The myth of Japanese policy ineffectiveness

Yesterday provided another example of how Japan is not stuck in a “liquidity trap”, and never has been. Here’s Bloomberg:

Bank of Japan Governor Haruhiko Kuroda shocked markets by doubling a cap on 10-year yields, sparking a jump in the yen and a slide in government bonds in a move that helps pave the way for possible policy normalization under a new governor.

The BOJ will now allow Japan’s 10-year bond yields to rise to around 0.5%, up from the previous limit of 0.25%, while keeping both short- and long-term interest rates unchanged, according to a policy statement Tuesday. 

The move caused a sharp appreciation in the yen, clear evidence that the effect was highly contractionary:

This action makes it even more likely that Japan will undershoot its 2% inflation target over the next decade. It was an obvious policy mistake, an unforced error.

But this is nothing new:

1. In 2000, the BOJ raised interest rates after years of deflation, insuring that the deflation would continue.

2. In 2006, the BOJ raised interest rates and sharply reduced the monetary base (quantitative tightening) after years of deflation, insuring that the deflation would continue.

In this case, it’s misleading to blame the BOJ. Kuroda probably opposed the move, at least in private. But he’s scheduled to be replaced by a more hawkish bank president in early 2023, and the bond price targeting program is likely to be abandoned. Ironically, in the long run the new BOJ president may well deliver even lower nominal interest rates than Kuroda.

The Japanese government may claim that it wishes to achieve 2% inflation, but is unable to do so. Their actions make it quite clear that this is not their actual policy goal, they are content with near-zero inflation. And yet most American macroeconomists will continue to believe in the myth that Japan is “stuck” in a liquidity trap, unable to achieve inflation.

“This is the west sir. When the legend become fact, print the legend.”



31 Responses to “The myth of Japanese policy ineffectiveness”

  1. Gravatar of Spencer Spencer
    22. December 2022 at 07:35

    A Higher Order Thinking.

  2. Gravatar of Christian List Christian List
    22. December 2022 at 13:35

    Is there something wrong with the blog? The comments seem less to me since a few days. And if one searches “The Money Illusion” via Google, the blog no longer appears as a result, at least not on page 1. Before that, the blog was always clear No. 1 on page 1. And now if one has found the blog via detour, there are long loading times for every simple page. And in 30-40% of the cases the browser doesn’t want to load the blog at all.

  3. Gravatar of Mark Barbieri Mark Barbieri
    22. December 2022 at 14:58

    I don’t understand how anyone could claim that a country with a large national debt denominated in it’s own country could be stuck in a liquidity trap. Couldn’t they just announce that the central bank was going to start purchasing and retiring debt until they achieve their inflation target? It seems to me that it would either have to cause inflation or it would be a free lunch way to eliminate your national debt.

  4. Gravatar of Trying to Learn Trying to Learn
    22. December 2022 at 17:37

    Why would the Japanese government’s goal be 0% inflation though? Wouldn’t their likely be healthier/wealthier (have higher long term RGDP) if they had a target above 0?

  5. Gravatar of David S David S
    22. December 2022 at 18:14

    The policy is what is achieved, and consistent with the recent history in Japan we can expect 2-3 years of a negative inflation rate.

    I wonder how many people in Japan have grown to accept this condition, and view it as a good thing?

  6. Gravatar of Ray Lopez Ray Lopez
    23. December 2022 at 07:16

    OT: The Economist this week on Arthur Burns. Contradicts our conventional thinking host, but what’s new? Keep in mind I believe money is neutral and the Fed follows the market, but still, excerpts: “With the holiday season upon us—and with the Fed approaching a turning point in monetary policy—it is a fine time to reassess the legacy of the much-maligned central banker [Arthur Burns].” “In 2016 economists from the Fed’s branch in Richmond assessed monetary-policy settings over the years. Their model suggested that the “Volcker shock” had not appeared like a bolt from the blue. Burns had laid the groundwork for it..” “Capital expenditures—that is, money spent by businesses on things such as buildings and equipment—reached about a third of American gdp in 1978, which still stands as the highest level since at least 1946. Responding to the supply shocks at the time, much of that went into energy and commodity production. Jeffrey Currie of Goldman Sachs, a bank, recently noted that these investments helped to “de-bottleneck” oil and metals production capacity for decades, setting the economy up for lower inflation in the long run.”

    PS–central banks around the world are raising rates, in response to inflation. Central banks follow the market. Today’s story is a non-story, which for some occult reason Sumner thinks is significant.

  7. Gravatar of Spencer Spencer
    23. December 2022 at 07:31

    Japan is a distinct example of the paradox of thrift and money demand. The Japanese save a larger proportion of their earnings and keep a larger proportion of those savings impounded in their banks.

    It is incontrovertible that banks don’t lend deposits – that deposits are the result of lending. It’s stock vs. flow. Savings aren’t synonymous with the money supply. From the standpoint of the commercial banks the savings practices of the public are reflected in the velocity of their deposits, and not in their volume.

    Whether the public savers, dissaves, chooses to hold their savings in the commercial banks or transfer them through intermediary institutions will not, per se, alter the total assets or liabilities of the commercial banks nor alter the forms of these assets and liabilities.

    “Japanese households have 52% of their money in currency & deposits, vs 35% for people in the Eurozone and 14% for the US.”

    See also:

    The nominal economy leads – by Marcus Nunes – Money Fetish (

  8. Gravatar of Dr Richard Dr Richard
    23. December 2022 at 07:32


    Can you explain to me why the Fed and the financial media believes that low unemployment is a bad thing? Every indicator I get is that they hate that we are in an economy where everyone who wants to find a job can find a job. As a person who was unemployed during the 2009 financial crisis and had difficult for years finding a job, I would much rather take today’s current low unemployment, high inflation environment over a decades ago high unemployment, low inflation environment.

    Here is a relevant sentence from an article on the latest CPI:

    “The labor market still remains stronger than the Fed likes, with the unemployment rate at 3.7%, but employers have begun reducing the number of positions they have open.”

    Reading that first sentence seems like we are in a bizarro world where good news is bad news.

  9. Gravatar of ssumner ssumner
    23. December 2022 at 09:27

    Trying to Learn, There is a split within the government.

    Ray, The Economist? Yes, there’s a good place to go to learn about monetary policy during the 1970s.

    Dr. Richard, I agree that 2009 was much worse than today. The Fed’s actual concern is (or should be) not low unemployment, it’s fast rising nominal wages, which make it harder to control inflation.

    In the long run, there’s no trade-off between inflation and unemployment. We should be aiming for something like 2019—low inflation and low unemployment.

  10. Gravatar of Spencer Spencer
    23. December 2022 at 09:53

    See: “Pay close attention to Chart #2, since you’re unlikely to see anything like it elsewhere. To begin with, it’s plotted using a logarithmic y-axis, which means that straight lines are equivalent to constant rates of growth. The dotted green line represents the annual growth trend which started in 1966 and persisted through 2007: 3.1% per year. That is, over this 56-year period the economy managed to grow by an annualized rate of 3.1%. Sometimes by more, sometimes by less, but over time it always came back to this trend line. The dotted red line shows the growth trend in place since mid-2009: 2.2%. Something happened during the Great Financial Recession of 2008-09 to put a permanent damper on growth, and it’s not just demographics—demographics don’t change dramatically from one year to the next.”

  11. Gravatar of Ray Lopez Ray Lopez
    23. December 2022 at 10:33

    SS: “Ray, The Economist? Yes, there’s a good place to go to learn about monetary policy during the 1970s.” – what do you have against the Economist? They are ‘right-wing’ but over the years have become more ‘left wing’. Check out their year end issue on inflation, pretty interesting, shows inflation nothing new and there was a Summers (Jean Cherruyer de Malestroit) and Krugman (Jean Bodin) in the 16th century who argued demand and supply shocks, respectively, were the cause of 5%/yr inflation (which at the time of 0% a year was unheard of). As for the influx of Spanish silver (monetarism) this is considered not a big deal, rather, demographics and demand (end of Black Death in 14th century, breakdown of feudal system and rise of the money economy) played a bigger role than silver; likewise the debasement of currency (Henry 8th’s) was not a big deal, as the king of France did the same thing to no effect during the preceding period (“France debased its silver coins 123 times between 1285 and 1490. Between those years there was no inflation”)

    Finally, it would be wise to heed the words of Jack Goldstone who argued inflation helped topple governments. Though money is neutral, people like the unit of account of stable currency. “In a paper published in 1986 Jack Goldstone, now of George Mason University, asked why from 1550 to 1650 “states broke down on a wide scale”

    Something to think about, radical Dr. Sumner, when advocating high inflation.

  12. Gravatar of Ray Lopez Ray Lopez
    23. December 2022 at 10:48

    @Spencer who says: “Something happened during the Great Financial Recession of 2008-09 to put a permanent damper on growth, and it’s not just demographics—demographics don’t change dramatically from one year to the next.” — this is a well known problem, and the answer is labor participation rates declined after the Great Recession, with Boomers retiring. I myself closed my consultancy a few years after 2008 (I had de facto retired even earlier, but the Great Recession was the final straw).

    Here’s a chart for you:

    Thanks for the link to the scottgrannis site, it had a nice PE ratio chart that I copied for my notes.

  13. Gravatar of Trying to Learn Trying to Learn
    23. December 2022 at 11:57

    @Scott that doesn’t really answer the question though? Why is there a split? What is the goal of the coalition who wants 0% inflation?

  14. Gravatar of Spencer Spencer
    23. December 2022 at 14:50

    Ray, if that was the answer, it would work both ways.

  15. Gravatar of Samuele Samuele
    23. December 2022 at 17:26

    Scott, largely unrelated to this particular post, but are your thoughts on Noah Smiths new article on the state of macroeconomics?

  16. Gravatar of Ray Lopez Ray Lopez
    23. December 2022 at 22:08

    @Spencer – it has worked both ways. On the way up, there was “capital deepening” and “increased labor participation rates” (chiefly among women after the 1950s) that raised GDP and GDP per capita to the trend line shown in the graph you cited. After the Great Recession, both productivity (total factor, and labor) and GDP fell since fewer bodies and people with expertise, namely the Boomers, retired and work fell to less capable Snowflakes. It’s not a big mystery, just follow the data. Kind of like money non-neutrality actually. I believed money is not neutral when I was young but then looked at the data and it’s clear it is not. Some people –that would be Sumner–stick to the ideas presented in textbooks from 50 years ago.

  17. Gravatar of dtoh dtoh
    24. December 2022 at 01:37

    I don’t know why any one cares about inflation or interest rates in Japan. They are irrelevant. Japan’s overarching problem is a lack of real growth caused by a confiscatory tax regime and a regulatory regime that’s hostile to new business formation.

    Almost all of the real growth in the past 15 years has come from increased female participation in the labor force, and that has run out of runway. The aging population and resulting decline in the labor force is going to significantly aggravate the problem over the coming years.

    There’s not even a discussion in politics or the media about ameliorating the structural factors that are strangling business formation and growth. Japan is basically screwed.

    And BTW, Japan’s low birth rate is caused by the country’s dismal economic prospects….. not the other way around.

  18. Gravatar of Spencer Spencer
    24. December 2022 at 05:42

    @Ray: You’ve looked at the data closer than me. But I approach it from a different angle, viz., transactions’ data, debits per deposit account.

    Even when more housewives were entering the workforce, bank debits per account rose. It’s more like the productivity data is off.

  19. Gravatar of ssumner ssumner
    24. December 2022 at 08:52

    Trying, Protecting savers?


    dtoh, As I’ve said many times, Japan has an unusually high birth rate by East Asian standards. The lowest rates are in the faster growing “tiger” economies. It has nothing to do with lack of growth or poverty. Check out Mali’s birth rate.

  20. Gravatar of dtoh dtoh
    25. December 2022 at 03:56

    Who said low birth rates had anything to do with poverty. In fact they are inversely correlated.

    Japan has a low birth rate relative to other affluent countries because of its lack of economic growth relative to other affluent countries.

    My main point though is that Japan is in deep trouble because of it’s lack of economic growth and the fact that there is no awareness of or discussion about the reasons or solutions for the problem. Discussion of inflation or monetary policy is a distraction and irrelevant.

    BTW – Mali is not in East Asia, and Japan has the 2nd lowest birth rate in East Asia

  21. Gravatar of Jeff Jeff
    25. December 2022 at 05:44

    “Wouldn’t their likely be healthier/wealthier (have higher long term RGDP) if they had a target above 0?”

    This seems to be a common belief but what really is the best evidence for this claim? Is it really just the wage stickiness claim or is it more a general sense that this must be the case because it seems theoretically more elegant? If it’s mostly about wage stickiness, I don’t fully grok the “so what” part of that argument, because it seems to rest on a sleight of hand that is hard for me to imagine can’t have hidden costs—if an employment relationship is maintained because the employee is possessed of an illusion that a static wage retains a static value when it does not, and/or the employer has some hangup about lowering the wages of underperforming employees, isn’t it at least possible if not probable that long run RGDP is higher if both parties are forced to reckon with reality, however painful in the short run? Has that ever been conclusively disproven?

  22. Gravatar of ssumner ssumner
    26. December 2022 at 21:26

    dtoh, Wrong. Every developed country in East Asia has a lower birth rate than Japan, often far lower. Try again.

  23. Gravatar of Doug M Doug M
    27. December 2022 at 01:46

    Dr. Richard says,

    “Reading that first sentence seems like we are in a bizarro world where good news is bad news.”

    Actually, this is the normal state for the financial markets.

    Dr. Sumner says,

    “In the long run, there’s no trade-off between inflation and unemployment.”

    Yes! the Phlips curve is dead!

  24. Gravatar of dtoh dtoh
    27. December 2022 at 02:00


    I don’t think so…. CIA World Fact Book..

    China 9.93
    Japan 6.95
    Mongolia 15.84
    North Korea 14.21
    South Korea 6.92
    Taiwan 7.39

  25. Gravatar of ssumner ssumner
    27. December 2022 at 07:11

    Out of date:

  26. Gravatar of dtoh dtoh
    27. December 2022 at 10:41


    They are not of date. They are 2022 numbers, and you are confusing the birth rate with the fertility rate.

  27. Gravatar of Ray Lopez Ray Lopez
    28. December 2022 at 22:57

    Scott, The Economist? Seriously?

  28. Gravatar of ssumner ssumner
    30. December 2022 at 07:57

    dtoh, Normally, when people find their views are based on false assumptions, they change their minds. They don’t deny the data.

  29. Gravatar of dtoh dtoh
    30. December 2022 at 20:13

    You are clearly wrong. Check the numbers.

  30. Gravatar of dtoh dtoh
    30. December 2022 at 20:23

    The numbers in the Economist are fertility rates not birth rates… and they are not just for East Asia… nor do they include all the countries in East Asia. The numbers I provided are the correct up to date and undisputed birth rate numbers for East Asian countries

  31. Gravatar of Mikk Salu Mikk Salu
    6. January 2023 at 05:19

    dtoh, CIA factbook numbers are estimates, numbers for 2022 cannot be undisputed. It should be evident that we do not have exact numbers from the year that ended just a few days back.

    Though, I agree with you that Scott makes a mistake here, mixing up the fertility rate and birth rate. Japan (and Korea) have low fertility and a low birth rate. Other developed countries from Asia have low fertility, but (still) considerably higher birth rates.

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