Introduction: Japan is an island nation in East Asia, located in the Pacific Ocean. Japan has the world’s tenth-largest population, which more than 126 million people. As of 2012, Japan is the third largest national economy in the world, after the United States and China, in terms of nominal GDP. One interesting point is as of december 2013, Japan’s public debt was more than 2 times of its annual gross domestic product. Like the U.S. Japan suffered a recession in 2008. Total loss in GDP over this recession was 12181.22 billion Yen from the first quarter of 2008 to the first quarter of 2009. This report examines the behavior of the Japanese economy in perspectives of internal shocks, such as investment, consumption, and import demand; external shocks, such as exports, import prices, foreign interest rates; and government policies, like government spending. The last part of the report shows that how would the economy have performed if these shocks had been absent.

The Model:
To examine the behavior of the Japanese economy, I formulated the following model, taken from Fair’s MCF model:

Equation 44: JALIMZ = -0.014 + 0.976*JALIMZ(-1) + 0.028*JALCIGZ + 0.04*JALPYZZ + [AR(-1)=0.134]
SE= 0.032

The log of imports per capita depends strongly on its out past, the relative price of imports and the log of domestic demand.

Equation 45: JALCZ =0.127 + 0.904 *JALCZ(-1) - 0.001*JARB + 0.071*JALYZ +[AR(1) = -0.233]
SE= 0.0098
The log of consumption per capita depends strongly on its past, the log of real GDP per capita and depends slightly on long-term interest rate.

Equation 46: JALY =0.028 + 0.070 *JALY(-1) + 0.928*JALX - 0.0007*JALV(-1) +[AR(1)=0.501]
SE = 0.003

The log of real GDP depends strongly on log of final sales, and depends slightly on the log of real GDP last year and the log of stock of inventories in past year.

Equation 47: JALPY = 0.015+ 0.988*JALPY(-1) - 0.0001*T +0.005*JALPM +[AR(1) =0.547]
SE = 0.007

The log of GDP or GNP deflator depends strongly on the log of GDP deflator in last year, and depends slightly on the log of import price deflator.

Equation 48: JARS = -0.115 + 0.834* JARS(-1) + 0.0998* JAPCPY+ 0.102* USRS +[AR(1)=0.347]
SE = 0.533

Three-month interest rate depends strongly on previous three-month interest rate, and depends slightly on US three-month interest rate and percentage change in relative price index.

Equation 49: JARBZ = 0.039 +0.888* JARBZZ +0.443*JARSZ -0.472*JARSZZ
SE = 0.409

Long term interest rate minus the period before last period three-month interest rate [RB-RS_2], depends strongly on [RB_1 - RS_2] , [RS - RS_2] and [RS_1 -RS_2]

Equation 50: JALE1Z = -0.119 -0.394*JALRSZ + [AR(1)=0.343]
SE = 0.046

The change in log of exchange rate depends on the log of [RS-RS_2]

Equation 51: JALF =1.001*JALEE +1.156*JALRSZ +[AR(1) =0.411]
SE = 0.008

The log of three month forward rate depends on the log of exchange rate and log of [RS-RS_2]
Equation 52: JALPXA=0.394* JALPXB +[AR(1)=1.269] + [AR(2)=-0.278]
SE = 0.013

Equation 53: JALJ1 = 0.006 -0.0001* T -0.034*JALEXL(-1) -0.046*JALY1
SE = 0.0035

The log of total employment depends slightly on log(employment/Employment-min) and change in log of output.

Equation 54: JALL1Z = -0.012 + 0.0001*T +0.972*JALL1Z(-1) -0.126*JAUR
SE = 0.003

The log of labor force per capita depends strongly on the log of labor force per capita from last period and depends slightly on unemployment rate.

Analysis:

External Shocks

Exports: As we can see from the graph below, Japan suffered a large drop in exports along with output during the recession. The following graphs and tables demonstrates that, had Japanese exports not fallen, the recession would have been not occurred. The table on the right shows that the cumulative loss in Japanese GDP due to this factor was 12,798 billion Yen.

Import Prices: As we can see from the graph below, import prices also fall along with the output. Had this not happened, showed from the