Prolonged Stagnation, Hesitant Recovery: Japan from an ‘Austrian’ Perspective

Tentative indications of recovery at the turn of the millennium offer the prospect of an end to the economic crisis that has afflicted the world's second largest economy since 1991. Both the duration of these difficulties and their insusceptability to conventional policy stimuli have presented challenges to mainstream macroeconomic thinking. It is argued here that the business cycle theory developed by Friedrich Hayek on the basis of the Austrian economic tradition, although eclipsed by the contemporary writings of Keynes, offers insight into the intractable nature of the Japanese crisis. This contrasting perspective stresses the links between monetary policy and the evolution of capital structure to provide an explanation for the inevitable dislocation following a credit‐financed boom. On these grounds, the application to Japan emphasises relaterd monetary and exchange rate developments in the 1980s as the underlying cause of the long stagnation of the 1990s. It therefore contradicts the view of the IMF and other multilateral bodies that the country's financial sector deficiencies were the primary factor. The structural focus of the analysis also suggests that the current (uncharacteristic) Fund emphasis on the need for demand stimulation is misplaced. Arguing that the surrounding economies have a particular interest in the means chosen to consolidate economic recovery in Japan, a policy approach consistent with the Austrain diagnosis is set out. It provides a framework in which fiscal consolidation and monetary policy normalisation, as desired by some elements of the country's administration, would be an appropriate strategy for the promotion of recovery.