Aggregate Demand In The Japan Economy

To improve the descending economy of Japan, the Abe administration has introduced many recovery plans in hopes that it will increase aggregate demand as well as aggregate supply. The two major plans that the administration came up with were the quantitative monetary easing and the rise in consumption tax from 5 percent to 8 percent. Yet, these actions are likely to have a negative impact on the Japanese economy in the long run.
Aggregate demand is the total amount of goods and services that are demanded in an economy at different prices during a specific time period. Aggregate supply is the total supply of goods and services that are produced within an economy at different prices during a specific time period.
When a central bank imposes quantitative monetary easing, it buys a specified amount of financial assets from private institutions. This raises the price of those financial assets and increases the monetary base. In Japan’s case, with the start of a new fiscal year, the Abe administration decided to use the monetary easing, which ultimately led to a cheaper yen. This resulted in the rightward shift of aggregate demand from AD1 to AD2, since exports are a part of the factors that affect aggregate demand. The average price level increases from P1 to P2, as real output also increases from Y1 to Y2. In Figure 1, the Bank of Japan’s quantitative monetary easing and its effect on the short run is shown.

Yet, cautions are spreading as some experts say that an extravagant drop in the price of yen is going to hurt the Japanese economy more than it will help. In the past, when the economy was majorly dependent on its exports, a cheap yen would have made Japanese goods and services very competitive, resulting in the increase in e...

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...emand. The increase in the consumption tax would subsequently result in the left shift of aggregate supply from SRAS1 to SRAS2. These taxation increases the costs of production for the firms. Figure 2 shows the market of Japan after the policies concerning the economy are implemented.
The currency exchange rates have fluctuated wildly, yet the Japanese economy has long dogged the danger of an economic crisis due to the excessive cost of the yen against other major currencies in the world. The decline of the cost of yen under the Abe administration has raised the popularity of his economic policy, but it has its disadvantages. For the rise of the consumption tax, the Abe administration and the Bank of Japan is responsible to carefully evaluate both the positive and the negative impacts of the falling yen, and take counteractive actions to avoid an economic disaster.