of the simulation period after a sharp decline in the initial years. Declining investment opportunities in the domestic market, higher returns in the foreign relative to the domestic market, and appreciation of the yen are the underlying forces for strong recovery in Japan's FDI. East Asia is considered the largest beneficiary of this development.

# VII. Concluding **Remarks**

The bursting of the Japanese financial bubble in the early 1990s and the subsequent continuing decline in asset prices have contributed to an increase in bad debts for the country's financial institutions, slowed credit extension through erosion of the capital base, and been a drag on attempts to produce a full recovery. Since Japan accounts for about 20 percent of foreign aid to developing countries and buys around 10 percent of their exports, its economic health is obviously important for the prospects of developing regions. This paper revisited the macroeconomic environment pertaining to the creation and bursting of the financial bubble, provided quantitative and qualitative assessments of the prevailing bad debt stock among the ailing financial sectors, and analyzed their negative effects on the economy. The study further investigated the risk of Japanese financial institutions failing to meet BIS capital adequacy criteria and policy options for Japan's monetary and fiscal authorities.

Although the possibility of a systemic financial sector crisis that will shake up world financial markets - the so-called "Japan Problem" - is unlikely, the authorities may have to restructure severely affected institutions, with or without the advent of an explicit financial sector crisis (bank runs), something which could result in higher fiscal expenditures or an increase in debt stock.

To investigate the likely effects of the financial sector crisis (limited-scale bank runs) we conducted scenario simulation analyses using the Economic Planning Agency's fifth generation global macroeconometric modeling framework. Even with limited-scale bank runs equivalent to 2 percent of nominal GDP, loss of household sector confidence in the financial sector would put the Japanese economy into a recessionary spiral. The simulation showed that the economy would never revert to the baseline level without supplies of short-term liquidity by the monetary authority. Thus, some sort of publicly funded rescue is regarded as inevitable under this scenario.

At the advent of the crisis in Japan's financial sector, world trade activity is depressed, interest rates are raised, and the terms of trade generally turn against primary commodity exporting developing regions. However, the widely feared contagious effects of Japan's financial crisis on the U.S. and other major financial markets was not detected in the simulation. This confirmed that an all-out, doomsday scenario is unlilkely.

Even with a limited financial sector crisis, however, the envisioned changes would force the pace of Japan's structural adjustmen **t** o accelerate, causing the economic pain associated with rapid adjustments. As to the ripple effects outside the country, many Asian economies could, surprisingly, turn out to be beneficiaries, while industrial countries and the financial centers of Asia will feel liquidity pressures and the effect of higher interest rates.

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