Japan (Re)Tries Fiscal Stimulus

Last week Japan announced a massive stimulus package designed to jumpstart its slumping economy, which is in the midst of its fifth recession in 15 years. The stimulus initiative, heavy on infrastructure spending and disaster preparedness, includes $117 billion in central government spending. Add in local government and private-sector support and spending could top $200 billion.  It’s a smart move if implemented quickly and effectively.

The Japanese cabinet claims the package will boost real GDP by 2 percent and create 600,000 new jobs; this sizable increase may be an understatement. In Japan’s $5.87 trillion economy, a $200 billion stimulus package could raise the short-run level of GDP by around 3 percent, assuming a dollar-for-dollar relationship between government spending and economic growth. (Government investment raises GDP when the outlay is made. Subsequent economic effects depend on the productivity of the investment—which can raise its net impact—and the effect on taxes and interest rates—which can reduce the net benefits.)

Moreover, research shows that when interest rates are at or near zero as is the case in Japan, the ability of government spending to stimulate economic growth is particularly acute. One economist estimated that each government dollar spent when interest rates are zero leads to over $3 in economic growth. If this is right, Japan’s stimulus will be a remarkable shot in the arm for a struggling economy.

There are, of course, large caveats to the above statement. Foremost is the need for productive public investments that leverage private sector activity—for example, helping to rebuild the regions affected by the 2011 tsunami. Japan’s jawdroppingly high national debt—the IMF projects Japan’s gross public debt to reach 240 percent of GDP in 2013—is in part due to wasteful public works projects undertaken over a decade ago. (Japan made several mistakes during its “lost decade,” including jacking up its consumption tax in the midst of a recovery and overinvesting in unproductive public works projects.)

Also, there is a big difference between announcing a stimulus package and implementing one. Japan learned this lesson in the 1990’s, when it announced large stimulus programs but never followed through.  Lastly, it’s vital that the programs quickly release funds to the economy; a slow drip of stimulus payments won’t help.

Japan’s move has two important implications for the U.S. For starters, recovery in Japan would likely boost growth here at home: the U.S. exported over $100 billion to Japan last year and would benefit from stronger demand. One recent IMF study found that Japan’s fiscal stimulus during the U.S. financial crisis—estimated at 1.8 percent of GDP over two years—boosted U.S. GDP by a small amount in 2010. The effect on the U.S. economy could be larger if Japan’s latest stimulus package exceeds $200 billion.

Perhaps more importantly, success in Japan might bring the word “stimulus” out of our nation’s collective doghouse. The tepid economic recovery in the U.S., combined with desperately needed relief for regions affected by Hurricane Sandy, begs for higher infrastructure and disaster relief spending. These conditions, combined with near-zero interest rates, make the U.S. economy an ideal candidate for temporary infrastructure spending of its own.