Japan's Slow-Down : Monetary Versus Real Explanations

Two kinds of view about the recent stagnation of the Japanese economy have been particularly popular. The first adopts a 'monetary' perspective, arguing that Japan has fallen into a liquidity trap from which only unconventional monetary policy can save it. The second maintains that a large part of Japan's macroeconomic difficulties is structural and related to problems in the 'real' side of the economy. We argue here that it is hard to justify a neat division between these real and monetary problems. Declining expectations of future productivity may have depressed real interest rates and reduced monetary policy flexibility, but they are also likely to have prompted real responses that have contributed to stagnation. In the long run, the conclusions of the two kinds of diagnosis are complementary, but in the short term tension may exist, with loose monetary policy weakening incentives for structural reform, and structural adjustment exacerbating demand deficiency