Edited by Paolo Onofri
Fumio Hayashi and Edward C. Prescott 1. INTRODUCTION The performance of the Japanese economy in the 1990s was less than stellar. The average annual growth rate of per capita GDP was 0.5 percent in the 1991–2000 period. The comparable ﬁgure for the United States was 2.6 percent. Japan in the last decade, after steady catch-up for 35 years, not only stopped catching up but lost ground relative to the industrial leader. The question is why. A number of hypotheses have emerged: inadequate ﬁscal policy, the liquidity trap, depressed investment due to overinvestment during the ‘bubble’ period of the late 1980s and early 1990s, and problems with ﬁnancial intermediation. These hypotheses, while possibly relevant for business cycles, do not seem capable of accounting for the chronic slump seen ever since the early 1990s. This chapter oﬀers a new account of the ‘lost decade’, based on the neoclassical growth model. Two developments are important for the Japanese economy in the 1990s. First and most important is the fall in the growth rate of total factor productivity (TFP). This had the consequence of reducing the slope of the steady-state growth path and increasing the steady-state capital–output ratio. If this were the only development, investment share and labor supply would decrease to their new lower steady-state values during the transition. But the drop in the rate of productivity growth alone cannot account for the near-zero output growth in the 1990s. The second development is the reduction of the workweek length (average...
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