Failure of Macroeconomic Policy and Decade Long Stagnation Case Study

Failure of Macroeconomic Policy and Decade Long Stagnation - Case Study Example Since 1990 Japan has experienced over a decade of slow growth in real economic activity. Between 1990 and 2000 per capita output raised at an annual rate of 0.68 percent, per capita investment dropped at the rate of 1.4 percent per annum and weekly hours per adult worker declined by 1.18 percent per annum. This period has come to be referred to as "the lost decade." During the same period the inflation rate, as measured by the growth rate of the GDP deflator, fell from 2.3 percent to -1.8 percent and the nominal interest rate fell from 7.4 percent to 0.1 percent. Japan's current experience of sluggish growth coupled by deflation and zero nominal interest rates raises questions about the role of monetary policy in times of deflation. Should monetary policy take actions to avoid the zero nominal interest rate bound and if so, what policies can avoid it and/or ameliorate its negative ejects? This paper deals with a model that accounts for the real and nominal facts from the 1990s and makes use of this model to answer the two questions posed above. We consider an expensive price adjustment model along the lines of Rotemberg (1996) and expand it to allow for capital accumulation. In this economy, monopolistically competitive firms face convex costs of adjusting prices. Households own the capital stock and are subject to convex costs of adjustment. ... Solving for the equilibrium is complicated by the likelihood of a zero nominal interest rate limitation. An algorithm for computing perfect foresight equilibria is developed in situations where the nominal interest rate is zero over some period of time. The model is then solved and replicated using a parameterization that is standardized to Japanese data. An impulse response analysis is used to answer the first question. We find that the dynamic response of the economy to shocks in technology and government purchases is very di.erent depending on whether the zero nominal interest rate constraint binds. When the constraint is not binding output and investment rise in response to improvements in technology under the interest rate targeting rule we mull over. Nevertheless, when the constraint binds, monetary policy cannot respond and output and investment all drop in response to positive technology shocks. A binding constraint also exacerbates the contractionary e.ects of negative government purchase shocks on these same variables. Overview of the Study First, I will analyze what is extent of stagnation and what are its evidences and proofs from economic conditions of the country. Besides this, what went wrong in demand side Second, I will examine the components of GDP which have been stagnant with reference to relevant theories. Third, I will explore the weaknesses of supply side and its relevant issue will be discussed. Background of the study From the beginning of the 1950s to the early 1970s, the Japanese economy experienced dramatic growth. Several institutional structures sustained this rapid growth. First, the stable