Question

Traditionally, the Japanese people tend to save more of their incomes than do Americans. During the 1990s, Japan experienced a deep recession. The Japanese government tried to stimulate the Japanese economy by increasing government spending and lowering taxes. But, the Japanese government’s efforts had a weak effect on Japanese real GDP. Explain why the Japanese government’s actions would have a weak effect on real GDP. (Remember, if the Japanese government isn’t paying for the increase in government spending by raising taxes, it must be borrowing the funds.)

Answer 1

Answer - There can be two reasons for the lack in effect of the stimulus package -

1 - Since the change in the spending seen was very less as compared to the stimulus of increased spending and decreased taxes , the value of MPC will be less. This will lead to lesser consumption and greater saving despite the stimulus and the economy will not grow as expected.

2 - If the taxes are not decreased , and the increased spending is financed by the rise in the borrowings of the government , this will lead to crowding out effect in the economy. The interest rates in the economy will be higher and this will lead to decrease in investment. Thus the growth in economy will not be experienced.