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Japan’s Lost Decade : An Introduction

Japan’s economy has endured the first lost decade during the 1990s. Looking at the current situation, experts are pointing out that Japan is now experiencing their second lost decade due to similar characteristics of the first which is stagnant, non-improving condition of their economy. Did Japan learn anything from the previous lost decade, or did the steps taken to avoid another lost decade were too weak? What was the problem? We will try to look into the situation of both crisis and highlight some major problems that contributed to this economic downturn.

During 1990s the major opinion claimed that the recession was caused by the crash of aggregate demand associated with land an...

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...d stock price. The government took a series of stimulating economy by adding public demand to private one, and piling up public projects. However the demand-driven policy failed to help the economy to fully recover from the bottom. Then an alternative view took dominance in the 21st century. The new view claimed that it was productivity slowdown that made Japanese economy to stagnate so long.

Right after the crash of the bubble economy, the dominating view on the recession was that 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. Keizo Obuchi, Japan’s Prime Minister at the time, changed economic policy and increases public demands. Thanks to Information Technology Bubble, Japanese economy recovered in 1999. However, the bubble crashed and Obuchi died in illness in 2000, and Junichiro Koizumi took over the Prime Minister’s seat.

Koizumi’s policy focuses on the supply side of the economy, viewing the persistence of low productivity firms as the main cause of the country’s economic slump. But the economy became even worse, thanks to demand fall associated with the 9/11 terrorist attack. The economic crisis was partly caused by Heizo Takenaka’s ( Koizumi’s Minister of State for Economic and Fiscal Policy) drastic policy to clear unperformed loans. Takenaka obliged banks to strictly evaluate their net assets in the balance sheets.

Many banks suffered capital shortage after they made their ‘true’ balance sheets open to public. Firms cannot invest as much as they want, because there is a limit on the amount they can borrow. This statement seems to be convincing because the collapse of bank loans occurred in the same period, due to the BIS regulation on the banks’ equity capital ratio. Japan’s banks have been heavily in debts, due to the insufficient development of capital markets. Takenaka dramatically changed his harsh policy on banks and bailout Resona Bank Co. in 2003.

Since then Japanese economy started to recover. In late 1990s, Hayashi and Prescott presented an academic framework to explain Japan’s economic slump by the slowdown of TFP growth. In 2003, Caballero, Hoshi and Kahyap focussed the Zombie firms as the main causes of Japan’s low productivity. In 1990s many firms were financially supported by the banks with the interest rate cut, 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 enter the industry.

Around the turn of the century, Japan’s inflation rate became negative. Bank of Japan (BOJ) was forced to take some untraditional policies such as zero interest and quantitative ease. Japan tried to Control on short-run interest rates by having BOJ intervenes in the inter-bank market to supply or absorb liquidity. They also introduced open-market operations on midterm or long-term securities such as national bonds (treasury bills in US). With zero interest rate, the inter-bank market loses its adequate function, and money is stored in cash.

BOJ was forced to make operations with longer maturities such as national bonds. BOJ took the quantitative ease policy to mandate banks not to hold too much liquidity. The Ministry of Finance (MOF), coordinated with BOJ, took a drastic intervention into the foreign exchange market to purchase 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 foreign exchange was the main demand-side factor for Japan’s recovery.

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