Keynes and capitalism: The case of Japan

Abstract

This chapter applies Keynes’s principle of effective demand to re-interpret the analysis of Japan’s lost decade(s) by Krugman, McKinnon, and Koo. The analyses by Krugman, McKinnon, and Koo are shown to be special or restricted cases of Keynes’s general theory. Faced with a negative structural marginal efficiency of capital due to international forces, domestic fiscal policy loses its effectiveness. Contra Krugman, Japan cannot then inflate its way out of the liquidity trap; contra McKinnon Japan cannot restore growth by pegging to the US dollar; contra Koo a balance sheet recession is not the cause of Japan’s slower growth. The causes of Japan’s slower growth are international factors that depressed the domestic marginal efficiency of capital in the post-bubble period. Predominant among these factors was the rise of China and the rest of Asia.