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What was the Lost Decade of Japan and what can we learn from it 7 July, 2009

Posted by David Anderson in Economic Policy.

The Economist said earlier this year that the lost Decade may look good in comparison to what may be in store for us. It may be smart for us to look closer at the Lost Decade. I plan a three part examination.

The nation of Japan suffered through over a dozen years of almost no economic growth. The nation had a huge increase in public debt as the government put up one stimulus after another. It protected banks as too big to fail. It tried to protect favored corporations. All of this was to no avail. Japan 101 described the problem.

The economic miracle ended abruptly at the very start of the 1990s. In the late 1980s, abnormalities within the Japanese economic system had fuelled a massive wave of speculation by Japanese companies, banks and securities companies. Briefly, a combination of incredibly high land values and incredibly low interest rates led to a position in which credit was both easily available and extremely cheap. This led to massive borrowing, the proceeds of which were invested mostly in domestic and foreign stocks and securities.

Recognizing that this bubble was unsustainable (resting, as it did, on unrealizable land values – the loans were ultimately secured on land holdings), the Finance Ministry sharply raised interest rates. This popped the bubble in spectacular fashion, leading to a massive crash in the stock market. It also led to a debt crisis; a large proportion of the huge debts that had been run up turned bad, which in turn led to a crisis in the banking sector, with many banks having to be bailed out by the government.

It sounds very similar to our current crisis. There are many lessons that people have drawn from the Japanese economic problem in the nineties. First, allow the market to work. No one should be considered too big to fail. You may have to manage it but don’t stop it. Second, it is okay to recapitalize institutions. Third, it is not caused by lack of demand and fiscal stimulus by spending won’t work. Fourth, avoiding two years of pain is not worth a decade and a half of distress. Fifth raising taxes is not smart. Sixth, monetary policy matters most. Having enough liquidity in the system is vital because credit will no longer increase the money supply.

The power of a comprehensive monetary strategy can not be over stated. If our policy leaders or the Republican opposition wants to be serious about offering solutions, they must become serious about developing one and marketing it to the public. Merely spending like the Democrats wish to do or cutting taxes like Republicans wish to do (as vital as tax policy is) will not solve the current problem.

Three Japanese Scholars formed a web blog on which they gave these lessons. This was in response to a statement by Secretary Clinton that Japan showed Monetary policy didn’t matter.

* Lesson One: Monetary policy is the most important measure to avoid Japanese-like situation. It isn’t limited to interest rates and money supply but the disposal of failed banks and debtors. The Ministry of Finance (MOF) ordered banks to hide their failure to put off the clearing of bad loans. So banks continued window dressing supported by the MOF.

* Lesson Two: If you can’t avoid the failure, the sooner, the better. In 1992, I produced a TV program “Bad Loans of 12 Trillion Yen ($120 billion)”. It was the official amount of gross bad loans in 1992. However, since the MOF didn’t dispose the loan then, the land price collapsed and the net bad loan became so huge as 100 trillion yen in 2003, according to the Financial Services Agency.

* Lesson Three: The central bank should ease money promptly after the crash. Since the Bank of Japan (BOJ) failed to stop the bubble, it didn’t change the very tight monetary policy after the bubble burst in January 1990. After July 1991, when the BOJ eased the monetary policy, they were too cautious because they were afraid of the second bubble. As a result, the prices of real estates and stocks fell to less than 1/5 of their peak.

* Lesson Four: Fiscal policy isn’t effective: Japanese government repeated trying to rescue the economy by “emergency fiscal stimulus”, which resulted only as the vast amount of government deficit, 180% of GDP. As many banks and companies were insolvent, the money supplied by the government was used to make up zombie banks and companies who looked alive but in fact dead.

* Lesson Five: Until the focus of disease is removed by surgery, no macroeconomic medicine will be effective. In 2002, an economist Heizo Takenaka became the Minister in charge of Economy and Finance. He changed the “soft landing policy” of predecessors and said “I don’t think there are too big banks to fail” in an interview with Newsweek. It aroused a panic among bankers, so they stopped postponing the disposal of bad loans.

* Lesson Six: The interest rate isn’t very effective under deflation, but money supply can help the restructuring. The BOJ made the interest rate zero in 1999, which didn’t improve the crisis, because the real interest rate was high under deflation. Since 2001, the BOJ began the “quantitative easing” policy that supplied huge amount of money, which lessened the pain of the surgery by banks and companies to restructure themselves.



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