Japanese Economy since 1990
Ryoichi Imai
Kyushu University

1Japan in 1980s• Japanese economy was highly acclaimed as“No.1” by western intellectuals in late1980s.
• The argued that Japan presented analternative model of capitalism, which isdistinguished from North American orEuropean Capitalism.
2The Lost Decade• The bubbles in the stock and real estatemarkets in the late 1980s crashed in theearly 1990s.
• Since 1990 Japanese economy sufferedfrom a more than decade long recession
until recently.
• The lost 90s were characterized by low
inflation and low interest rate.
3

The Yen has appreciated in the last 70 years
Yen / U$, Period Average
400.00Bretton-Woods

350.00Nixon Shock
300.00250.00200.00

Plaza Agreement

150.00100.00Abenomics
50.00

0.00

https://data.imf.org/regular.aspx?key=61545850

4

Japan’ economy has been growing steadily.

CoronaLehmanBubblehttps://data.oecd.org/gdp/gross-domestic-product-gdp.htm

5

BubbleAbenomics

https://data.oecd.org/price/share-prices.htm

6

Bubblehttps://data.oecd.org/price/housing-prices.htm

7

1st oil shock

2nd oil shock

VAT
VAT

https://data.oecd.org/price/inflation-cpi.htm

LehmanVAT

Corona8

Bubblehttps://data.oecd.org/interest/long-term-interest-rates.htm

9History of the Yen-Dollar
Exchange Rate
Ryoichi Imai

10

Bretton-Woods (BW) system• From 1948 to 1971, the global economy wasin a fixed-exchange rate system.
• Countries except US are responsible tomaintain the fixed exchange rate of theirdomestic currencies with the US dollar.
• The US had an obligation to exchange 1 ozof gold with $35.
• The BW system was a type of gold standard.
11

The Nixon Shock• Members of BW were allowed tochange the exchange rate only if theirbalance of payment was in a“fundamental disequilibrium.”• In late 1960s, US suffered theincreasing current account deficit,
which was settled only by the
reduction of the gold reserve.
• In August 15, 1971, the US President
Richard Nixon finally announced
that US suspended the convertibilityof the US dollar with gold.
12

Transition to the Floating System• (Smithsonian Agreement 1971) Japanagreed with America on the appreciation of
Yen to ¥308/$.
• The new parity lasted until 1973, when thenthe leading economy switched to thefloating exchange rate system.
• Since then Yen has been appreciating. In
1978 it reached ¥180/$.
13

The Two Oil Shocks• In the 1980s, the West suffered from inflation and low growth,
the so-called stagflation. One backdrop is the two oil shocks.
• The first oil crisis was triggered by the OPEC (Organization of
the Petroleum Exporting Countries)'s announcement of a 70%
increase in the official price of crude oil during the fourth
Middle East war, when Israel attacked the Arab countries.
• The second oil crisis was caused by the Iranian revolution,
which ousted the Shah, who had been cooperating with theWest, and brought to power a regime based on Islamic
fundamentalism.
14

The Reaganomics• In late 1970 the US economy
suffered inflation and low
GDP growth (stagflation),
which lowered US dollar.
• In 1980 Ronald Regan
became the US President andtook a drastic economic
policy to raise interest rates
and expand the government
deficits. “Bedtime for Bonzo
15

The Twin Deficits• The high interest rate attracted foreign investors to
buy US dollar at a higher exchange rate, which inturn made US industries less competitive andincreased the current account deficit.
• The Regan administration cut taxes but raised
military expenditure, which resulted in the hugegovernment budget deficit.
• The Twin Deficits were gradually recognized as afatal disease of the global economy.
16

Why military expansion?
• In 1980, the Soviet Union invaded Afghanistan. In
response, the West protested strongly.
• That year, Moscow was scheduled to host the
Olympics Games, but many Western countries,
including the United States, Japan, and West
Germany, boycotted their participation.
• On the other hand, most of the major European
countries, including Britain and France,
participated in the Moscow Olympics.
17

The Olympics as a meansof political demonstration• In 1984, the Olympic Games were held in Los
Angeles; the Soviet Union and Eastern European
countries did not attend in protest at the U.S.'s nonparticipation in the Moscow Olympics in 1980.
• Thus, the Olympic Games tend to be used as a symbolof political demonstration.
• In response to the escalating military tension between
the U.S. and the Soviet Union, the Reagan
administration expanded its military budget.
18

After the Afghanistan Invasion• In response to the Soviet invasion of
Afghanistan, the U.S. provided economic
and military support to Muslim volunteer
organizations.
• One of the young men trained in that
program was Osama bin Laden, who later
became infamous for the 2001 attacks.
19

The Plaza Accord• In 1985 the financial ministers andpresidents of the central banks of the G5
countries (Japan, Germany, France, UK,
and US) met at New York, and agreed on
the devaluation of the US dollar.
• The US dollar dropped from ¥240 in 1985
to ¥120 in 1988.
20

The Ever-Appreciating Yen• The Purchasing Power Parity (PPP) is the foreignexchange rate which equates the prices of tradable
commodities across countries.
• In the long-run, the Yen/Dollar rate tends to converge to its
PPP, which reflects the gaps in the inflation andproductivity growth between countries.
• The productivity growth rates had been higher in Japan
than in the US after the WWII, while the inflation rates
higher in US since 1970s. Then the Yen must appreciate
against the US dollar.
• The actual rate has been moving around the PPP.

21

•
•
•
•

Indigo: Market rate
Red: PPP based on CPI
Green: PPP based on corporate price
Blue: PPP based on exported goods

22

The Ever-Appreciating Yen
Syndrome• We can say that the Yen is overvalued if the actual rate ishigher than its PPP based on the CPI (Consumer Price Index).
• The overvalued Yen creates deflationary pressure on theJapanese
economy.
• The overvalued yen forces Japanese firms to exert someunsustainable efforts to reduce their production costs, whichmakes them even more competitive in the global market andyields further evaluation of the Yen.
• Eventually, the Japanese manufacturing firms reach their limit
to the cost reduction, and close domestic plants and fire
employees.
• This consequence is called as the Ever-Appreciating Yen
Syndrome by Ronald McKinnon and Ken-ichi Ohno in 1999.
23

The Five Crises• The Crush of the Bubble (1990)• The Asian Currency Crisis (1997-98)• The IT Bubble and its Crush (2000)• The ‘Subprime’ Crisis (2007) and theLehman Shock (2008)• The Great East-Japan Earthquake (2011)24

The Reason for the Lost Decade 1• During 1990s the major opinion claimed
that the recession was caused by the crashof aggregate demand associated with landand stock price.
• The government took a series of stimulating
economy by adding public demand to
private one, and piling up public projects.
25

The Reason for the Lost Decade 2• However the demand-driven policy failed tohelp the economy to fully recover from thebottom.
• Then an alternative view took dominance inthe 21st century.
• The new view claimed that it was
productivity slowdown that made Japanese
economy to stagnate so long.
26

Complex Recession• Right after the crash of the bubble economy,
the dominating view on the recession wasthat it was caused by insufficient demand,
associated with the crash of land and stock
prices.
• Economist Miyazaki called this “Complex
Recession”, and his view was widely
accepted in early 1990s.
27Temporary Recovery• Thanks to the demand-added policies
repeated by the government, our economy
recorded 3.8% real growth in 1996.
• Then the government raised theconsumption tax rate from 3% to 5%.

28

Asian Currency Crisis• International Investors attacked the currencies ofsome economic growth leaders in Asia in 1997.
• Before the crisis those Asian countries attracted
global money into their growing industries withvery high interest rates.
• However the growing pessimistic view among
foreign investors caused a reversal of capital flow.
• The crisis was harsh especially for Thailand,
Malaysia, Indonesia, and South Korea.
29

Fixed Exchange Rateand Foreign Currency Reserve• Most of the emerging Asian economies
adopted fixed exchange rate (FER) systemand protected the value of their currencies
by foreign currency reserves (FCR).
• But their FCR were not sufficient for
maintaining the FER.
• Many of them dropped out of the FER
system.
30

Crisis Prevention
1.
2.
3.
4.

Exchange rate regime
Financial sector soundness
Regulation on capital flow
Data transparency

31

Exchange rate regime• In order to maintain a fixed exchange rate
regime, a sufficient quantity of foreign
reserves has to be maintained.
• But it is not clear how much is sufficient,with huge capital flows.

32

The Bipolar View
(the two-corner solution)• The only stable, exchange rate systems are
the two extremes:– The free floating exchange rate system– The hard peg (a currency board or
dollarization)• Any intermediate regime (managed
exchange rate, crawling peg, soft peg, etc.)
is unstable.
33

Currency Board System• In the currency crises of 1997-2000, Argentina
and Hong Kong survived spillovers fromsurrounding countries, because they adopted acurrency board.
• Under a currency board, the amount of issued
currency is restricted by the foreign reserves.
• The bipolar view lost its key evidence when
Argentina was forced to devalue and float in
December 2001.
34

Basket Band System (BBS)• The currency authority takes policies tostabilize the value of the currency to aweighted average of the currencies of thecountries trade partners.
• The BBS appears to a better solution thanthe bipolar view now.

35

Crisis of Japan in 1998
• The temporary recovery of Japanese economy was
reversed by the double attack of the drop in
demand caused by VAT increase and the Asian
Currency Crisis.
• The financial system became fragile and threemajor financial corporations (Hokkaido-takushoku,
Sanyo, Yamaichi) bankrupted.
• The leading party, LDP, lost the election in theUpper House, and PM Hashimoto resigned.
36

LDP cabinets• Hashimoto (1996-1998): Lost election.
• Obuchi (1998-2000): died of a brain stroke.
• Mori (2000-2001): unpopular and resigned.
• Koizumi (2001-2006): retired successfully.
• Abe (2006-2007): threw away his cabinet.
• Fukuda (2007-2008)• Aso (2008-2009)37

DP cabinets and the Return of Abe• Hatoyama (DPJ, 2009-2010)• Kan (DPJ, 2010-2011)• Noda (DPJ, 2011-2012)• Abe (2nd, 2012-2020, assassinated in 2022)• Suga (2020-2021)• Kishida (2021-)
38

Why Japan’s cabinets last so short?
• The short tenure of the DP cabinets can be explained by
the “nejire (twist)”, that is, the fact that the majority partyof the lower house does not hold majority of the upperhouse.
• However, the short tenure of Japan’s cabinets started in thelate 1980s.
• The reform of election system (, introduction of the oneseat districts) done in the early 1990s might have made ourpolitical rule fragile, although PM Abe maintained his
position for 8 years.
39

IT bubble• Obuchi changed economic policy andincreases public demands.
• Thanks to Information Technology Bubble,
Japanese economy recovered in 1999.
• However, the bubble crashed and Obuchi
died in illness in 2000.

40

Koizumi and Takenaka• In 2001, Koizumi waschosen as LDP president by
LDP’s party member’svote, to be elected as Prime
Minister.
• He appointed Takaneka as
Minister of Economy, andstarted Koizumi Reform.
41

“Structural Reform”• Koizumi’s policy focuses on the supply side of theeconomy, viewing the persistence of lowproductivity firms as the main cause of oureconomic slump.
• Postal Saving (PS), government-run financial
service corporation, was regarded by Koizumi as
the main financial sources for those inefficientfirms.
• Koizumi’s goal was to privatize PS.
42

Economic Crisis Again• Koizumi was applauded by people for hisstrong political leadership.
• But the economy became even worse,
thanks to demand fall associated with the9.11 terrorist attack.
• In 2003, Nikkei index of Tokyo Stock
Exchange (TSE) recorded the historicallowest at 7600 yen.
43

The Bad Loan problem• The economic crisis waspartly caused by
Takanaka’s drastic policy
to clear unperformed loans.
• Takenaka obliged banks toreport the true values of
their net assets in thebalance sheets.
• Many banks sufferedcapital shortage after they
made their ‘true’ balance
sheets open to public.
44

Was Investment Constrained?
• The “Credit Crunch” hypothesis:– Firms cannot invest as much as they want,because there is a limit on the amount they canborrow.

• This hypothesis seems to be convincing
because the collapse of bank loans occurredin the same period, due to the BIS
regulation on the banks’ equity capital ratio.
45

ASSETS

LIABILITIESBank’s Balance Sheet

Loans andother Assets

Deposits

Equity capital

Japan’s banks havebeen heavily in debts,
due to the insufficientdevelopment of capital
markets.

BIS regulation:
Equity capital must be
higher than 8% forinternational business46

Reversal of the Fortune• Takenaka dramatically changed his harsh
policy on banks and bailed out Resona Bank
Co. in 2003.
• Then Japanese economy started to recover.

47

Supply-Side Views on the Lost 90s• In late 1990s, Hayashi and Prescottpresented an academic work to explain
Japan’s economic slump by the slowdown
of TFP growth.
• In early 2000s, Hoshi and others pointed out
the Zombie firms as the main causes ofJapan’s low productivity.
48

The Neoclassical Growth Theory
•
1.
2.
3.
4.

Output per adult y can be decomposed into
four factors:
TFP (productivity growth)
Workweek (How long you work)
Employment rate (Who are hired at jobs)
Capital intensity (capital per unit labor)49

50

Growth Accounting (TABLE 1)• Except for 73-83, the TFP growth accounts
for the most part of the sources of Japan’s
economic growth.
• There is a dramatic decline in TFP growthin the early 1990s.
• Both the workweek length and theemployment rate have been declining.
51

Economics of Zombie(Caballero, Hoshi, and Kashyap)• In 1990s many firms were financially
supported by the banks with the interest ratecut, while most of them lacked productivity
growth and should be replaced by new firms.
• Persistence of low productivity firms
supported by banks makes it hard for new,productive firms to enter the industry.
52

Deflation• Around the turn of the century, Japan’s
inflation rate became negative (deflation).
• Bank of Japan (BOJ) was forced to takesome untraditional policies such as zerointerest and quantitative ease.
• Shirakawa, the former BOJ governor
argues (in 2012) that Japanese economy
change around 1997, not around 1990.
53

Conventional Monetary Policy• Control on short-run interest rates: BOJ
intervenes the inter-bank market to supply
or absorb liquidity.
• Open-Market Operations on midterm or
long-term securities such as national bonds(treasury bills in US).
• These policies are effective if the nominalinterest rate is sufficiently above zero.
54

Unconventional Monetary Policies• With zero interest rate, the inter-bankmarket loses its adequate function, andmoney is stored in cash.
• BOJ was forced to make operations withlonger maturities such as national bonds.
• BOJ took the quantitative ease policy to
mandate banks not to hold too much
liquidity.
55

Intervention into FOREX• The MOF, coordinated with BOJ, took a drastic
intervention into the foreign exchange market topurchase US dollars to keep the value of Yen low.
• Some leading economists like John Taylor (deputy
director of US Finance Department) acknowledge
that this decisive intervention into FOREX incoordination with BOJ was the main demand-side
factor for Japan’s recovery in the early 2000s.
56

The Mundell-Fleming Model• Fiscal Policies (public investment, tax cut) will temporarily
increase the interest rate, attract foreign capital, cause thecurrency appreciation , and reduce exports, withoutchanging national output.
• Monetary Policies (increasing money supply) will
temporarily reduce the interest rate, lose foreign capital,
cause the currency depreciation, and increase exports andnational output.
• In both the cases, the interest rate will return to its originallevel, because the financial market is integrated acrossnational borders.

57Price of $ in ¥LM
IS

Public projects or
Tax cut simply raises
the value of Yen, does
not affect GDP.

GDP
58

Price of $ in ¥Increase inmoney supply
reduces thevalue of Yen andincreases GDP.

LM
IS

GDP
59

Weak Yen and Japan’s Recovery• In an open economy, the central bankcannot directly control the domestic interest
rate because it is determined by theinternational capital flow.
• However, increasing money supply will
reduce the Yen’s value and drive theeconomy out of slump through increasing
exports.
60

The Recovery with/without
Structural Reforms?
• In 2005, Japan almost fully recovered fromthe lost decade, while a few evidences ofsuccessful structural reforms being done.
• The bad loan problem was almost solved,
while the removal of the credit-crunch on
firms’ balance sheet did not automaticallyincrease investment.
61

Still in Deflation• Even after the recovery, domestic consumption was
still weak and the CPI excluding foods and energy
showed no significant inflation.
• This was explained by:– global competition with the emerging economies– BOJ’s reluctance for further monetary expansion.

• A drastic policy change occurred in 2012, when
Shinzo Abe was appointed to be PM.

62Supplement: Government Sponsored
Financial Institutions
Takeo Hoshi and Anil K Kashyap
Journal of Economic Perspective 200463

Government Financial Institution• Postal saving systems provide much moreconvenient services (huge number of branches,competitive interest rate on deposits, nomaintenance fees).
• Government Housing Loan Corporation (GHLC)
accounts for 40% of all home mortgage loans.
• The public has not been convinced that the
government-sponsored financial institutions are
the reasons of Japanese banks’ low profitability.
64Fiscal Investment and Loan Program(FILP)• A large part of deposits collected by postal saving
system go to FILP, which in turn lends togovernment-sponsored corporations such as:• Government Housing Loan Corporation (¥66
trillion)• Development Banks of Japan (¥15 tr.)
• Japan Highway Public Corporation (¥22 tr.)
• Japan Finance Corporation for MunicipalEnterprises (¥18 tr.)
• Urban Development Corporation (¥15 tr.)
65

Why is FILP so bad?
• Most of borrowers of FILP are doing unprofitable
activities.
• The loss of FILP is compensated for by thegovernment subsidies, and eventually require a
taxpayer bailout.
• The assets of FILP borrowers are overvalued.
– Most of assets are counted by the high book values atwhich the ypurchased them in the Bubble Period.

66

Most of the FILP problems havebeen alleviated• The Postal Saving System, the largest
financing source of the FILP, was privatizedin 2007.
• The FILP agencies finance theirinvestments by issuing bonds in the market.
– The quality of investment is always evaluatedin the market.
67

The ‘Subprime’ Crisis (2007) andthe Lehman Shock (2008)
Ryoichi Imai

68The ‘Subprime’ loan in the US• The US residential land prices had been
increasing more than proportionally to its
GDP since 2003.
• This was caused significantly by theincrease in generous loan offers tofinancially unreliable households with highbankruptcy risks.
69

Crush of the Bubble• In the late 2006, the land price started to
decline.
• The Housing Bubble was recognized by the
US stock market in July 2007.
• Finally, Lehman Brothers bankrupted in
October 2008.
• Dow index declined from 14000 (October2007) to 6547 (March 9, 2009).
70

Bailouts• (Wikipedia) A bailout is a fresh injection of liquidity to abankrupt or nearly bankrupt entity, such as a corporation ora bank, in order for it to meet its short-term obligations.
• Bailout Examples– Bear Stearns (investment bank)– Fannie Mae and Freddy Mac (semi-public corporation tounderwrite the mortgage loans created by banks in private sector)– American International Group (world’s largest insurance company)• Lehman was not bailed out.

71

Bailout in balance sheet
Firm in Crisis
ASSETSLIABILITIES

Loans
and
other
Assets

Debts

Equity capital

After Bailout
ASSETSLIABILITIES

Loans
and
other
Assets

Debts

Equity capital

Public funds72‘derivative’ securities.
• There is a tradeoff between the high risk and thehigh return.
• The ‘subprime’ loans was combined with ‘prime’loans and sold to investors as ‘derivative’securities.
• Investors tend to neglect the high risk of thederivative securities, because they are advertisedas ‘safe’ thanks to the highly developed financial
technologies.
73

Black-Scholes Formula• Fischer Black and Myron Scholes published amathematical formula to calculate the theoreticalprice of European stock options in Journal of
Political Economy (1973).
• Their research was soon extended to the pricing ofvarious financial products. The formulae havebeen widely used by the financial industry to makehuge profits.
• Scholes and Robert Merton were awarded a Nobel
Prize for Economics in 1997.
• Unfortunately, Black died in 1995, before he wasawarded.
74

Taking Huge Risks• The core strategy to obtain huge profits inthe financial industry (investment banks andhedge funds) is to make a portfolio thatyields the highest expected profits for agiven risk distribution.
• Sometimes they take too much risks toobtain huge profits.
• They often fails by the fat tail events.
75

The fat tail
Probability
density• In the real world, a rare event
often occurs with a skewed
distribution.
• A fat tail is a set of events that
occur with a very low probability
and bring a huge gain or loss.

fat tail

Low

Interest rate

High 76

The LTCM• Before 1998 the Long-Term Capital Management
was the “Dream Team” in the financial industry,hiring Merton and Scholes.
• They bet on the prospect that the interest rate gap
within Europe would be reduced thanks to theeconomic integration.
• But the sovereign bond crisis in Russia caused by
the Asia Currency Crisis increased the interest
rate gap in Europe, which resulted in a bankruptcy
of LTCM.
• The Fed coordinated other banks to bailout LTCM.
77

The Liquidity Crisis in 2008
• This time, the US private sector could no longer
bailout all the financial institutions, because thecrisis is was huge and profound.
• Due to the complexity of the derivative securities,
it was hard to verify the true loss caused by the
housing price decline.
• (Disorganization) Firms could no longer rely on
the financial sustainability of their business
partners.
• Bailout by public funds was the only way tostabilize the economy.
78

Emergency Economic Stabilization Act (EESA)• The Emergency Economic Stabilization Act was proposedby the Bush administration in September 2008, but was
rejected by the US congress in the first round, and wasapproved by the US diet in the early October 2008.
• The Congress rejected it in the first round, being afraid of
the tax payers’ anger on the CEOs of the financial industry.
• The bill enabled the government to inject public funds into
the balance sheet of the weak business.
• However, the stock market focused more on the weak real
economy (consumption, production, and employment).

79

The Stagnation• After several policy measures were taken, the initialcrisis was over in March 2009, according to the NBER
report.
• The US and the World Economy steadily recovered.
• However, the true recovery came in 2016, when theunemployment rate returned to its pre-crisis level.
– https://fred.stlouisfed.org/series/UNRATE

80

The Euro Crisis• The stagnation was even worsened by the
public finance crises in Europe in 2011.
• Greece was near bankruptcy.
• Spain and Italy seemed to follow Greece.
• The EU faced a difficult choice between;– Bailing out the financially weak Euro members, or– Kicking them out of the Euro zone.
81

“Japanization”• The US government spent a huge budget tostimulate the economy.
• The Fed took a series of unconventional monetary
policies, named QE1 and QE2.
• Even after the recession was over, the nominalinterest rate remained close to zero, and the US
economy looked like Japan since 1990, until theworld was hit by the Covid-19 pandemic in 2020.
82

The Endaka• In 2009, Japan’s export industries suffered the
Yen appreciation to the even higher level than the
one reached in 1995.
• At the nominal value, the Yen is at the historicallyhighest level, 75¥/$ in October 2011, when Japanwas hit by the great east-Japan earthquake.
• However, the effective real exchange rate was not
so high as the nominal one.
83

The Effective Real Exchange Rate
• The nominal exchange rate is not a goodmeasure of a country’s competitiveness in
the global economy.
• Inflation and trade shares must be
accounted for the global competitiveness.

84

Inflation• In the last three decades, Japan suffereddeflation, which involved a continuing decline
in the production costs, including employees’
wages.
• On the contrary, the inflation rate in the US
was significantly above zero, which reflected
the continuing rise in the production costs.
85

Trade Shares• 20 years ago, the US was the largest trade partner of Japan.
• Today, the US is replaced by China.
• Therefore, the weight of China’s Yuan is higher than thatof the US dollar in the calculation of the effective
exchange rate of the Yen.
• The Nominal Effective Exchange Rate is the exchange rateindex based on the trade share.
• The Real Effective Exchange Rate is the exchange rateindex based on both the trade share and inflation.

86

Nominal versus Real Effective Exchange Rate

https://data.imf.org/regular.aspx?key=61545850

87

NEER and REER
• The difference between NEER and REER is
the effect of inflation in the foreign countries.
• As a total, the REER is at a historically lowest
level since the early 1970s.
• The NEER of the Yen seems not to be too low,while it does not account for the higher
inflation rates in the foreign countries, which isaccounted by the REER.
88

Real Effective Exchange Rates of the Major Economies

http://www2.ttcn.ne.jp/honkawa/5072.html

89Balassa-Samuelson Effect• (Balassa-Samuelson) Economic theory suggests thatdomestic currency is overvalued if productivity growthis faster in the tradable sector than in non-tradable sector.
• The REER of the Yen in 1990s was high partly because
productivity growth was higher in tradables than in nontradables.
• In the last two decades, Japan’s productivity growth isslowing down in the tradable sector and accelerating in
the non-tradable sector, which may explain the low realeffective rate in recent years.
90