Japanese Economy A 2011 Fall

Japanese Economy A2012 Fall

Seinan Gakuin UniversityNoriaki EZOE Professor Ph.D.Economics DepartmentSeinan Gakuin UniversityJapanMail address: ezoe@seinan-gu.ac.jpHomepage address: https://w3.seinan-gu.ac.jp/~ezoe/

1Part Chapter 5 Lost decades and Macroeconomic policies What you will learn in this chapter1 The bubble economy and its collapse2 Economics ; review of macroeconomics AD-AS analysis, Fiscal and Monetary policies3 The lost decades2Japanese EconomyKey Historical EventsJapanese Economy 3yearDomestic eventsOverseas events1985Yens evaluationPlaza Accord1987BOJ historical low bank rate 2.5%Black Monday1989Emperor died. Heisei era begins.Nikkei stock index 38,130Fall of Berlin wall1990BOJ tight money 6.0%1991Bubble burstGulf war. Soviet Union resolved1992Non-LDP government established1995Great Kobe earthquakeWTO starts1997Big Bank Bankruptcy Asian financial crisis1999BOJ call rate 0%Euro adopted2001Koizumi administrationGeorge W. Bush U.S. president9.11 terrorist attack. Iraq war2007Privatization of Japan PostFinancial crisis ( subprime problems)2009DPJ government startsBarack Obama U.S. president20113.11 Great east Japan earthquakeChina's GDP surpassed Japan's

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Shift from political to economic agendaPost WW2 Real Growth1st Oil Shock2nd Oil ShockYen floatsBubble collapses

1 The bubble economy and its collapse1.1 The road to Bubble Economy

Stagflation And Trade FrictionsAfter oil crisis, world economy experienced a stagflation (stagnation and inflation)The Cause of 1970s StagflationSupply shock viewOPECs oil The Cause of 1970s Stagflationprice hike was the main cause. Aggressive wage hikes also contributed.Expansionary fiscal & monetary policy accommodated and softened the blow.Global monetarist viewAs US lost monetary discipline, the fixed rate regime collapsed in 1971-73 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 Economy5land myth:-the belief that land prices would never fall. Banks expanded their loans with land as collateral. The rise in the value of assets and the resulting unrealized profits only encouraged individuals and corporations to invest more5Japan regained its competitiveness in the export market and the export-led economy caused trade frictions.

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Japanese Economy7U.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 agreedthe 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 1989. Similarly, the price index for commercial land in six metropolitan cities tripled between March 1986 and March 1990.

Japanese Economy8Nikkei Stock Average 225Urban land price indexSource: Japan Real Estate Institute

Three reasons to believe that expectations about future returns of stock and land assets became more optimistic (the 1980s)Financial 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 BOJs monetary policy eased significantly in 1986 and 1987. Japanese Economy10The Heisei Bubble (Economic Boom in late 1980s)CausesStructuralbank 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.Monetaryas 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 (1990-1995)

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 1995. Representative land prices in metropolitan areas also declined by half from 1991 to 1995, and they continued to decline through early 1996. 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.

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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 ASAD 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 = kYAD 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 curveJapanese Economy14The 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 Economy15Figure The ASAD ModelTheir point of intersection, ESR , 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 Economy1616Figure Caption: Figure 7: The ASAD modelThe ASAD model combines the short-run aggregate supply curve and the aggregate demand curve. Their point of intersection, ESR , is the point of short-run macroeconomic equilibrium where the quantity of aggregate output demanded is equal to the quantity of aggregate output supplied. PE is the short-run equilibrium aggregate price level, and YE is the short-run equilibrium level of aggregate output.

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 stagflationwhich is caused by a negative supply shock.

Japanese Economy17Figure 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 Economy1818Figure Caption: Figure 8: Demand ShocksA demand shock shifts the aggregate demand curve, moving the aggregate price level and aggregate output in the same direction. In panel (a) a negative demand shock shifts the aggregate demand curve leftward from AD1 to AD2, reducing the aggregate price level from P1 to P2 and aggregate output from Y1 to Y2.Figure Shifts of the SRAS Curvea negative supply shock Stagflationthe combination of inflation and falling aggregate outputpositive supply shock prices falls output rises

Japanese Economy1919Figure Caption: Figure 9: Supply ShocksA supply shock shifts the short-run aggregate supply curve, moving the aggregate price level and aggregate output in opposite directions. Panel (a) shows a negative supply shock, which shifts the short-run aggregate supply curve leftward, causing stagflationlower aggregate output and a higher aggregate price level. Here the short-run aggregate supply curve shifts from SRAS1 to SRAS2 , and the economy moves from E1 to E2. The aggregate price level rises from P1 to P2 , and aggregate output falls from Y1 to Y2.

Figure The Supply Shock of 2007-20082007-08 ,the prices of many raw materials began shooting up. The surge in raw-material prices amounted to a global negative supply shock

Japanese Economy2020In the summer of 2007, for reasons that are still a matter of dispute, the prices of many raw materials sold on world markets began shooting up. By the middle of 2008, the price of oil had doubled, the price of rice had tripled, and there had been major increases in the prices of many other commodities, from wheat to iron ore. The surge in raw-material prices amounted to a global negative supply shock, affecting all economies. This figure shows the rate of inflation, as measured by the percentage increase in the consumer price index over the previous year, for five major economies from May 2007 to May 2008. The countries started from very different initial positions, ranging from 2.7% inflation in the United States to zero inflation in Japan. Yet all of the countries experienced a substantial jump in prices.20

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 shockThere can be drawbacks, the budget deficit and crowding out of private investment

Japanese Economy21The 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

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Figure Expansionary Fiscal Policy Can Close a Recessionary Gap

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Expansionary fiscal policy increases aggregate demand.

Monetary policy Figure Monetary Policy and Aggregate Demand

Expansionary monetary policy is monetary policy that increases aggregate demand.

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Contractionary monetary policy is an opposite policy. Figure The Short-Run and Long-Run Effects of an Increase in the Money Supply

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3 The lost decades3.1 Long recessionAs 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 Economy26Expansionary Fiscal Policy in Japan

At the end of the 1980s Japans bubble burststock 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.

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Debate on Fiscal StimuliSince 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.211-212Government debt in % of GDPBubble burstPM Koizumi (2001-06) set limits on spending (infrastructure, welfare).PM Aso (2008-) and DPJ (2009-) returned to big fiscal spending.

KoizumiAbeFukudaAso

HatoyamaKanLDPDPJ

Figure The public debt :Global ComparisonJapanese 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.Cant a government that has trouble borrowing just print money to pay its bills? Yes, it can, but this leads to another problem: inflation.

Japanese Economy30Monetary policy issuesBad loans IssueThe 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.

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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 (MBMoneyLending)--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)

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Call rate (interbank short-term interest rate)Money & bank lendingBubbleZerointerest ratepolicyExcess 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 Japans economic system became obsolete 4 Aging population and associated problems (pension, medical care, dissaving, etc.) 5 Snowballing fiscal debt 6 Peoples lack of confidence in the future or policy 7 The China challenge 8 The political leadership Government lacks in the political leadership--political instabilityJapanese Economy 34End of Lost DecadeThe government of J.Koizumi (2001- 2006) 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 Economy 35This period is called the "Lost Decade."35Recovery, Global RecessionMain causes of recovery (2003-2007)--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 2008-2009)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 Economy 36banking system that channels savings and investment spending

Government negligence and the failure of government economic policy (such as putting off dealing with the non-performing loan issue) were major causes of the prolonged economic stagnation.36

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 Economy37ReferencesThomas 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, 2th edition, Worth Publishers.Gregory N. Mankew [2007], Macroeconomics, 6th edition, Worth Publishers. Kenichi Ohno[2006], The Economic Development of Japan, GRIPS Development Forum.

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