"If Japan Fails to Utilize Low Interest Rates and Yen Depreciation for 'Innovation,' It Will Not Escape Long-Term Stagnation"

Kinyung Yeon, Report on 'The Lost 30 Years and Japan's Choice'

There is an analysis that if Japan fails to utilize the current low-interest-rate environment to achieve innovation, it will not help the Japanese economy escape from long-term stagnation. Long-term stagnation can have side effects that limit a country's policy choices and even cause it to lose opportunities to improve its economic structure.

The Korea Institute of Finance recently stated in its report "The Lost 30 Years and Japan's Choices" that "it will be difficult for Japan to voluntarily raise interest rates in the near future."

Since 2013, Japan has maintained an ultra-low interest rate policy despite being in a situation of ultra-low interest rates and excess liquidity due to bold quantitative and qualitative monetary easing. The reason for this policy choice is that Japan's potential growth rate, which was in the 4% range until the 1980s, has declined to 0.25% in 2023.

Senior Research Fellow Kim Dong-hwan of the Korea Institute of Finance said, "The decline in potential growth rate is due to supply-side factors such as a decrease in total factor productivity (TFP) growth rate and a reduction in the working-age population caused by low birth rates and aging," adding, "There are also demand-side factors such as continued domestic demand sluggishness since the 1990s bubble collapse, yen appreciation after the 2008 global financial crisis, and export slowdown due to the hollowing out of manufacturing."

According to existing research, when the cause of long-term stagnation lies on the demand side, accommodative macroeconomic policies to stimulate aggregate demand are prescribed, while when it lies on the supply side, structural reforms to improve productivity are suggested as remedies.

Krugman, Bernanke, and others have argued that when nominal growth rates are stagnant or in a liquidity trap, it is necessary to expand aggregate demand through quantitative and qualitative monetary easing policies. Kikawa and others emphasized that to raise the natural growth rate, which has fallen into stagnation since the global financial crisis, or to improve productivity in non-manufacturing and non-tradable sectors, structural reforms such as innovation and new industry development are necessary.

Ultimately, Japan's adherence to a low-interest-rate policy is largely due to both supply-side and demand-side factors pointing to interest rate cuts as the prescription for escaping long-term stagnation in the Japanese economy.

Senior Research Fellow Kim said, "There has been discussion that with the prolonged yen appreciation trend after the global financial crisis, Japan's monozukuri (manufacturing) economy faced a crisis of collapse, while the capital market might have an opportunity for development," adding, "If Japan fails to utilize the current low-interest-rate environment to achieve breakthrough or disruptive innovation, a return to the monozukuri economy and trade-dependent nation will not help the Japanese economy escape from long-term stagnation."

[Image source=AFP Yonhap News]

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