During periods where there is an enormous demand shortfall, such as the 1930s and the period after 2008, there is a resurgence of interest in demand-side models. This is good. But it also produces an unfortunate side effect—mission creep.

Demand stimulus can help reduce unemployment. It can also ease debt burdens. But that’s pretty much all it can do. Unfortunately, many pundits are claiming that demand stimulus is some sort of magic potion, which can cure structural problems, boost productivity, increase labor force participation, etc. If we learned anything from the 1970s, it’s that demand stimulus cannot solve supply-side problems.

Here’s Barclay’s Bank:

“We estimate that core inflation ex-VAT effects eased to 0.3% y/y in January. With the sharp drop in oil prices, we believe the BoJ’s 2% target will remain out of reach even toward end-2016. We estimate that unemployment stayed at 3.4% while jobs/applicants improved slightly. Policies are needed to resolve labor shortages and alleviate structural unemployment, turning attention to the third “arrow” of Abenomics.”

I think this is right. Demand stimulus is not likely to boost growth in an economy with “labor shortages.” Or to be more specific, we should only expect a slight boost to growth. And by the way, although the “third arrow” is needed, the terminology is unfortunate. The “second arrow” was supposed to be fiscal stimulus, but Japan did not do fiscal stimulus, they sharply raised taxes. So it’s all about monetary stimulus and structural reforms, as it should be.

Although further demand stimulus will not create many jobs, the BOJ should continue to boost the inflation rate, until they reach their 2% target (or better yet a 2% or 3% NGDP growth target.) This will reduce the burden of Japan’s huge public debt. Normally the benefit of higher inflation is offset by a higher nominal interest cost. However Japan is at the zero bound, so they can raise inflation without raising nominal interest rates. Indeed they have already done so, and it worked. They also brought the unemployment rate down to 3.4%. With more demand stimulus it might fall a bit further, but not much.

Mission creep doesn’t just occur in Japan, many British Keynesians suggested that a demand shortfall explained Britain’s low growth a few years back. But the data showed exactly the opposite—jobs were growing, but productivity was declining. Demand stimulus does not address productivity problems.

In the US, demand proponents have occasionally argued that demand stimulus can boost the labor force participation ratio. It’s conceivable that it could have a very small effect, but I’ve been skeptical all along. And now as the unemployment rate approaches the natural rate, it’s looking less and less likely that there is a hidden pool of workers just waiting to jump back in when jobs become available. If there were, they would be looking for jobs right now.

To summarize:

1. Where there is lots of involuntary unemployment, demand stimulus might help.

2. If you are at the zero bound and face a large public debt problem, demand stimulus might help.

Otherwise focus on supply-side reforms, meaning privatization, deregulation, tax simplification, and lower MTRs on capital income.