Japanese Economy A 2012 Fall Seinan Gakuin University Noriaki EZOE Professor Ph.D. Economics Department Seinan Gakuin University Japan Mail address: Homepage address: 1

Part Ⅰ Chapter 5 Lost decades and Macroeconomic policies What you will learn in this chapter 1 The bubble economy and its collapse 2 Economics ; review of macroeconomics AD-AS analysis, Fiscal and Monetary policies 3 The lost decades 2Japanese Economy

Key Historical Events Japanese Economy3 yearDomestic eventsOverseas events 1985Yen’s evaluationPlaza Accord 1987BOJ historical low bank rate 2.5%Black Monday 1989Emperor died. Heisei era begins. Nikkei stock index 38,130 Fall of Berlin wall 1990BOJ tight money 6.0% 1991Bubble burstGulf war. Soviet Union resolved 1992Non-LDP government established 1995Great Kobe earthquakeWTO starts 1997Big Bank BankruptcyAsian financial crisis 1999BOJ call rate 0%Euro adopted 2001Koizumi administrationGeorge W. Bush U.S. president 9.11 terrorist attack. Iraq war 2007Privatization of Japan PostFinancial crisis ( subprime problems) 2009DPJ government startsBarack Obama U.S. president Great east Japan earthquakeChina's GDP surpassed Japan's

Shift from political to economic agenda Post WW2 Real Growth 1st Oil Shock 2nd Oil Shock Yen floats Bubble collapses

1 The bubble economy and its collapse 1.1 The road to Bubble Economy Stagflation And Trade Frictions After oil crisis, world economy experienced a stagflation (stagnation and inflation) The Cause of 1970s Stagflation Supply shock view OPEC’s oil The Cause of 1970s Stagflation price hike was the main cause. Aggressive wage hikes also contributed. Expansionary fiscal & monetary policy accommodated and softened the blow. Global monetarist view As US lost monetary discipline, the fixed rate regime collapsed in and USD fell. Major central banks expanded money to counter appreciation pressure, causing global liquidity glut in the early 1970s. Oil shock was the result, not the cause, of global inflation. Japanese Economy5

trade frictions Japan regained its competitiveness in the export market and the export-led economy caused trade frictions. Japanese Economy6

7 U.S. introduced Reaganomics. The interest rate was raised to reduce the inflation Foreign money was flowing into the US. The US dollar had been appreciating and the Japanese yen depreciating. Plaza Accord(1985) : The summit meeting agreed the Japanese yen appreciated (1$= 242 to 200yen) Japanese export industries suffered Recession Began In order to cope with this, government cut the official discount rate and expansionary government spending the yen appreciated capital was back to Japan the official discount rate was the lowest (2.5%). These process led to a boom in domestic investment in real estate and stocks. Stock and land prices both rose

1.2 The bubble: The fluctuations of assets prices 1986,the prices of assets (ranging from stock and land to paintings and country club memberships) doubled and then tripled within a few years. The Nikkei 225 index, for example, increased from the 13,000s in December 1985 to the 39,000s in December Similarly, the price index for commercial land in six metropolitan cities tripled between March 1986 and March Japanese Economy8

Nikkei Stock Average 225 Urban land price index Source: Japan Real Estate Institute

Three reasons to believe that expectations about future returns of stock and land assets became more optimistic (the 1980s) 1Financial liberalization in Japan created a boom in the financial services and banking industry. 2 Economic growth rates rose= expectations of future economic growth became more optimistic. 3 BOJ’s monetary policy eased significantly in 1986 and Japanese Economy10

The Heisei Bubble (Economic Boom in late 1980s) Causes Structural—bank deregulation and the loss of large corporate borrowers in the early 1980s led banks to over lend to risky borrowers (SMEs, real estate developers) without proper risk management. Monetary—as the yen rose sharply after 1985, the Bank of Japan injected liquidity to counter it and ease high-yen caused recession. This led to asset bubbles without igniting inflation. Consequences Excess investment in properties, over-expansion in capacity, lavish consumption, rise in outward FDI

1.3 The Burst of the Bubble ( ) – the Bank of Japan changed to a tight-money policy and, in 1990, raised the official discount rate to 6%. – Banks restricted their financing of property assets. Stock prices declined by 60 percent between 1990 and August 1992, and they continued to decline until the Nikkei index began to rebound after June Representative land prices in metropolitan areas also declined by half from 1991 to 1995, and they continued to decline through early Sources of Decline: A combination of policy actions and the self- correcting mechanism of the speculative process (deflating the bubble) were responsible. After the bubble, the Japanese economy entered a long period of stagnation. – This period is called the Lost Decade. Japanese Economy12

2 Review of Macroeconomics In this section, we discuss the short-run fluctuation in economic activities = business cycles in Japan. The model of aggregate supply and aggregate demand provides a framework to analyze economic fluctuations. Then we see how the impact of macro policies and events varies. In the section 1,we briefly learn the basic concepts of these macroeconomic theories. Japanese Economy13

2-1 the AS–AD model Aggregate demand curve AD curve is the relationship between the price level P and the quantity of goods demanded Y. The quantity theory: MV = PY M/P = kY AD curve is downward sloping (higher P, lower M/P, lower Y ) shift factors: changes in expectations, changes in wealth, and the effect of the size of the existing stock of physical capital. Policy makers can use fiscal policy and monetary policy to shift the aggregate demand curve Japanese Economy14

The aggregate supply curve AS curve : is the relationship between the price level P and the quantity of goods supplied Y. The short-run AS curve is upward sloping. – because nominal wages are sticky in the short run: a higher aggregate price level leads to higher profit per unit of output and increased aggregate output in the short run. – Shift factors : Changes in commodity prices, nominal wages, and productivity The long-run AS curve is vertical at potential output. - In the long run, it does not depend on the price level. Only depend on the capital, labor and tech. Japanese Economy15

Figure The AS–AD Model Their point of intersection, E SR, is the point of short-run macroeconomic equilibrium where the quantity of aggregate output demanded is equal to the quantity of aggregate output supplied. Japanese Economy16

2.2 Demand shock and supply shock Economic fluctuations occur because of a shift of the aggregate demand curve (a demand shock) or the short-run aggregate supply curve (a supply shock). A demand shock causes the aggregate price level and aggregate output to move in the same direction as the economy moves along the short-run aggregate supply curve. A supply shock causes them to move in opposite directions as the economy moves along the aggregate demand curve. A particularly serious is stagflation— which is caused by a negative supply shock. Japanese Economy17

Figure Shifts of Aggregate Demand: Short-Run Effects A negative demand shock shifts the aggregate demand curve, moving the aggregate price level and aggregate output in the same direction. Japanese Economy18

Figure Shifts of the SRAS Curve a negative supply shock Stagflation the combination of inflation and falling aggregate output positive supply shock prices falls output rises Japanese Economy19

Figure The Supply Shock of ,the prices of many raw materials began shooting up. The surge in raw-material prices amounted to a global negative supply shock Japanese Economy20

2.3 The government macro policies Economy is self-correcting in the long run. But, the high cost inflation, deflation, unemployment. Stabilization policy : government policy to reduce the severity of recessions and rein in excessively strong expansions using fiscal or monetary policy to offset shock budget deficit crowding out There can be drawbacks, the budget deficit and crowding out of private investment Japanese Economy21

The Government Budget and Total Spending  Fiscal policy is the use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve. GDP = C + I + G + X - IM Lags in Fiscal Policy - Realize the recessionary/inflationary gap by collecting and analyzing economic data →takes time - Government develops a spending plan→ takes time - Implementation of the action plan (spending the money→ takes time Japanese Economy22

Figure Expansionary Fiscal Policy Can Close a Recessionary Gap Japanese Economy23 Expansionary fiscal policy increases aggregate demand.

Monetary policy Figure Monetary Policy and Aggregate Demand  Expansionary monetary policy is monetary policy that increases aggregate demand. Japanese Economy24 Contractionary monetary policy is an opposite policy.

Figure The Short-Run and Long-Run Effects of an Increase in the Money Supply Japanese Economy25

3 The lost decades 3.1 Long recession As the bubble burst around 1990, the Japanese economy entered a long period of deflation and recession. Growth slowed down and became even negative. For the first time in the postwar period, prices declined persistently. Consumers and producers became extremely pessimistic. Japanese Economy26

Expansionary Fiscal Policy in Japan At the end of the 1980s Japan’s bubble burst—stock and land values plunged. Japan turned to expansionary fiscal policy in the early 1990s. During the years that followed, Japan relied on large- scale government purchases of goods and services, mainly in the form of construction spending on infrastructure, to prop up aggregate demand. This spending was scaled back after 2000, but at its peak it was impressive. In 1996 Japan spent about $300 billion on infrastructure. Japanese Economy27

Debate on Fiscal Stimuli Since the 1990s, large fiscal spending has been used to stimulate the economy. But there was no strong recovery, while the government debt skyrocketed. Some argued for even bigger stimuli; others said that would only worsen the debt crisis. Ohno PP Government debt in % of GDP Bubble burst PM Koizumi ( ) set limits on spending (infrastructure, welfare). PM Aso (2008-) and DPJ (2009-) returned to big fiscal spending. Koizumi AbeFukuda Aso HatoyamaKan  LDP DPJ 

Figure The public debt :Global Comparison Japanese Economy29

Problems Posed by Rising Government Debt Public debt may crowd out investment spending, which reduces long-run economic growth. And in extreme cases, rising debt may lead to government default, resulting in economic and financial turmoil. Can’t a government that has trouble borrowing just print money to pay its bills? Yes, it can, but this leads to another problem: inflation. Japanese Economy30

Monetary policy issues Bad loans Issue The most serious consequences brought by the collapse of bubbles was Nonperforming loans (NPLs) in banks. Financial institutions ended up with very large levels of non-performing loans as a result of the collapse in share prices and land values. Asset-price deflation During the bubble, banks lent out vast money to companies taking land and stock as collateral. After the bubble, many companies were unable to repay their loans. Because of the drop in value of this land and stock, banks were unable to recover their loans. Thus, banks ended up with huge amounts of non-performing loans on their books. Japanese Economy31

Policy Issues for the Bank of Japan Monetary policy for recovery --Injecting liquidity by buying up unconventional assets (corporate & bank bonds, etc.): but the monetary transmission mechanism was broken (MB  Money  Lending) --Zero interest rate policy : The Bank of Japan lowered the official interest rate (Feb.1999-Aug.2000; Mar.2001-Jul.2006; Dec.2008-) --Inflation targeting (debated but not adopted) --Foreign exchange intervention to prevent yen appreciation (but without aggressive yen depreciation) Japanese Economy32

Call rate (interbank short- term interest rate) Money & bank lending BubbleZero interest rate policy Excess reserves are built up during zero interest rate periods

Why Did the Recession Last So Long? After the bubble, the Japanese economy entered a long period of stagnation. The 1990s is sometimes called the Lost Decade for Japan. 1 Long adjustment after a large asset bubble -Stock adjustment meant removing excessive debts and writing off nonperforming loans. 2 Non-performing loans (late policy response) 3 Japan’s economic system became obsolete 4 Aging population and associated problems (pension, medical care, dissaving, etc.) 5 Snowballing fiscal debt 6 People’s lack of confidence in the future or policy 7 The China challenge 8 The political leadership Government lacks in the political leadership--political instability Japanese Economy34

End of Lost Decade The government of J.Koizumi ( ) had tried to push “reforms” forward. These include privatization of post offices, putting a stop to highway construction, pension reform, local government reform, and bank reform. Non-performing loans : 43.2 trillion yen (2002) were major causes of the prolonged stagnation. Koizumi Cabinet (2001) forced banks dispose of their non- performing loans. By 2004, the total bad loans had fallen to 26.6 trillion yen. Finally,the Japanese economy began to show signs of recovery and began to emerge from its long period of stagnation. Koizumi reform was sufficient to revitalize ? – no. Japanese Economy35

Recovery, Global Recession Main causes of recovery ( ) --Strong foreign demand (US, China) --Decade-long corporate restructuring effort --Yen depreciation (up to 2007)  Recovery was not mainly due to reforms or good macro policies Global financial crisis (late ) Traditional industrial exports (cars, electronics) which led recovery suddenly lost export markets. Thanks to strong demand in China and other emerging economies, growth picked up in 2010 (>2%?) Japanese Economy36

Remaining issues Agriculture, services, distribution, finance remain uncompetitive. Long-term problems remain unsolved - fiscal crisis, pension & medical reforms, aged society, new energy…) Koizumi deregulation & liberalization increased income gaps and created new poors (“working poor”). Earthquake and Nuclear Disaster in 2011 Japanese Economy37

References Thomas F. Cargill, Michael M. Hutchison and Takatoshi Ito [1997], The Political Economy of Japanese Monetary Policy, The MIT Press. Dadid Flath [2005], The Japanese Economy, Oxford University Press. Takatoshi Ito[1992], The Japanese Economy, MIT Press. Paul Krugman and R. Wells [2009], Economics, 2 th edition, Worth Publishers. Gregory N. Mankew [2007], Macroeconomics, 6 th edition, Worth Publishers. Kenichi Ohno[2006], The Economic Development of Japan, GRIPS Development Forum. 38Japanese Economy