Hayashi and Prescott (2002) speculate that the anemic performance of the Japanese economy since the early 1990s can be understood in terms of how any "well-functioning" private sector might react to an exogenous "productivity shock." In particular, they downplay the role of monetary and financial factors in shaping Japan's "lost decade."
But many view the monetary and financial developments in Japan as direct evidence of a "malfunctioning" financial sector. These developments include a steady decline in bank lending and the money multiplier; unexpected declines in inflation (and even the price level); nominal interest rates that are close to zero; and massive infusions of liquidity by the Bank of Japan that seem to have no effect at all (a "liquidity trap").
The primary purpose of my paper is to show that the Hayashi-Prescott hypothesis is not inconsistent with these monetary and financial developments. To the extent that this is true, monetary and fiscal policies, or reforms directed exclusively at the banking sector, are unlikely to reestablish productivity growth. What is likely needed are economy-wide reforms that enhance the willingness and ability of individuals to adopt potentially disruptive technological advancements and work practices.
Keywords: Productivity slowdown; Money multiplier; Monetary policy; Liquidity trap
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.