Structural and monetary explanations for Japan's long slump

This dissertation analyzes existing structural and monetary explanations for Japan's slump since 1991 and contributes a new explanation based on the idea of a negative risk premium in Japanese interest rates.First, three structural explanations of Japan's slowdown---the hypothesis of demographic change and slower labor force growth, the conjecture of statutory workweek reduction, and the observed slowdown in productivity growth---are analyzed. Using a standard neoclassical growth model, it is shown that none of these explanations by themselves can account for Japan's slowdown. Taken together, however, they are able to do so until 1997.Second, Krugman's theory of Japan's "liquidity trap", which was developed in an endowment economy with sticky prices but without an explicit mechanism to achieve inflation targets, is extended and analyzed. A dynamic general equilibrium model with production, capital accumulation, an explicit monetary policy and sticky prices is used. In this more general model, negative labor force growth, which was Krugman's original motivation for the liquidity trap, results in an increase in inflation that does not match the data. Slower productivity growth, shorter workweeks and negative labor force growth match the real data and, for a zero percent steady state inflation target, imply falling nominal interest rates and temporary deflation that match the data. Different inflation targets affect the nominal variables but not the real variables. Therefore, it is not clear that Krugman's prescription of inflation targeting would jump-start Japan.Third, the persistent interest differential between long-term Japanese and US government bonds is analyzed. Foreign exchange risk, more than expected yen appreciation, is shown to account for the differential. As a creditor nation, Japan has a negative risk premium that has become more negative with continuing current account surpluses and increasing net foreign assets. This negative risk premium maintains the interest differential. Falling US nominal interest rates and a more negative risk premium have pushed Japan into a liquidity trap where net exports are constrained by the unwillingness of Japanese financial institutions to buy dollar assets and profit margins for lending are compressed. This provides an account of the slump in the late 1990s.