Understanding the Normalization of the Japanese Economy

This paper focuses on three aspects of the Japanese economy that deviated from “normalcy”—unconventional monetary policy, unsustainable fiscal policy, and declining growth and productivity. Non-normality in Japan has developed over the past few decades, but has become more prominent during the Abenomics years starting in 2013. Regaining normalcy in monetary policy requires a gradual increase in the policy interest rate to the neutral interest rate, achieving a 2% inflation rate, and reducing the Bank of Japan's balance sheet by quantitative tightening. Regaining normalcy in fiscal policy requires reducing government fiscal deficits, which tend to ratchet up as the country experiences a crisis. This fiscal tightening has to be done in an environment where monetary normalization proceeds. Japan's per capita GDP relative to other countries has declined over the last three decades. Japan's per capita GDP relative to that of the US in 2025 is about that of 1980. Similarly, the yen's purchasing power in 2025 is similar to what it was in the early 1970s. Japan has become poorer since the mid-1990s. To prevent Japan from further sliding back into the emerging market group, the government has to promote research and development in high-value-added technologies.