japan™s lost two decades: asset price bubble any lessons

Japan’s LostDecades

Fujiwara (ANU)

Introduction

TechnologicalCatch-Up

Monetary PolicyAsset Price Bubbleand Monetary PolicyPreemptive PolicyZero Bound and RealInterest Rate

Societal Aging

Conclusion

Japan’s Lost Two Decades:Any Lessons for Australia?

Ippei Fujiwara

Crawford School of Public PolicyCAMA, EABCN, GMPI (FRB Dallas) and RIETI.

21 August 2012

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Japan’s Lost Two Decade: GDP

I GDP growth rateI 9.4% between 1955 and 1970I 3.8% between 1971-1990I 0.8% from 1991 (in lost two decades)

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GDP (Log Level)

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Japan’s Lost Two Decade: Inflation (Deflation)

I CPI inflation rateI 2.5% in the 1980sI 1.2% in the 1990sI -0.2% in the 2000s

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CPI Inflation Rate

Source: Bank of Japan

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The Simplest AnswerI There were structural breaks in the trend technology(TFP) growth rate!

I The resource constraint isExpenditure (Demand)︷︸︸︷

C + I =

Production (Supply)︷︸︸︷f (T ,K , L) .

I TFP (T ) does not have to be the supply side factor. Itis considered rather residuals.

I For example, it contains information for factor hoarding(capacity utilization). Thus, a possible scenario throughdemand is

I Monetary policy (nominal spending control) was notaccommodative enough. Demand is relatively lowcompared to the supply. TFP falls reflecting the loweredcapacity utilization. Deflation occurs.

I “Needed: a theory of total factor productivity”byPrescott (1997).

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Aims of Today’s Presentation

I To discuss the factors that have been considered toaffect the Japan’s lost two decades.

I Especially to evaluate three factors from both demandand supply sides.

1. Technological catch-up2. Monetary Policy3. Societal Aging

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Structure of Presentation

I IntroductionI Technological Catch-UpI Monetary PolicyI Societal AgingI Conclusion

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GDP per Capita (PPP, %, Relative to France,UK and US)

0%

20%

40%

60%

80%

100%

120%

1950 1960 1970 1980 1990 2000 2010

Japan

Korea

China

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Societal Aging

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Re-Statement of the Problem

I The most important factor of economic growth istechnological adoption.

I If there is no barrier to technology diffusion, keepinghigher per capita GDP than in other advancedeconomies should be diffi cult.

I Around 1990, per capita GDP was almost the same asthose in advanced economies.

I Until 1970, labor moved from rural to cities, whichfacilitated the technological adoption.

I Japan’s lost two decades should not be understood intime-series as the decrease of the GDP growth ratefrom 3.8% to 0.8%.

I The problem to be investigated is milder one incross-section: why GDP growth rate has been lowerby about 0.5% than in other advanced economies.

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GDP Growth Rate in the 2000s

Source: Bank of Japan12 / 47


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Monetary Policy to Be Blamed

I Given long-lasting deflation, natural criticism is that theBOJ has not properly conducted monetary policy.Especially,

I The BOJ should have reacted to the asset price bubblein the late 1980s.

I The BOJ should have reduced nominal interest ratesmuch quicker in the early to middle 1990s.

I The deflation and zero lower bound has been keepingreal interest rates higher and therefore constrained theaggregate demand.

I I will discuss

1. Asset price bubble and monetary policy2. Preemptive policy3. Zero Bound and Real interest rates

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Asset Price Bubble in Japan


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FED View vs BIS View

I Quite often, it is casually argued that monetary policyshould respond to asset prices.

I There exist two famous views on monetary policy andasset prices.

1. FED ViewI Ex post clean-up operations

2. BIS ViewI Ex ante extra operations

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Asset Price Bubble and Monetary Policy

I Although very appealing ex post, it is very diffi cult toimplement monetary policy following the BIS view.

I According to the standard theory, asset prices increasewith the technological progress.

I This implies that tightening monetary policy conditionagainst increase in asset prices is an awful policy.

I This is to contract demand when supply is increasing(production possibility frontier is expanding) andtherefore welfare-deteriorating.

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Asset Price Bubble in Theory

I To date, according to the theory on bubbles, such asTirole (1985) or Venture (2002), bubble is effi cient.

I Under the situation of dynamic ineffi ciency, the rate ofreturn is lower than the rate of economic growth,bubble can result in higher return and therefore bewelfare-improving.

I Fiat money, whose intrinsic value is zero, can be veryvaluable in an OLG model without any other saving tool(Samuelson’s classic idea).

I Theoretical model with welfare losses from (the burstof) the bubble is an on-going research agenda.

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Preemptive Policy

I Ahearne et al. (2002) state that deflation could havebeen averted through early monetary easing.

I Using a macroeconomic model of the Japaneseeconomy (FRB/Global), Ahearne et al. (2002) find thatdeflation could have been avoided if interest rates hadbeen permanently decreased by 2.5 percentage points atthe beginning of 1991, the beginning of 1994, or thebeginning of 1995.

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Srouce: FRB21 / 47


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I This retrospective policy prescription of “early andlarge-scale monetary easing”takes a particular economicmodel as given and assumes that the BOJ had accurateknowledge regarding the economic structure.

I Can such a policy prescription be considered realistic?I No! We need to take model uncertainty into account.

I We do not have any perfect knowledge about structuralparameters.

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Monetary Policy under Uncertainty

I Fujiwara et al. (2007) conduct stochastic simulationswith a large-scale macroeconomic model of theJapanese economy (JEM).

I We find that the BOJ’s monetary policy at that timewas essentially optimal under uncertainty about thepolicy multiplier (Brainard Conservatism)

I On the other hand, we also find that the BOJ’s policywas not optimal under uncertainty about inflationdynamics, and that a more aggressive policy responsethan actually implemented would have been needed.

I Optimal monetary policy differs greatly depending uponwhich type of uncertainty is emphasized.

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I Taking into account the fact that overcoming deflationbecame an important issue from the latter 1990s, it ispossible to argue that during the early 1990s the BOJshould have placed greater emphasis on uncertaintyabout inflation dynamics and implemented a moreaggressive monetary policy.

I The result from a counterfactual simulation indicatesthat the inflation rate and the real growth rate wouldhave been higher to some extent if the BOJ hadimplemented a more accommodative policy during theearly 1990s.

I However, the effects would have been limited, and thatan accommodative monetary policy itself would nothave changed the overall image of the prolongedstagnation of the Japanese economy during the 1990s.

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Monetary Policy under the ZLB


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I Casual claim is that since nominal interest rate isconstrained at zero, real interest rates should becomehigher than optimal under deflation.

I This can constrain the real aggregate demand.

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Real Interest Rates from 10y Government Bond(ex post)

6

4

2

0

2

4

6

8

10

12

1980 1985 1990 1995 2000 2005 2010

US Japan

%

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Monetary Policy and Lost Decade

I Inflation rate could have been higher with moreaccommodative monetary policy.

I Real interest rates, albeit ex post, have beensurprisingly at similar level to those of the US especiallyunder the zero interest policy regime.

I What matters for the real economic activities is realinterest rates, not nominal interest rates.

I Under free capital trade, if consumption basked issimilar and the law of one price holds for most of thegoods, real interest rates must be equated.

I Monetary policy should have had limited effects on theJapan’s lost two decades.

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Societal Aging and Japan’s Lost Two DecadesI Recently, lots of attentions are paid to societal aging asthe primal cause of the Japan’s lost two decades.



Fujiwara (ANU)

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Demographic Changes in Japan


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GDP Growth Rate per Working Age Population


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Societal Aging and GDP

I Production should be a function of working agepopulation.

I It is natural that GDP (not GNP) becomes lower withdecreasing working age population.

I Japan’s lost decade may not be a puzzle at all. Thiscan be solely explained by the supply side factor.

I Asset price bubble in the late 1990s may be also relatedto the societal aging.

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Property Price and Inverse Dependency Ratio(Working Age / Rest)- How many working age people there are to one dependent.

Source: Bank of Japan and Bank for International Settlement35 / 47


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Source: Bank of Japan and Bank for InternationalSettlement

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Source: Bank of Japan and Bank for InternationalSettlement 37 / 47


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Source: Bank of Japan and Bank for InternationalSettlement 38 / 47


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Spurious Relationship?

I Society is only gradually aging. Therefore, the pace ofsocietal aging is predictable.

I If agents are rational, the return from land or otherassets should be the same as the interest rates onaverage.

I Ex ante expected return must be the same acrossdifferent assets.

I Hence, there should not exist any structural relationshipbetween societal aging and asset prices.

I Above figures may just reflect spurious relationship.

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Optimistic Forecasts of Fertility Rate


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Societal Aging and Asset Price Bubble

I Demographic changes are not predictable.I In addition, there should exist “limits of arbitrage.”

I Transaction costs are huge in land trading.

I The relationship between societal aging and asset pricebubble can be structural.

I We need a structural model to investigate thisrelationship.

I Through this channel, economic conditions after theburst of the bubble might have become much severerdue to balance sheet adjustments.

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Conclusion

I It is natural that the growth rate became lower after1990, since technological catch-up phase ended then.

I Monetary policy may be responsible for thedevelopments of nominal variables but not those of realvariables.

I Societal aging can cause significant effects on realeconomic activities for a long run.

I There exist other concerns related to societal aging,such as polictical decision making, fiscal policy(government budget) and many more.

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Lessons for Australia

I Even though it turns out to be bubble ex post, it ishardly possible to react preemptively.

I Other than this, economic situation in Australia now isquite different from that in Japan in the late 1980s.

I Societal aging is not be an issue for Australia.I GDP per capita has been high in Australia.

I The question is whether current trend is sustainable ornot.

I Yet, “this time is different”is typical recognition in anbooming economy. For example,

I Societal aging in East Asian countries can have asignificant impact on Australian economy, althoughthere still exists huge room for growth in China.

I High leverage in household sector may result in longlasting recession through de-leveraging.

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Housing Price in Australia

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

Mar2002

Sep2002

Mar2003

Sep2003

Mar2004

Sep2004

Mar2005

Sep2005

Mar2006

Sep2006

Mar2007

Sep2007

Mar2008

Sep2008

Mar2009

Sep2009

Mar2010

Sep2010

Mar2011

Sep2011

Mar2012

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GDP per Capita (PPP, %, Relative to France,UK and US)

0%

20%

40%

60%

80%

100%

120%

140%

160%

1950 1960 1970 1980 1990 2000 2010

Japan Korea China Australia

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Growth Rate of Working Age Population in EastAsia


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japan™s lost two decades: asset price bubble any lessons

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