Many people, including economic professors think that the prescription for the economy, when it is ailing is lowering interest rates, lowering taxes, and increasing deficit spending. This isn’t correct it only exacerbates the recession. When the economy is ailing, you must decrease taxes, let the market place dictate interest rates, and balance the budget. When we look at Japan in the 1990’s we should learn from their mistakes. Let us use an analogy to see the problem with deficit spending. Deficit spending is the air being pumped into the bubble, and the government will be the air pump. In the short-term deficit spending will grow the economy, but eventually the air expands it so much that the bubble pops and the economy implodes or starts to shrink rapidly. “The Austrian economists argue that the boom and bust cycle is a natural outgrowth of government intervention in the market through the central bank. The central bank attempts to stimulate economic growth by lowering its interest rates, increasing the money stock, which encourages banks to lend out money to businesses or consumers. The consumers spend and businesses invest. Ideally, the central bank is able to turn off the monetary spigots when sufficient credit is produced for desired consumption and profitable projects, and the bank raises its rates to cool growth. The problem with this is that according to the Austrians, no group of central bankers has the ability to factor every variable in to select the “natural” rate of interest, or the rate that governs the allocation of resources between current consumption and investment.” “The boom occurs when the central bank holds rates below the natural rate, incentivizing consumers and businesses to spend or invest in more unnecessary or riskier ventures than they would were the cost of money at its natural level. The Austrians call this malinvestment. As the money is spent or invested, this leads to a general rise in prices. This is exactly what occurred in Japan. The bust occurred when Japan raised its interest rates.” “Japan’s bubble was fueled by cheap and super easy credit. Japan’s gross consumer debt increased by seven fold from 9 trillion yen in 1979 to 67 trillion yen in 1991. The slide in interest rates during the 1980’s led to major and unsustainable increases in asset prices, as the easy credit incentivized people to take on more debt and companies to invest in riskier ventures than they would have were the interest rates reflective of the time preference of the Japanese. Ultimately, the bubble was pricked, as the Japanese monetary authorities aggressively raised interest rates. The worst the government can do, and incidentally its most common measures for fighting the recession include: preventing or delaying liquidation, inflating further, keeping wages up, keeping prices up, stimulating consumption, discouraging saving, and subsidizing employment. Japan increased aggregate demand through public spending and tax decreases. These policies while well-intended failed to bring the economy out of stagnation. In fact, they served to exacerbate many of the problems Japan already had, and created other ones in the process. First, Japan’s undertaking of Keynesian fiscal stimuli led to the creation of a massive increase in Japan’s public debt, as the debt by 2000 exceeded 100% of Japan’s GDP. The Austrians would argue that the last thing a country would want to do during a recession is to become fiscally more irresponsible, yet this is what the Japanese did.” “When you increase the money supply in distributing the checks, the value of the purchasing power of their cash decreases. Thus, the economic stimulus ends up as a tax on the consumer as prices, ceteris paribus, will rise as the new money floods the economy” The two factors that caused and exacerbated Japan’s recession were lowering and raising the interest rates and deficit spending. Japan should have let the market fluctuate the interest rates, and Japan should have tightened the belt on spending and tried to balance the budget. (Ludwig von Mises Institute: Benjamin Weingarten Japanese Politics: The Cause of Japan’s Boom and the Reasons for its Prolonged Bust: http://www.mises.org)
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