The 1990s were characterized as the “lost decade” for Japan. Growth in per-capita GDP was very...

The 1990s were characterized as the “lost decade” for Japan. Growth in per-capita GDP was very low as the economy stagnated. The IS-LM model played a key role in the economist’s debates. This question is about trying to understand which policy the government should use to try to pull Japan out of a recession.

1. Interest rates were extremely low in Japan at this time. When interest rates get close to zero, the demand for money is extremely high (say close to infinity). In this case, what does the LM curve look like? Draw a picture of what the LM curve may look like for Japan.

2. Now, let’s think about the IS-LM equilibrium in Japan. Which part of this LM curve do you think the Japanese economy is in equilibrium at? Indicate this on your graph and draw in the IS curve now to give you an equilibrium at that point.

3. How effective a tool is a monetary policy for pulling the economy out of the recession in Japan?

Expert Solution

Rahul Sunny answered 7 months ago

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