Lost Decades

However, as deflation persisted, the traditional monetary policy of setting low interest rates to stimulate investment and consumption, which typically causes inflation, became ineffective.

[19][20][21] While there is some debate on the extent and measurement of Japan's setbacks,[22][23] the economic effect of the Lost Decades is well established, and Japanese policymakers continue to grapple with its consequences.

"[26] Economist Richard Werner writes that external pressures such as the Plaza Accord and the policy of Ministry of Finance to reduce the official discount rate are insufficient to explain the actions taken by the Bank of Japan.

Equity and asset prices fell, leaving overly-leveraged Japanese banks and insurance companies with books full of bad debt.

[29] Additionally, Michael Schuman of Time magazine wrote that these banks kept injecting new funds into unprofitable "zombie firms" to keep them afloat, arguing that they were too big to fail.

His "three arrows" of reform intend to address Japan's chronically low inflation, decreasing worker productivity relative to other developed nations, and demographic issues raised by an aging population.

The Bank of Japan has set a 2% target for consumer-price inflation, although initial successes has been hampered by a sales tax increase enacted to balance the government budget.

A Kyodo News poll in January 2014 found that 73% of Japanese respondents had not personally noticed the effects of Abenomics, only 28 percent expected to see a pay raise, and nearly 70% were considering cutting back spending following the increase in the consumption tax.

[43] Economist Paul Krugman has argued that Japan's lost decades are an example of a liquidity trap (a situation in which monetary policy is unable to lower nominal interest rates because it is already close to zero).

Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP.

In a balance sheet recession, GDP declines by the amount of debt repayment and un-borrowed individual savings, leaving government stimulus spending as the primary remedy.

[44][45] Economist Scott Sumner has argued that Japan's monetary policy was too tight during the Lost Decades and thus prolonged the pain felt by the Japanese economy.

[46][47][48][49] Economists Fumio Hayashi and Edward Prescott argue that the anemic performance of the Japanese economy since the early 1990s is mainly due to the low growth rate of aggregate productivity.

Their hypothesis stands in direct contrast to popular explanations that are based in terms of an extended credit crunch that emerged in the aftermath of a bursting asset "bubble."

They are led to explore the implications of their hypothesis on the basis of evidence that suggests that despite the ongoing difficulties in the Japanese banking sector, desired capital expenditure was for the most part fully financed.

Rather, to return Japan's economy back to the path to economic prosperity, policymakers would have had to adopt policies that would first cause short-term harm to the Japanese people and government.

[example needed][52] Under this analysis, says Ian Lustick, Japan was stuck on a "local maximum," which it arrived at through gradual increases in its fitness level, set by the economic landscape of the 1970s and 80s.

[53] After the Great Recession of 2007–2009, many Western governments and commentators have referenced the Lost Decades as a distinct economic possibility for stagnating developed nations.

[54] And in 2010, Federal Reserve Bank of St. Louis President James Bullard warned that the United States was in danger of becoming "enmeshed in a Japanese-style deflationary outcome within the next several years.