1. Class use only. Not for citation without permission. 1 From Bubble to Stagnation, 1985-2003 James R. Rhodes, Ph.D. Professor of Economics National Graduate Institute for Policy Studies Tokyo, Japan

2. Class use only. Not for citation without permission. 2 I: The Bubble Period, 1985-1990

3. Class use only. Not for citation without permission. 3 Bubble Economy Roughly covers period 1985:1 to 1990:3. Chief characteristic was a rapid rise in asset prices (land, equities, golf memberships, collectibles). Period of great optimism and overseas expansion. Strong, investment-led growth.

4. Class use only. Not for citation without permission. 4 Fig. 1: Asset Prices

5. Class use only. Not for citation without permission. 5 Fig. 2: Growth Rate of Asset Prices

6. Class use only. Not for citation without permission. 6 Fig. 3: Investment and GDP

7. Class use only. Not for citation without permission. 7 Background Large current account surpluses of 1980s. U.S. pressure to liberalize trade and financial sectors. Plaza Accord of September 1985 sought appreciation of yen. Louvre Agreement of February 1987 sought to stem rise in yen (fall in dollar).

8. Class use only. Not for citation without permission. 8 Proximate Causes of Bubble Large current account surpluses led to pressure for Japan to stimulate aggregate demand. Expansionary monetary policy adopted since MoF did not want to use deficit finance.

9. Class use only. Not for citation without permission. 9 Fig. 4: External Factors

10. Class use only. Not for citation without permission. 10 Fig. 5: Money Growth

11. Class use only. Not for citation without permission. 11 Fig. 6: BoJ Policy Rates

12. Class use only. Not for citation without permission. 12 Fig. 7: Discount Rate Policy

13. Class use only. Not for citation without permission. 13 Fig. 8: BoJ Window Guidance

14. Class use only. Not for citation without permission. 14 Inflation Puzzles Puzzle 1: Why did inflation remain under control in spite expansionary monetary policy? Puzzle 2: Why did asset prices rise relative to commodity prices?

15. Class use only. Not for citation without permission. 15 Reasons for Inflation Containment Decline in relative price of oil. Yen appreciation. Ongoing trade liberalization and “voluntary export restraints (VERS)”

16. Class use only. Not for citation without permission. 16 Why Asset Appreciation? Financial liberalization and the stock market boom reduced demand for bank loans. Fixed interest rates discouraged conventional loans and investments. Banks, focused on size maximization, used excess liquidity to make real estate loans and loans to nonbank financial intermediaries. Government policies encouraged housing and real estate investment.

17. Class use only. Not for citation without permission. 17 Fig. 9: Bank & Non-Bank Loans

18. Class use only. Not for citation without permission. 18 Fig. 10: Real Estate Loan Share (Share of total bank loans)

19. Class use only. Not for citation without permission. 19 Loan Growth Rates

20. Class use only. Not for citation without permission. 20 Fig. 11: Growth of Government Budgets

21. Class use only. Not for citation without permission. 21 Fig. 12: Government Lending

22. Class use only. Not for citation without permission. 22 International Ranking of Japanese Banks Bank Ranking by Total Assets (Fortune Magazine) Ranking by Shareholders Equity (Euromoney) RankAssets (FY 1991, Bil. $)RankEquity (1991, Bil. $) Dai-Ichi Kangyo1475.8213.6 Sumitomo2464.1115.2 Fuji3155.4313.3 Sakura4448.3811.6 Sanwa5445.0413.0 Mitsubishi6432.1612.0 Industrial Bank of Japan7333.3159.4 Norinchukin8311.01541.6 Tokai13271.0237.4 Mitsubishi Trust & Banking14261.6405.9 LTCB16255.7247.4 Bank of Tokyo17247.2296.7 Sumitomo Trust19234.9415.8 Kyowa Saitama (Asahi)23227.3703.5 Mitsui Trust & Banking24226.7504.8

23. Class use only. Not for citation without permission. 23 Pricking of the Bubble BoJ began a tight monetary policy in early 1989. In May 1989 the discount rate was raised progressively from a then historical low of 2.5% to a 10 year high of 6.0 percent. Money growth abruptly collapsed in 1990.

24. Class use only. Not for citation without permission. 24 II. Post-Bubble Stagnation

25. Class use only. Not for citation without permission. 25 After Shocks of Bubble Collapse of Jusen loan corporations. Banking crisis. Collapse of asset prices. Numerous scandals. Big Bang proposal. Restructuring of industry, government, and society. Prolonged economic stagnation.

26. Class use only. Not for citation without permission. 26 GDP Growth & Inflation

27. Class use only. Not for citation without permission. 27 What is the problem? Cyclical downturn? Long-term growth slowdown? Both?

28. Class use only. Not for citation without permission. 28 Causes or Symptoms? Bad bank loans. Asset price deflation. Commodity price deflation. Rising unemployment. High savings rate (until recently).

29. Class use only. Not for citation without permission. 29 Failed Policy Efforts Highly expansionary and erratic fiscal policy. –Weak fiscal multiplier? Highly expansionary monetary policy. –Liquidity trap? –Weak loan demand? –Weak loan supply? Limited bank bailouts. Limited structural reforms.

30. Class use only. Not for citation without permission. 30 National Government Budgets General account (GA) budget. Special accounts (SA) budget. Government-affiliated agency (GAA) budget. Fiscal Investment and Loan Program (FILP) plan.

31. Class use only. Not for citation without permission. 31 Long-Term Fiscal Problems Low productivity of public investments. Large and growing public debt. Rising social security burden. Competition with private sector.

32. Class use only. Not for citation without permission. 32 Marginal Productivity of Capital PeriodPrivate CapitalPublic Capital 1955-590.83460.2468 1960-640.86850.3216 1965-690.82040.3610 1970-740.47400.1802 1975-790.31440.0944 1980-840.28130.0722 1985-890.24160.0621 1990-930.24100.0592 Source: Yoshino and Nakahigashi (1999)

33. Class use only. Not for citation without permission. 33 Social Security Benefits (MOF)

34. Class use only. Not for citation without permission. 34 Gross Government Debt (Relative to GDP)

35. Class use only. Not for citation without permission. 35 Recent FILP Reforms (2001.04) –Reduction in scale of FILP. –TFB replaced by Fiscal Loan Fund SA. –Postal Savings System manages own funds. –FILP agencies raise funds to finance projects. –MoF required to publish Policy Cost Analysis of FILP agency subsidies from tax payers.

36. Class use only. Not for citation without permission. 36 Continuing Controversies Postal Savings System continues to be main source of funds for FILP. –PSS buys FILP bonds since safe investment. FILP agencies compete with private companies. FILP subsidies. Postal Savings System competes with private financial firms.

37. Class use only. Not for citation without permission. 37 Questionable Policy Solutions Inflation targeting. Bank bailout. Targeted fiscal spending. Tax cut.

38. Class use only. Not for citation without permission. 38 Fundamental Problems Structural growth slowdown. –Convoy system no longer works. –Institutional fatigue. Uncertainty concerning replacement for convoy system. –Consensus that old system no longer works but concern about replacement system. –High cost of transition.

39. Class use only. Not for citation without permission. 39 Multifaceted Structural Uncertainty Uncertainty concerning regulatory reform. –Magnitude of change required. –Difficult transition to indirect control system. –Bureaucratic and political intransigence. Uncertainty concerning corporate governance system. Uncertainty concerning changes in employment system.

40. Class use only. Not for citation without permission. 40 Obstacles to Structural Change Elite fear loss of status and privilege. Workers fear loss of job security (end of social contract). Fear of social unrest under cowboy capitalism of USA. High transaction costs of change due to network society (connectivity).

41. Class use only. Not for citation without permission. 41 Japan’s Policy Options Radical change (USA model). Cosmetic changes (muddle along). Gradual but steady structural change driven by market forces and consensual policy decision making.

42. Class use only. Not for citation without permission. 42 Policy Guidelines Predictable monetary and fiscal policies. Steadfast commitment to new FILP principles. Insist on policy transparency as the paramount governing principle. Think long term.

43. Class use only. Not for citation without permission. 43 Final Comments Japanese people are open to experiment and change! Japan is changing in profound ways! It will take time, but Japan will come back strong (it always does)!

44. Class use only. Not for citation without permission. 44 References Budget Bureau, MOF. Financial Bureau, MOF, FILP Report (various issues). Rhodes, J.R. “The Cyclical Behavior of Government Lending Institutions in Japan,” Journal of Economics, vol. 23, no. 1, 1997.