This chapter, written in honour of our old friend Prema-Chandra Athukorala, is designed to unravel a set of complications and mysteries concerned with the Japanese macroeconomy for the last twenty years, or even longer. This is the period of Japan's two lost decades, beginning around 1995. We draw on a huge and highly sophisticated, even brilliant, literature on this, written principally by Japanese economists (and also some Americans). Fortunately for us, much of it is written, or translated into, English, and we have tried to understand it. Our aim is to make the complex issues and possible solutions simple enough for non-specialists to understand. We also wish to see whether there are some lessons for other countries.

What are these mysteries? Well, the single most interesting one is this. For about twenty years, the Japanese government has run significant and deliberate budget deficits that have been motivated by the Keynesian objective of stimulating the economy. Plenty of countries have run budget deficits for long periods, usually because of political difficulties in raising taxes or cutting spending. But this is different because the explicit Keynesian “fiscal stimulus” motive for maintaining aggregate employment or the growth rate is usually only short term, whereas the Japanese case is unique because it has gone on for more than two decades. But this does not mean that it is interesting only as a historical curiosity. Since the global financial crisis (GFC) of 2008, prolonged application of stimulus policies has become increasingly common as many major economies struggle to restore growth, and the Japanese experience is likely to hold lessons of wider contemporary relevance.

THE BUBBLE AND AFTER

The economic recovery of Japan after the war was impressive. It was indeed a boom, especially a boom in manufactured exports. The main problems came from two sharp world oil price rises. Details of this post-war period go beyond this chapter. The economic situation of Japan was dramatically transformed in a short period of five years — from 1985 to 1990 — by “The Bubble”. Indeed, this surprising episode was the bridge between the remarkably successful post-war years (lasting about thirty years) and the later long unfortunate period of stagnation or recession — described as the two lost decades — with which this chapter is mainly concerned.