More than five years after the financial crisis hit its peak, the world is still far from recovering the ground lost. Tens of millions of people in the wealthy countries of North America and Europe remain unemployed or underemployed as a result of the collapse of the housing bubbles that drove their economies before the crisis.
This downturn has robbed workers of the opportunity to have a decent job and the income necessary to raise their children. It has also resulted in trillions of dollars of lost output. Millions of workers who could have been employed improving our infrastructure, making our homes and businesses more energy efficient or better educating our children have instead been left idle.
According to the dominant strand of economic thinking in policy circles, if not also academia, this suffering was necessary because of the sins associated with the inflation of credit bubbles in the lead-up to the crisis. Their bursting threw budgets out of whack, causing large government deficits. The conventional wisdom in Brussels, London and Washington is that governments must focus on reducing their budgets in order to reduce their debt to more normal levels and lay the basis for renewed growth.
Fortunately this position is not universally shared. Japan’s new prime minister, Shinzo Abe, has taken the opposite tack. Abe became prime minister at the end of 2012 and quickly embarked on a program of aggressive government stimulus. He pushed through spending measures focused on improving Japan’s infrastructure, child care and health care, plus other measures anticipated to provide long-term benefits.
This commitment to additional spending, which means raising Japan’s deficit, is especially striking because Japan is by far the world’s leader in its debt-to-GDP ratio — an allegedly key metric for determining whether a government should cut spending for the sake of economic growth. In a widely cited but later debunked paper, economists Kenneth Rogoff and Carmen Reinhart claimed that when a country’s debt-to-GDP ratio breached 90 percent, it could expect reduced economic growth. Japan’s ratio of gross government debt to GDP is over 240 percent. This is more than twice as high as the United States’ and more than 100 percentage points above that of Italy, which ranks second in this category among major economies.
Abe also got Japan’s central bank to commit itself to increasing the inflation rate, ending two decades in which Japan has seen a modest bout of deflation. This meant setting a 2 percent inflation target, with the commitment to buy as much government debt as necessary to reach the target. A higher inflation rate will reduce debt burdens on the population and lower the real interest rate, giving firms more incentive to invest.
In addition, Abe promised to remove a number of structural obstacles to growth. These barriers take a wide variety of forms, including strong protections for agriculture that raise the price of food and limit the availability of land for other purposes. However, the most important barriers targeted by Abe are the obstacles that prevent women from being full and equal participants in the labor force.