What is the true nature of the current recession in Japan? Is it cyclical, a result of asset deflation, or has it been caused by the deteriorating competitiveness of this country as an industrial location? These questions must be answered to formulate an effective economic policy. In my view, the economic policy of the past decade has failed to halt the recession because policymakers have misjudged its nature.
The government relied chiefly on fiscal and monetary policy throughout the 1990s, probably because it believed that the recession was cyclical. Many economists called for fiscal and monetary measures to end the recession, and politicians took advantage of those measures. The reasoning was that structural reform, anathema to interest groups, would be unnecessary if the slump could be ended by fiscal and monetary means.
So interest rates have been reduced to almost the lowest level possible, while public works spending has increased as never before. As a result, the economy is now so dependent on such spending that drastically reducing it threatens to send the economy into a tailspin.