Japan's Post-Bubble Economy
Japan experienced large asset price bubbles in its stock and commercial real estate markets during the second half of the 1980s. These bubbles peaked in 1989 and 1990, respectively. Subsequently, both Japanese share prices and land values fell, surrendering all of their gains during the bubble-years by 1993 and 2000, respectively. After these bubbles popped, real GDP growth slowed abruptly. However, a series of fiscal and monetary blunders by the Japanese government transformed the inevitable post-bubble recession into a "lost decade" of deflation and stagnation.
In May 1989, the government tightened its monetary policies to suppress the rise in value of assets such as land. However, higher interest rates sent stock prices into a downward spiral. By the end of 1990, the Tokyo stock market had fallen 38%, wiping out 300 trillion yen (US $2.07 trillion) in value, and land prices dropped steeply from their speculative peak. This plunge into recession is known as the “bursting” of the “bubble economy.”
The value of real estate and stocks continued to decline in the 1990s. Most households are solvent, due to the traditionally high savings rate of Japan's population. However, a significant share of Japan's industrial and financial firms was heavily burdened by debt, which was often incurred through the purchase of high-priced assets during the bubble period. The assets were worth much less after the bubble burst. The value of the debt fell slowly, in part, because Japan has had very little inflation in its currency and, since 1999, has experienced deflation (falling prices).
The 1990s have been dubbed Japan's "Lost Decade," during which the country's growth in gross domestic product (GDP) averaged a mere 1.6 percent, or less than half the 3.8 percent average of the preceding decade. Japan's growth has been impeded by its inability to recover from massive asset deflation in the wake of the burst economic "bubble" of the early nineties (manifested in numerous non-performing loans) and its failure to reform political, economic and social systems in order to adapt to the changing international economic environment. As is typical of highly regulated economies, the Japanese economy suffered from a serious misallocation of resources, a lack of investment, and a dearth of entrepreneurial innovation.
The collapse of these bubbles wrecked Japanese banks and other depository institutions. Japanese banks and other depository institutions were allowed to invest directly in stocks. The unrealized capital gains on these shares fell from ¥49.1 trillion ($355 billion) in 1989 to ¥5 trillion ($42 billion) in 2001, reducing bank capital. Japanese banks and other depository institutions secured almost all of their commercial and industrial loans through commercial real estate mortgages. As commercial real estate values escalated, credit standards deteriorated. Instead of examining whether non-financial firms could service their loans out of their cash flow from operations, Japanese banks and other depository institutions increasingly relied on rapidly escalating collateral values for repayment. Weak credit standards during the bubble years boosted problem loans and credit losses in Japanese banks and other depository institutions during the lost decade. This weakness in Japanese banks and other depository institutions had especially devastating effects on the non-financial business sector in Japan because Japanese non-financial firms were more dependent on bank loans than their counterparts in the United States and other developed countries during the 1980s.
Despite the adoption of a $172 billion stimulus package in November 1999, the ninth since 1992, Japan's economy had yet to exhibit clear evidence that a sustained recovery is underway. In 1999, the Japanese economy generated a growth rate of only 0.2 percent. Japan's economy continues to be hampered by problems in the financial sector, relatively high unemployment and excessive regulation. In addition, the burgeoning government budget deficit may limit further recourse to fiscal stimulus packages.
In the aftermath of the bursting of Japan’s bubble economy in the 1990s, economic activity languished and consumer price deflation set in. The Bank of Japan’s (BOJ) reduction of its policy rate to zero by 1999 failed to reverse the process. In March 2001, declining consumer prices, a weak banking system, and the prospect of renewed recession following the collapse of the global IT bubble prompted the BOJ to launch “quantitative easing policy,” or QEP.
The QEP consisted of three key elements: (1) The BOJ changed its main operating target from the uncollateralized overnight call rate to the outstanding current account balances (CABs) held by financial institutions at the BOJ (i.e., bank reserves), and ultimately boosted the CAB well in excess of required reserves. (2) The BOJ boosted its purchases of government bonds, including long-term JGBs, and some other assets, in order to help achieve the targeted increases in CABs. (3) The BOJ committed to maintain the QEP until the core CPI (which in Japan is defined to exclude perishables but not energy) stopped declining.
In 2001, Japan entered its third recession in a decade, after a short-lived recovery attempt failed to take hold. Japan's real GDP dropped 1.2 percent during the second quarter of 2001 and fell by another 0.5 percent in the third quarter. In November 2001, the Government of Japan reversed its economic projection for Fiscal Year (FY) 2001 (March 2001-March 2002) from 1.7 percent growth to a contraction of 0.9 percent in terms of real GDP.
After sustaining several consecutive years of growth earlier this decade, the Japanese economy began to slow in line with global economic conditions, and the country fell into its first recession in roughly six years in 2008 as worldwide demand for its goods tumbled. The Bank of Japan reported real GDP growth of -1.8% in FY 2008 and has forecast a decline of 2.0% in 2009.
Most analysts agree that QEP was not very successful in achieving its goal of stimulating aggregate demand sufficiently to eliminate persistent deflation. If the current deflation continued, the cost of past borrowing will grow even larger. For example, 1,000 yen borrowed in 1989 could grow to the equivalent of 1,100 yen by 2012, because the yen was more valuable (within Japan). The BOJ formally ended QEP in March 2006, returning to the overnight call rate as its policy target. It is possible that QEP exerted positive effects, but that these were simply overwhelmed by the drag on aggregate spending coming from severe weakness in the banking sector and balance sheet problems among households and firms.
Japan's government has tried to keep industrial and banking companies from collapsing, with increasing success in recent years. Banks and industrial companies, however, were slow to invest in new projects, and economic growth was meager through 2002. Government attempts to stimulate growth with public-sector spending helped increase the government's accumulated deficits, so that in 2009 public debt amounted to over 185 percent of the value of Japan's GDP. Japan's economy grew in 2003-07 (although deflation persisted), and signs of increased investment encouraged hopes that the growth could be sustained. However, Japan entered a recession in 2008 as a result of the global financial crisis. The recession deepened in 2009, but growth resumed in 2010.
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