decade to argue that government could have responded more strongly to the collapse of the economy when the real estate bubble deflated. He then argued that the US did the same thing in the aftermath of the financial crisis. In this article he defends his assumption that Japan really had a lost decade that a stronger response by government could have altered. He ignores some of the arguments made by his critic that the use of GDP as a measure of happiness may be misplaced, and attempts to show that japan really did have a lost decade. He compares output per worker in the lost decade with more recent decades to make his point.

It seems to me that Japan's economy crashed when the real estate bubble burst, and that government might have done a better job of dealing with the crisis. One could make a similar case for our response to the financial crisis. The loss of household wealth in Japan and in the US from deflating real estate bubbles was so severe, however, that any government response via fiscal policy would have been futile. In both cases we had economies in which aggregate demand was predicated on inflated wealth. Trillions of dollars of lost wealth is not an easy problem to fix when spending is fueled by credit instead of income, and the source of credit evaporates. We do a pretty good job responding to the normal swings in the business cycle with fiscal policy and monetary policy. It is more difficult to deal with a dramatic collapse of wealth and a collapse of the banking system. It has taken Japan a long time to recover from its problems and it will take a long time in the US as well. The problems in Japan were probably more severe than those in the US because their banks were not only stuck with bad mortgages, they had invested heavily in zombie businesses that were unable to pay down debt. This has not been the case in the US. We still have healthy corporations that have the funds to invest in the economy. Our major problems are how to deal with the housing crisis, and how to figure out how to grow an economy in the absence of asset bubbles which supported growth in the absence of rising household income.