Overview

Traditional analysis of Japan’s deflationary slump tends to fall into two classes: “structuralist” or monetary. These forms of analysis have proved wanting.
Orthodox theory sits awkwardly with Japan’s experience in four principal areas. First, the suggestion that Japan’s structural deformity manifests itself in a low level of TFP carries no weight, because the theory behind concept itself is circular. Second, “structural reform” was counterproductive, because it reduced effective demand - just as it was in the 1920s and 1930s. Third, the limitations of purely monetary perspectives were exposed by Japan’s long deflation; the importance of the exchange rate regime was, by contrast, brought to the fore. Fourth, Japan's post-1990 experience reveals how comparatively little orthodoxy has to offer in terms of addressing the importance of resetting asset valuations.
Japan’s slump is more easily explained by recourse to political economy approaches. Naïve belief in neoclassical theory allowed a prolonged pursuit of policies tending to reduce effective demand while having important distributional implications. Support for such a policy regime was political and class-based in origin precisely because of these distributional consequences. The awkwardness of Japan’s case serves as an admonition to developed economies that economic orthodoxy carries impressive costs. Japan's inchoate moves towards restoring a bias in favour of full employment and higher wages even at the cost of higher inflation might offer the world an important and positive example.