Joe Barbieri
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Joe Barbieri in Joe the Investor,

Is Japan On Track With its Economic Growth Plan?

Is Japan making the same mistakes as everyone else with respect to its economy? So far, it seems like it. The Japanese economy has been in a slow growth mode for many years. In an effort to speed up growth, more money was flooded into the Japanese economy in the hope of increasing consumer spending. (6)(7)(8) This extra money would be derived from lowering interest rates as people would be forced into taking more risk with their capital. This in turn would create demand for the countries equities, creating a stock market boom. When the stock market booms, people feel wealthier and spend more money, creating more purchasing of goods by consumers.

So far, the strategy has worked, but the problems occur in trying to close the loop. How is this “flood of money” paid for? The mechanism used to create lower interest rates is typically the purchase of government bonds and relending them at lower rates. Since the only government revenue stream is taxes, they must be raised to pay for the interest generated by this economic growth initiative. Since the taxes are being paid by the same people who are doing the consumer spending, a spending drag is created by taking more money away from the people. This has happened in the last 12 months with the sales tax increase in Japan. (5)(1) Once the taxes rise, growth begins to slow down and in the case of Japan has contracted. (1)(2)(3)(4)

It is assumed that the effect of the tax hike is temporary and that the economic growth will resume. The tax hike however is permanent – so people will have less money to spend for quite a while. Does it make sense that you will spend more money if you have less of it available for you to spend? If Japan is following the U.S. and Europe, which it seems to be doing – growth will stagnate and the unemployment will continue to stay high. This has happened in the U.S. and Europe in spite of this strategy being employed for a longer time period and more aggressively than in Japan. Also, the cost of the strategy is perpetual because interest is compounding on the original borrowed money used to flood the economy in the first place. If growth does not materialize quickly and the loans are not repaid, the tax increases will remain permanent and the economy will be worse off than before.

If two economic regions of the world have tried this strategy and it has not produced results after 5 years, why would a third region have a different outcome?