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Japan’s Bubble
Economics 285
Fall 2000
Prof. Michael Smitka
Two key causes
• Management geared for high growth
Interacting with
• Macroeconomic policy mistakes
As a result...
• Interest rates were 0%
• Firms overborrowed• Projects that earned a mere 0% passed muster
• Banks overlent• Collateral or track records were enough
• Asset prices proved unrealistic• Projects didn’t earn 0% ex post
• Banks couldn’t collect on their loans
Japan’s Case- high-growth underpinnings of a bubble -
• Management had no need for financial controls– project selection was easy
– failure was hard / recessions were few & far between
• But pricing long-lived assets was hard– Real estate grew faster than economy
– Stock prices grew faster than economy
– Growth industries grew very fast indeed!!
Why the “bubble”?- the lending side -
• Change undermines rules of thumb for banks
– Change in types of industry / borrowers
– Change in strategic environment / flow of funds
– Change in regulatory environment
• Mistakes are made …
– … and a shock produces crisis
Growth Dynamics
• Transition out of agriculture– Fast productivity growth in industry– Urbanization!
• Household formation
• Infrastructure, housing
• But it’s a one-time transition!– And eventually ends
Slowdown
• Industry no longer needs funds• 1970s: 10% of GDP swing in under a decade!!
• But households keep saving• Past savings were when incomes were low
• So accumulated wealth was modest
• So people needed to keep saving to fund old age
• Who then will borrow this funds?• Paradox of Thrift!!
Shifts in Japanese Savings Flows
1961-65 1966-70 1970 1971-75 1976 1976-80 1981-85 1986-92I (business) 17.0 16.7 19.6 15.2 8.8 8.3 8.5 11.1
S (business) 5.2 8.7 10.7 4.0 0.8 2.7 2.9 2.3S - I -11.7 -8.0 -8.9 -11.2 -8 -5.7 -5.5 -8.8
I (household) 2.8 4.3 4.5 4.0 7 6.1 2.8 1.3S (household) 12.1 12.0 12.8 16.4 19.9 17.1 13.6 11.6S - I 9.2 7.7 8.3 12.4 12.9 11.0 10.8 10.3
S - I Private -2.5 -0.3 -0.6 1.2 4.9 5.3 5.3 1.5
I (Center 5.5 5.7 5.7 6.9 6.5 7.5 6.8 6.4S & Local) 6.9 6.6 7.6 6.7 2.3 2.4 3.6 8.3T - G 1.4 0.9 1.9 -0.2 -4.2 -5.1 -3.2 1.9
T - G + S - I -1.1 0.6 1.3 1.0 0.7 0.3 2.0 3.4
The Primary Shock1970 vs 1976
• Corporate investment fell 10% of GDP
• Savings rose!
• Banks were left to scramble
Interregnum
• Japanese fiscal deficits– created a new borrower for banks– MOF policy stopped that by 1982
• Reagonomics: US consumption boom– Export-led growth from 1982– Appreciation / Plaza Accord stopped that from
1986
Secondary Shock
• Bad macro policy– Easy money from 1986– “Japan as Number One” psychology
• Just as banks sought new borrowers– Real estate … and more real estate!– Small business– Also international loans
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
10/22/834/22/84
10/22/844/22/85
10/22/854/22/86
10/22/864/22/87
10/22/874/22/88
10/22/884/22/89
10/22/894/22/90
10/22/904/22/91
10/22/914/22/92
10/22/924/22/93
10/22/934/22/94
10/22/944/22/95
10/22/954/22/96
10/22/964/22/97
10/22/974/22/98
10/22/984/22/99
10/22/994/22/00
10/22/00
BOJ Discount Rate Target Call Rate
Nov 1, 1986following
"Plaza Accord"
Feb 23, 1987
May 31, 1989first anti-"Bubble"
rate hike
Aug 30, 1990
Jul 1, 1991interest rates
kept high for 18 months following
the "bubble's" peak
Sept 8, 19950.5%
discount rate!!
Feb 12, 1999"Zero InterestRate Policy"commences
Christmas 1989rate hike
– "bubble" peaks –
Shocks, continued
• “Bubble” economy – Stock prices doubled– Urban real estate prices rose even more
• Fiscal policy mistakes accentuated– On-again, off-again policy built up debt
• Regulatory policy errors accentuated– Banks allowed to make more bad loans
Stock market- today’s market is no higher than in 1986!! -
Closing Price, Nikkei 225
10000
15000
20000
25000
30000
35000
40000
8/4/862/4/878/4/872/4/888/4/882/4/898/4/892/4/908/4/902/4/918/4/912/4/928/4/922/4/938/4/932/4/948/4/942/4/958/4/952/4/968/4/962/4/978/4/972/4/988/4/982/4/998/4/992/4/008/4/00
Peak = 38957Dec 31, 1989
Today's Close14,988 is 37% lower than 10 years ago, and 61.5% below peak!
Today’s Dilemmas
• Monetary policy doesn’t work• Interest rates can’t be pushed below 0%
• But prices are falling ==> real rates are positive
• Banks (rightly) fear bad assets• Outstanding loans are shrinking!
• Money growth is of cash…
• “Liquidity Trap”• If monetary policy doesn’t work, how about fiscal??
ZIRP
Interest Rates
Current lending rates:Short-term prime rate: 1.5%Long-term prime rate: 2.25%
Credit Creation & Money
Fiscal Policy
• Repeated fiscal packages• Short-term policies are discounted by consumers
• Higher temporary incomes are counteracted by stagnant consumption
• Credibility lost
• Permanent tax cuts??• Huge deficits already - 7% of GDP
• Demographic “old age” boom looms
• No room left to add fiscal stimulus?
Predictions
• Japan will underperform growth elsewhere
• Safety valve: exports?• Real wages / labor costs remain high
• Must have counterpart capital flows
• Global capital markets are crippled• Can’t sustain large trade surpluses / capital deficits
• Firms engaging in DFI - doesn’t help domestic GDP
• J will permanently underperform OECD