In the past five years, as the Western world has encountered similar problems that Japan has been dealing with since 1989 (the breakdown of asset prices, a surge in distressed debt and an imminent threat of deflation), the country has provided some valuable lessons on how governments should, and should not, attack systemic financial meltdowns.
Japan, in tandem with all developed nations, slowly underwent a period of deindustrialization and ageing population. Although the Japanese unemployment remains low and standard of living high, the country faces one of the largest debts in history.
After the World War II, Japan was a defeated and destroyed country but, in the following years, a truly “post-war miracle” materialized based on Japan’s economic strengths – a skilled labour force who works in an advanced technological sector and high savings rates.
By the 1970’s, the banking industry began a slow deregulation process. In fact, it is considered that the “Lost Decades” began with the appreciation of the yen that led the Central Bank of Japan (CBJ) to inject liquidity in the economy. Consequently, there was an increase in the stock market (peaking near 40.000 points in 1989), real estate and foreign investment. However, as the price upsurge was deemed too speculative, the government decided to raise interest rates and, consequently, the bubble burst. The stock market crashed 50% in 1991 and the prices of real estate dropped 80% from 1991 to 2000. (Kawai et al., 2010)
During that time, several monetary-policy errors were made. As Ben Bernanke (1999) argued: … the important (…) mistakes were 1) the failure to tighten policy during 1987-89, despite evidence of growing inflationary pressures (…); 2) the apparent attempt to “prick” the stock market bubble in 1989-91, which helped to induce an asset-price crash; and 3) the failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously.
Among the most important lessons apprehended during this time we must highlight the following ones:
- It was a clear demonstration of this time is different syndrome as multiple reasons were presented to try to explain why the Japanese overheating was sustainable: “… conservative fiscal policies, stable exchange rates, high rates of growth and saving, and no remembered history of financial crises.” (Reinhart and Rogoff, 2008)
- It represented paradigm shift away from too-big-to-fail: the demolishment of the myth that bigger institutions would never go bankrupt (Yamaichi Securities, 1997) took a long time and implied perception changes for managers, employees, public authorities and depositors.
- There was a Dilemma from the CBJ to act as a Lender of Last Resort: The lack of a sense of urgency and the fear of inducing instability in the market led the authorities to postpone their reaction.
- As Paul Krugman (1998) stated: To the extent that modern macroeconomists think about liquidity traps (…) their view is basically that the liquidity trap can’t happen, it didn’t happen, and it won’t happen again. But it has (…). Money market rates in Japan have been consistently below 1 percent (…) and the economy, which has been stagnant since 1991, is sliding into recession.
This episode triggered a debate on macroeconomic theory. The Japanese had the misfortune of having to learn through trial and error but, thanks to this precedent, many insights were rapidly put into practice to face the current Crisis in the West. Policymakers decided to provide liquidity to their banks) and to deliver substantial doses of fiscal stimulus to offset the collapse in private demand. And like the CBJ, they cut interest rates and took extraordinary measures to try to preserve credit flowing (QE and LTRO).
A message is common to all economic disasters: don’t be fooled by false signs of recovery. In Japan’s case, such hopes have led it repeatedly to tighten fiscal policy before a sustainable path was reached.
Policymakers on both sides of the Atlantic would do well to learn from the third largest economy in the world. Monetary policies are no easy to manage and will never be the same. While short-term stimulus is important, long-term stagnation is an enemy that should also be fought. (Blanchard, 2013)
Sandra Aranda 611
João Pereira dos Santos 547