Evaluate the likely costs of a long period of deflation for an economy.
2.1.2
Japan shows the costs- Prices fell or stagnated for most of 1998–2012.
- Real value of debt rose, so firms repaid debt instead of investing.
- Real interest rates stayed positive even with nominal rates at zero.
Costs were limited- Deflation was mild, usually under 1% a year: no spiral.
- Unemployment stayed low, never above about 5.5%.
- Real incomes of savers and pensioners were protected.
ChainPrices expected to fall → consumers and firms delay spending → AD ↓ → real debt burden ↑ and real interest rate ↑ → investment ↓ → further downward pressure on prices.
JudgmentThe main cost was not a collapse in output. It was that monetary policy lost its power once rates hit zero. Mild deflation with stable jobs is less damaging than a spiral, but it locks in low expectations that take decades to change.
Assess the effectiveness of quantitative easing in raising inflation and growth.
2.6.2 · 4.4.3
It worked- Abenomics QE weakened the yen and lifted share prices and profits.
- Unemployment fell from over 4% to under 3%.
- Deflation ended: prices rose modestly before 2020.
It disappointed- Inflation stayed below the 2% target until imported shocks in 2022.
- Banks had plenty of reserves but little demand for loans.
- The Bank of Japan ended up owning about half of all government bonds.
ChainCentral bank buys bonds → bond prices ↑, yields ↓ → cheaper borrowing and a weaker currency → investment and net exports ↑ → AD ↑ → inflation and growth ↑.
JudgmentQE is weakest when firms and households want to save rather than borrow (a liquidity trap) and when inflation expectations are firmly low. It helps most through the exchange rate, which only works if trading partners are not doing the same.
Discuss whether a high ratio of public debt to GDP is always a problem for an economy.
4.5.3
Not always- Japan carries ~230% of GDP without a crisis.
- About 90% of debt is held at home, in yen.
- For years yields near zero kept interest costs low.
Growing risks- 10-year yields near 3% (2026); debt service ~¼ of the budget.
- Ageing will push up pension and health spending.
- Rate rises to fight inflation now raise borrowing costs.
ChainInflation ↑ → central bank raises rates → bond yields ↑ → new debt costs more → debt interest ↑ → less room for other spending or higher taxes.
JudgmentDebt matters less when it is in a country's own currency, held by domestic savers, and when interest rates are below nominal growth. Compare Greece, which owed euros to foreign creditors. Japan's risk rises as rates rise.
Evaluate the effects of an ageing population on economic growth.
2.3 · 2.5
Harmful- Working-age population falling since the mid-1990s.
- Natural decrease of 918,000 in 2025.
- Older people save less and consume differently; pension costs rise.
Can be offset- Employment of women and over-65s rose strongly after 2013.
- Automation: Japan builds ~45% of world industrial robots.
- GDP per working-age adult has grown at G7-average rates.
ChainFewer people of working age → labour supply ↓ → LRAS grows more slowly → lower potential growth → tax base shrinks while pension and health spending rise.
JudgmentAgeing cuts total GDP growth almost automatically, but living standards depend on GDP per head. Productivity and participation decide whether ageing lowers living standards.
Assess the impact of a depreciation of the currency on an economy.
4.1.8 · 2.1.4
Benefits- Record exporter profits (Toyota) and a tourism boom.
- Record current account surplus in 2025, helped by yen value of overseas income.
- Helped end deflation.
Costs- Imported food and energy prices ↑; real wages fell.
- Export volumes barely rose, as firms now produce abroad.
- Worsened terms of trade.
ChainYen falls → exports cheaper in foreign currency, imports dearer in yen → export revenue ↑, import costs ↑ → cost-push inflation → real wages ↓, consumption ↓.
JudgmentThe effect depends on price elasticities (Marshall–Lerner) and on where production happens. Japan's firms make much of their output overseas, so a weak yen raised profits more than export volumes, while households paid more for imports.
Evaluate the impact of a sharp rise in oil prices on an oil-importing economy.
2.3 · 2.1.2
Severe- Imports ~95% of crude from the Middle East.
- 1973 shock ended the high-growth era.
- 2026 Hormuz closure: higher import bill, inflation risk.
Cushioned- Energy efficiency far higher than in 1973.
- Government subsidies and stockpile releases capped prices.
- Growth stayed positive in Q2 2026.
ChainOil price ↑ → firms' costs ↑ → SRAS shifts left → price level ↑ and output ↓ → import bill ↑ worsens trade balance.
JudgmentThe size of the impact depends on how long the shock lasts, the energy intensity of output and policy response. Subsidies protect households in the short run but cost money and delay the switch away from oil.
Discuss whether monetary and fiscal policy can conflict.
2.6.4
Conflict- Bank of Japan raises rates to fight inflation (1.25%, Sept 2026).
- Government expands spending and cuts food tax.
- Higher rates raise the cost of that borrowing.
Coordination- Under Abenomics both pushed in the same direction.
- Central bank independence allows separate goals.
- Spending on supply-side measures can lower inflation in time.
ChainFiscal expansion → AD ↑ → inflation pressure ↑ → central bank raises rates → borrowing costs and yen ↑ → offsets part of the stimulus.
JudgmentConflict is most likely when inflation is above target and debt is high. Japan in 2026 shows both at once.
Evaluate the impact of the collapse of an asset price bubble on the real economy.
4.4.2 · 2.2
Large impact- Nikkei fell about 60% from its 1989 peak.
- Bad loans weakened banks; credit was squeezed.
- Weak growth and deflation for two decades.
Policy mattered- Slow clean-up of bad loans prolonged it ("zombie" firms).
- Policy rates were cut slowly at first.
- Tax rises in 1997 hit the recovery.
ChainAsset prices fall → negative wealth effect and weaker balance sheets → banks cut lending, firms repay debt → C and I ↓ → AD ↓ → lower growth and deflation.
JudgmentThe damage depends on how fast the banking system is repaired. Compare the US after 2008, which recapitalised banks faster and recovered sooner.
Assess the use of immigration to tackle labour shortages.
2.1.3 · 2.3
For- Record 2.57 m foreign workers (2025) fill care, building and factory jobs.
- Raises labour supply and the tax base.
- Young migrants lower the dependency ratio.
Against / limits- Still under 4% of the workforce.
- Political resistance; language and integration costs.
- Firms may delay automation and pay rises.
ChainMore migrant workers → labour supply ↑ → fewer vacancies, lower cost pressure → LRAS ↑ → higher potential output.
JudgmentMigration can ease shortages in specific sectors, but the numbers needed to offset Japan's decline would be politically unrealistic. It works best alongside automation and higher participation.
Evaluate a policy mix combining monetary, fiscal and supply-side measures.
2.6
Abenomics successes- Over 4 m more people in work, mostly women and older workers.
- Record corporate profits and share prices.
- Deflation ended before the pandemic.
Shortfalls- Inflation stayed below 2%; real wages stagnated.
- 2014 and 2019 tax rises offset fiscal support.
- Productivity reforms were weak.
ChainMonetary easing and fiscal support raise AD → output gap closes → structural reform raises LRAS → growth without inflation.
JudgmentThe demand arrows worked faster than the supply arrow. A mix only works if all parts point the same way; Japan's tax rises pulled in the opposite direction.