Download The Role of the Private Sector in Japan`s Recovery from the Great

The Role of the Private Sector in Japan’s Recovery
from the Great Depression
Changmin Lee
Discussion Paper No. 2013-11
July 1, 2013
Department of Social Engineering
Tokyo Institute of Technology
1
The Role of the Private Sector in Japan’s Recovery
from the Great Depression
Changmin Lee1
July 1, 2013
Abstract
Japanese economic thought includes a long debate on the driving forces behind the country’s early
and rapid recovery from the Great Depression. Most previous studies attribute the Japanese recovery
to expansionary policy measures, but a minority view emphasizes the role of the private sector. This
paper, while considering the contribution of the private sector, reassesses the impact of the policy
measures on real output and, in turn, on the upswing in the 1930s. The analysis reveals that neither
fiscal policy nor monetary policy had a consistent or potent effect on real output but the private
sector, specifically private-sector consumption, accounted for large part of output fluctuations.
However, in contrast to previous studies, the response of export shock on output is unclear. Finally,
the study shows that both fiscal and monetary policies have an indirect effect on output via the
private sector.
Keywors : Great Depression, fiscal policy, monetary policy, private sector
1
Changmin LEE is currently working as an Assistant Professor in the Department of Social
Engineering, Tokyo Institute of Technology (Tokyo Tech.), Tokyo, Japan. He has published several
papers in both international and national journals. His research interests include comparative
economic analysis, economic history and business history.
2
1. Introduction
The purpose of this paper is to identify the crucial elements in Japan’s economic recovery in the
1930s. To put it more concretely, I reassess, from a private sector perspective, the impact of the fiscal
and monetary policies implemented by Korekiyo Takahashi, finance minister of Japan from
December 1931 to February 1936. Previous studies have evaluated Takahashi as a politician who led
Japan’s recovery from the Great Depression2. I intend to offer policy recommendations based on our
findings from an empirical analysis of this historical event.
After the asset price bubble collapsed in the early 1990s, Japan entered a long period of stagnation
referred to as the “lost two decades.” Economic recovery has been a key campaign issue in Japan for
a number of years. The Liberal Democratic Party, which used an economic recovery as an election
slogan, returned to power after winning a clear majority in the lower house general election on
December 6, 2012, after only over three years in the opposition. Shinzo Abe became prime minister
for the second time and promptly initiated bold expansionary policies: targeting a 2% annual
inflation rate, correction of excessive yen appreciation, radical quantitative easing, expansion
of public investment, and construction bond purchases by the Bank of Japan (BOJ). These policy
measures are similar to Takahashi’s remedies in the 1930s3. Immediately after Takahashi was
appointed finance minister, he decided to go off gold; he then pursed expansionary policies such as
fiscal expansion, easy money, and depreciation of the yen. The story of Japan’s recovery from the
Great Depression may provide lessons for the revival of the country’s economy, struggling under a
long stagnation, although.
Opinions vary about the driving force behind Japan’s economic recovery in the 1930s. Some
previous studies have attributed Japan’s recovery to Takahashi’s expansionary policies. However,
this claim is not wholly justified, because the studies utilized long annual time series that included
the last few decades before the 1930s4. Studies based on monthly time series do not seem to have
2
In particular, Korekiyo Takahashi has been overrated a pioneer, ahead of John Maynard Keynes, in
the descriptive analysis of Japanese history. To quote Nanto and Takagi (1985: 374), “The
contribution of fiscal policies, as important as they may be from the point of view of the history of
economic thought in Japan, may well have been given too much credit.”
3
When the so-called Abenomics was launched at the beginning of 2013, it seemed similar to
Takahashi’s policies. In particular, Kikuo Iwata’s appointment as vice president of BOJ was
significant. A famous economist who led the research on the Showa Depression, another name for
the Great Depression in Japan, Iwata is a supporter of bold monetary easing policies to rescue
Japan’s economy from chronic deflation. For more on his ideas, see Iwata (2004).
4
Nanto and Takagi (1985) emphasized the role of the price factor, primarily brought about by
Takahashi’s exchange rate policies, while devaluating the contribution of fiscal policies that may
well have been given too much credit. Yasuba (1988) pointed out that government purchases,
especially military expenditure, was a decisive causal factor in the recovery of the Japanese
economy in the 1930s. Using a vector error correction (VEC) analysis, Hamori and Hamori (2000)
showed that most of the fluctuations in real GNP were independent of money supply, although
money supply and prices affected each other. It follows from what has been said thus far that
3
achieved a consensus on what was the most effective factor. This debate has raised a number of
questions about the impact of policy measures on output and prices. One hypothesis is that fiscal
policy was the most consistent and potent force that aided recovery. Cha (2003) argued that
Takahashi’s spending was indeed crucial in ending the depression quickly 5 . An alternative
hypothesis is that monetary policy was an important component during the upswing. Harada et al.
(2008) suggested that the easy money policy was a key factor because money supply was the
primary shock stimulating output and prices 6 . Finally, some studies hypothesize that Japan’s
recovery was led by the private sector. They suggest that private investment and consumption may
have been the fundamental drivers of Japan’s recovery although this argument is not supported by
appropriate quantitative analysis.7
In this paper, I empirically examine these three hypotheses and reassess the impact of government
policies. The results show that fiscal and monetary policies affect output indirectly through the
private sector but not directly. They also demonstrate that a revival of private investment and
consumption in the early 1930s drove Japan’s economic recovery from the Great Depression.
This paper is organized as follows. Section 2 lays the foundation for further analysis of the
hypotheses mentioned above by providing and overview of the driving forces behind Japan’s
economic recovery in the 1930s. Section 3 describes the data and methodology. The empirical results
based on a vector autoregression (VAR) framework are presented in section 4. Section 5 concludes
the paper.
2. The causes of Japan’s recovery in the 1930s
The Great Depression was the worst economic downturn in U.S. history since 1848 when records
begin. From August 1929 to March 1933 real GDP fell by about 25 percent and nominal GDP by
about 50 percent. During this recession, the price level, measured as the GDP deflator, fell by 25
percent (Hall and Ferguson 1998: 4). The Great Depression caused as much damage to Europe as to
the U.S. However, the Japanese contraction rate during the Great Depression was lower than the U.S.
and even European rates. In fact, Japan’s real GDP showed only a slight decline in 1930-1931,
previous studies attributed Japan’s early and rapid recovery to timely expansionary policies
propelled by finance minister Takahashi, who also decided to take Japan off gold. The above results,
however, are limited by the use of long annual time series.
5
From a Japanese economic history perspective, Hashimoto (1984), Oishi (1987), Nakamura(1989),
and Ide(2006), for example, agreed that Takahashi’s expansionary policy was basically successful.
6
Most of the macroeconomic studies on the Showa Depression, Nakazawa and Harada (2004), and
Umeda (2006), for example, confirm the contribution of an easy money (including foreign exchange
rate) policy, but reject a fiscal role, in Japan’s recovery from the Showa Depression.
7
Sima (1983) insists that Japan’s recovery was led by the private sector. Tominaga (1986, 1987)
also supports the role of the private sector in Japan’s recovery from the Showa Depression of the
1930s.
4
though nominal GDP dropped by 25% from a sharp fall in the price level (Nakamura 1989: 304).
Figure 1 shows that the output index decreased by a much smaller amount than did the price level
during the Great Depression. This is one of the most important features of the Showa Depression8.
More importantly, the fall in price level differed by product type. Textile prices including raw silk
and cotton yarn are easily transmitted from the domestic and overseas markets. Likewise, metal
product and construction material prices slumped quickly from capital investment effects, whereas
the fall in food product and fuel prices was relatively low9. During the stagnation of the 1920s and
the Great Depression in 1930-1931, some commodities such as textiles and metal products led the
decline in price level, whereas output in real terms did not change significantly. In the upswing from
1932, however, both output and prices escalated simultaneously and quickly. The depression was of
shorter duration in Japan than in other countries, and the subsequent growth of the Japanese
economy was unusually rapid (Cha 2003: 127). What was the driving force behind the fast recovery
of the Japanese economy from the Great Depression? Which of the policies made the biggest
difference?
According to the gold-standard theory as proposed by Barry Eichengreen and Peter Temin (2003),
both the severity of the Great Depression and the vigor of the recovery depended on how early a
country abandoned the gold standard10. As long as the gold convertibility of a currency remained the
predominant policy, the room for bold reflationary measures was severely limited. Therefore, the
earlier the departure from the gold standard, the faster was the recovery likely to be. There was
already wide speculation that Japan would go off gold when Britain did so in September 1931. The
newly appointed finance minister Takahashi’s decision came at the end of the year11. Japan left the
gold standard in 1931, and its growth resumed in 1932. The U.S. and France, which maintained the
gold standard, had to wait until 1933 or more to see production and prices rebound.
Having decided to go off gold, Takahashi pursued highly expansionary policies: fiscal expansion,
easy money, and the yen’s depreciation. In adverse international circumstances that the world has
ever seen, Japan executed one of the most successful strategies: a combination of fiscal, monetary,
and foreign exchange rate policies (Patrick 1971: 256). However, there is very little agreement on
which of the policy measures was the most effective. Using a structural VAR analysis and a monthly
time series, Cha (2003) revived this controversy. He argued that early departure from the gold
standard explains only part of the Japanese recovery. He evaluated and measured the impact of
8
For a general overview of the international comparison of the damage during the Great Depression,
see Bernanke (2000).
9
Although the agricultural sector suffered from an agricultural depression in the late 1920s, hardly
any agricultural prices declined almost since autumn 1930. In the wake of a good harvest in autumn
1930, however, the agricultural depression aggravated rapidly.
10
See Temin (1989), Eichengreen (1992), and Eichengreen and Temin (2003).
11
For a specific discussion of inflation expectations brought about by the departure from the gold
standard, see Shibamoto and Sizume (2011).
5
policy measures, properly controlling for other shocks, and contended that Takahashi’s fiscal policy
was indeed crucial in ending the depression quickly. Actually, Takahashi proposed an expansionary
budget involving military spending and civil engineering expenditure for rural rescue. Government
spending moved upward to 2.1 billion yen in 1932 and 2.3 billion yen in 1933, and then, was
sustained at approximately 2.2 billion yen until 1936. For fiscal expansion, he avoided a tax increase
and instead selected public debt underwritten by the BOJ12.
However, many macroeconomic studies on the Showa Depression, while basically agreeing with
the impact of going off gold, have supported monetary policy rather than fiscal policy. According to
Hori (2002), it was nothing but monetary policy neither fiscal policy nor an increase in exports that
drove Japan’s recovery in the 1930s. Follow-up studies have clarified that monetary policy, and not
fiscal expansion, was indeed crucial factor with respect to both output and prices (Nakazawa and
Harada 2004; Umeda 2006; Harada et al. 2008). However, they concede that the increase in export
and price levels induced by the yen’s depreciation also contributed to Japan’s recovery after the
Great Depression. Contrary to Cha’s view, which emphasized the role of fiscal policy in saving
Japan from the recession, they argued that Japan’s recovery was mainly led by monetary policy and
partly by exchange rate policy.
Incidentally, the macroeconomic effects of the yen’s depreciation need to be interpreted. The
currency depreciation resulting from gold standard abandonment has been directly linked to the
increase in exports. Usually, two effects follow a depreciation of the yen. First, the weak yen leads to
a price increase. Shibamoto and Shizume (2011) argued that, overall, changes in the exchange rate
played the most important role in Japan’s economic recovery of the early 1930s. During the second
half of 1931, speculation about Japan’s break from gold and the inflation likely to follow reversed
public expectation from deflation to inflation well ahead of the actual abandonment in December
1931. Although I agree that currency depreciation led to inflation, the question whether exchange
rate was the most crucial factor in Japan’s recovery requires further discussion.
Second, a fall in the exchange rate of the yen could stimulate exports. Nakamura (1983) argued that
currency devaluation by almost 40% spurred Japanese exports. Most conventional research in
Japanese economic history has emphasized the role of exports in lifting the economy out of the Great
Depression13. Actually, when Japan went off gold and the exchange rate subsequently fell, demand
for Japanese goods perked up in some countries. However, it seems that the increase in exports from
the yen’s depreciation is not clearer than the inflation response. Table 1 shows that the largest
12
Cha’s view corresponds to the Keynesian remedies. Keynesian economics suggests increasing
government spending and decreasing tax rates are the best ways to stimulate aggregate demand, as
well as decreasing spending and increasing taxes after the economic boom begins. Keynesians
propose this method as an essential tool to build the framework for strong economic growth and
work towards full employment in times of recession or low economic activity.
13
See Hashimoto (1984), Oishi (1987), Nakamura and Odaka (1989), and Ide (2006).
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percentage of exports during the upswing phase from 1929 to 1937 is attributed to Asia rather than
North America and Europe. Japanese colonies in Asia, which used the currency linked by Japanese
yen, and China, which adopted the silver standard, were hardly affected by the gold standard. Unlike
in the western countries, export recovery in Japan in the 1930s was not due to changes in the yen
exchange rate but to the increase in exports to the colonies and semi-colonies (Iwami et al. 1998;
Okura and Teranishi 1994). For this reason, I directly use an export series, instead of an exchange
rate series, to properly control for export shock.
As stated above, most previous research focuses on the policy measures of fiscal expansion, easy
money, the yen’s depreciation, or a combination of the three, but some studies argue that the
recovery was initiated by the private sector14. They attribute Japan’s recovery to private investment
and consumption demand. In fact, a significant amount of Japanese economic thought suggests the
likelihood of domestic demand-led recovery. Table 2 shows that consumption- and
investment-induced effects on aggregate demand are even larger than those of government spending.
At lease from 1933, it was private sector revival that drove the recovery of the Japanese economy
(Hashimoto 1984: 204).
Since the 1920s, the private sector has played a leading role in the Japanese economy.
After
World War I, Japan economy converted from an export-driven economy, which achieved rapid
growth during the wartime period, into a domestic demand-led economy. Although capital
investment was stagnant in the 1920s, consumption growth was sustained. At least in the mid-1920s,
increase in consumption played a significant role creating business cycles at least (Takeda 1983:
350). The import substitution industry, such as machine tools, railway vehicles, and generators,
began to grow, and the industrial structure, centered on light industries, notably textiles, changed into
one led by heavy and chemical industries, for example, iron and steel, chemicals, and machinery.
These industries were intrinsically driven by domestic rather than export demand. The growth in
domestic demand was accompanied by urbanization during the interwar period with the increase in
population. As a result, about one-third of the population came to live in cities in the 1930s15. When
urban residents gradually spread to the suburbs with the growth in population, private railway
companies, with department stores located in their terminals, connected the suburbs with the large
cities for commuters16. The resultant lifestyle changes led to the emergence of a mass consumption
society in the 1930s (Nakamura and Odaka 1989: 64).
During the upswing in the 1930s, private consumption powered the Japanese economy with vigor
and vitality to recover from the chronic recession. Although real wage increase slowed down to a
crawl, unemployment shrank, and farm incomes gained momentum quickly (Shima 1983: 110). The
14
See Sima (1983) and Tominaga (1986, 1987).
Urbanization was triggered by the electrification of cities, which began with the construction of a
large hydroelectric power plant in the central mountainous area.
16
See chapters 3 and 4 of Wakuda (1981).
15
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prospects of higher income led to an increase in private consumption. Furthermore, the expansion of
private consumption fueled domestic demand for durable and intermediate goods, promoting the
growth of heavy and chemical industries in tune with increasing private investment. The monthly
issuance of bonds and stocks began to rise from 1932, and was sustained at a high level of 200
million yen or more in 1933-1934 17 . In contrast to large industries, small and medium-sized
industries showed more than three-fold output increases between 1929 and 1936 in a variety of
products such as sewing machines, gramophones, and radios (Nakamura and Odaka 1989: 62).
Recovery of private consumption, which stimulated an increase in investment, lifted the Japanese
economy out of the Great Depression in the 1930s.
3. Data and methodology
3.1. Variables and Data Sources
I conducted a VAR analysis with eight variables: Spending, Public debt, Money, Bank rate, Export,
Investment, Consumption, and Output. I used monthly time series data, for the sample period:
January 1929 to December 1936 18 . All series except Bank rate were seasonally adjusted by
X12-ARIMA and log-transformed before estimation. The Spending and Public debt series represent
fiscal policy and the Money and Bank rate series stand for monetary policy19. Variable definition and
data sources are as follows:
1. Spending. Spending is calculated by deflating nominal expenditure on the general account of the
central government with the wholesale price index. Nominal expenditure and the wholesale price
index are available from the Annual Report of the Ministry of Finance (Ōkurashō Nenpō) and the
Wholesale Price Index of the BOJ (Orosiuri bukka sisu), respectively.
17
Nissan Zaibatu, for example, benefited from this situation, developing into a holding company in
a short time. Nissan began to expand its dominance such that it obtained a large percentage of the
shares of a company struggling under depression.
18
Whereas Cha (2003) selected from January 1929 to September 1936 as the sample period, Harada
et al. (2008) used an extended sample period from May 1926 to December 1936 (the spending series
started from February 1926). I selected the sample period for this study following Cha, considering
this paper’s focus on the recovery process of the 1930s.
19
Cha (2003) derived nominal deficits by deducting monthly revenue from spending and then
adding net monthly public debt accumulation. However, Nakazawa and Harada (2004) opposed this
methodology. They argued that public debt accumulation encompasses the effect of not only
expansionary policies but also easy money generated by the central bank. Furthermore, they
suggested that government spending is better than public debt accumulation to properly express the
stance of government fiscal policy. This paper utilizes both, spending and public debt. According to
one view, M2 is not a policy variable, because it cannot be controlled directly. However, Harada and
Sato (2007) and Naito (2008) clarified that M2 could be controlled in the 1930s through a check on
high-powered money. This paper utilized both M2 and the official discount rate of the BOJ to denote
monetary policy.
8
2. Public debt. Public debt is public debt accumulation, categorized into domestic debt and foreign
debt. Public debt is calculated by dividing the nominal debt from the Annual Report of the
Ministry of Finance (Kokusai tōkei nenpō) by the wholesale price index from the Wholesale
Price Index of the BOJ.
3. Money. Money refers to the amount of money supply (M2), including an outside bank checking
account, a special checking account, a deposit at notice, a separate deposit, an endorsed bill, and
cash out of the bank. The Money series is available from the Economic Index (Keiki Sisu) edited
by Fujino and Igarashi20.
4. Bank rate. Bank rate is the official discount rate of the BOJ, which is available from Japanese
Money Supply (Nihon no Mane Sapurai) edited by Fujino.
5. Export. Export is calculated by deflating nominal export with the wholesale price index, which is
available from the Annual Report of the Ministry of Finance.
6. Investment. Investment is derived from the sum of stocks and bonds, available from the Oriental
Economic Year Book (Tōyōkeizai Keizai Nenkan). As a measure of the level of private
investment, I used newly issued stocks and corporate bonds divided by the wholesale price
index.
7. Consumption. I use the amount of railway passenger fares as an alternative series of
consumption, because no monthly series of consumption is available. I could confirm a
co-movement relationship between the monthly series of railway passenger fares and the annual
series of total consumption. The series of railway passenger fares is available from Reference
Financial Matters of the Bank of Japan (Kinyū Jikō Sankōsho) and is deflated with the wholesale
price index.
8. Output. Output refers to the production index which is available from the Oriental Economic
Year Book21.
3.2. Stationarity Test
To estimate a VAR model, each variable has to be checked for a stationary condition by the unit
root test. Three types of analyses are performed: one with nothing included, another with an
intercept term, and a third with an intercept term and a time trend. I performed the augmented
Dickey-Fuller (ADF) test and the Phillips-Perron (PP) test on the three types, and obtained the same
results.
20
The September 1932 value (4.7 billion yen) in Fujino and Igarashi’s series appears abnormal. It
seems to be a clerical error for 37 billion yen, considering the August and September values in the
same year.
21
The June 1928 value in the Oriental Economic Year Book is 79.2, but it seems to be a clerical
error, considering that the May and July 1928 value are 100.5 and 100.7, respectively. Additionally,
there was no remarkable macro shock in June 1928. Therefore, I used the average of the May and
July values for June 1928.
9
The results of the stationarity tests reported in Tables 3 and 4 show that Money, Bank rate, Export,
Consumption, and Output are non-stationary in levels, whereas Spending, Public debt, Investment
are stationary series at the level. Having found that some of the variables are not stationary at the
level, the next step is to conduct the unit root test at the first difference. The results of stationarity
tests in first differences based on the ADF and the PP tests are also reported in Tables 3 and 4. As is
clear from these tables, it is found that all variables except Spending, Public debt and Investment
which are stationary series in levels, included the unit root at the level but not at the first difference.
In this study, I used the time series data of Spending, Public debt and Investment at the level, and
those of Money, Bank rate, Export, Consumption, and Output at the first difference for a VAR
analysis.
3.3. VAR Model
To empirically examine the three hypotheses and reassess the impact of government policy, I
construct four models: two models to measure the effect of fiscal policy (𝐺) and two models for
monetary policy (𝑀). Model 1, measuring fiscal policy effects, has five components: Spending (𝐺),
Export (𝑋), Investment (𝐼), Consumption (𝐶), and Output (𝑌). Model 2, which also represents the
fiscal expansion effects, encompasses the following five components: Public debt (𝐺), Export (𝑋),
Investment (𝐼), Consumption (𝐶), and Output (𝑌). On the other hand, Models 3 and 4 are designed to
measure monetary policy effects. Model 3 has five components: Money (𝑀), Export (𝑋), Investment
(𝐼), Consumption (𝐶), and Output (𝑌), whereas Model 4 includes Bank rate (𝑀), Investment (𝐼),
Consumption (𝐶), and Output (𝑌)22.
To analyze the dynamic impact of random disturbances on the system of variables, I construct a
five-variable VAR model expressed as
𝐵𝑍𝑡 = 𝛤1 𝑍𝑡−1 + 𝛤2 𝑍𝑡−2 + ⋯ + 𝛤𝑝 𝑍𝑡−𝑝 + 𝑒𝑡
𝑒𝑡 ~𝑖𝑖𝑑𝑁(0, 𝐼𝑛 )
(1)
where 𝑍𝑡 = [𝐺𝑡 , 𝑋𝑡 , 𝐼𝑡 , 𝐶𝑡 , 𝑌𝑡 ]′ (or [𝑀𝑡 , 𝑋𝑡 , 𝐼𝑡 , 𝐶𝑡 , 𝑌𝑡 ]′) is a five-by-one matrix, 𝐵 is a five-by-five
coefficient matrix, and 𝑒𝑡 = [𝑒𝐺𝑡 , 𝑒𝑋𝑡 , 𝑒𝐼𝑡 , 𝑒𝐶𝑡 , 𝑒𝑌𝑡 ]′ (or [𝑒𝑀𝑡 , 𝑒𝑋𝑡 , 𝑒𝐼𝑡 , 𝑒𝐶𝑡 , 𝑒𝑌𝑡 ]′) is a five-by-one
vector representing contemporaneously uncorrelated structural shock. This structural model can be
transformed to a reduced form VAR.
𝑍𝑡 = 𝐵−1 𝛤1 𝑍𝑡−1 + 𝐵−1 𝛤2 𝑍𝑡−2 + ⋯ + 𝐵−1 𝛤𝑝 𝑍𝑡−𝑝 + 𝐵−1 𝑒𝑡
(2)
𝑍𝑡 = 𝛷1 𝑍𝑡−1 + 𝛷2 𝑍𝑡−2 + ⋯ + 𝛷𝑝 𝑍𝑡−𝑝 + 𝑢𝑡
(3)
22
𝑢𝑡 ~𝑖𝑖𝑑𝑁(0, 𝛺)
Money supply has been used as an indicator of monetary policy in the previous study; however,
one might find dubious the claim that the monetary base is endogenously determined by demand for
money of private banks, enterprises and households. Meanwhile, Bank rate is considered as an
exogenous indicator of monetary policy in prewar Japan.
10
where 𝑍𝑡 = [𝐺𝑡 , 𝑋𝑡 , 𝐼𝑡 , 𝐶𝑡 , 𝑌𝑡 ]′ (or [𝑀𝑡 , 𝑋𝑡 , 𝐼𝑡 , 𝐶𝑡 , 𝑌𝑡 ]′) is a five-by-one matrix, Φ is a five-by-five
coefficient matrix, and 𝑢𝑡 = [𝑢𝐺𝑡 , 𝑢𝑋𝑡 , 𝑢𝐼𝑡 , 𝑢𝐶𝑡 , 𝑢𝑌𝑡 ]′ (or [𝑢𝑀𝑡 , 𝑢𝑋𝑡 , 𝑢𝐼𝑡 , 𝑢𝐶𝑡 , 𝑢𝑌𝑡 ]′) is a five-by-one
′
vector that represents the reduced-form shock with zero mean and a covariance of Ω(= 𝐵−1 𝐵−1 ). I
provided the policy variables (Spending, Public debt, Money, and Bank rate) first because the
government determined the policy measures independently. Then, I placed the variables in the
following order: Export, Investment, Consumption, and Output. Finally, I confirmed that the changes
in the order of variables between policy variables and Output do not alter the regression results. The
Akaike information criterion (AIC) and the Schwarz information criterion (SIC) indicated that two
lags were optimal. However, I added three more lags to the AIC and SIC results23.
4. Analysis results
4.1 Impulse Responses
Not only dose a shock to the i-th variable directly affect the i-th variable, but it is also transmitted
to all of the other endogenous variables through the dynamic lag structure of the VAR. An impulse
response function traces the effect of a one-time shock to one of the innovations on current and
future value of the endogenous variables.
Impulse responses for fiscal policy are reported in Figures 2 and 3, and monetary policy in Figures
4 and 5. The solid lines are impulse responses to one standard deviation shock and the dotted lines
represent 95% confidence bands. The row variables indicate their one standard deviation shock, and
the column variables refer to the accumulated responses to Cholesky one standard deviation shock.
For example, the leftmost column in Figure 2 respectively indicates the accumulated responses of
Spending, Export, Investment, Consumption, and Output to the Spending shock.
First, I consider the results of fiscal policy shock. The bottom row in Figure 2 shows the response
of the five variables’ shock on Output. The Spending shock on Output has no effect at a significant
level. Export shock and Investment shock could not show significant results, either, though their
effects are positive. In contrast, Consumption shock on Output has a positive impact at the 5%
significant level. As shown in the leftmost column, the Spending shock on Export, Investment and
Consumption are positive, though at a significance less than 5%.
Now I will focus on another indicator of fiscal policy, Public debt. The bottom row in Figure 3
shows the impact of shocks on Output. Even though the sign of the response of Public debt shock to
Output is positive, the significance level is less than 5%. Furthermore, the effects of Export shock
23
Pantula et al. (1994) recommended a longer lag for monthly time series data. Moreover, citing
Pantula et al. (1994), Harada et al. (2008) added three more lags to their AIC and SIC results. This
paper follows their method.
11
and Investment shock to Output have unclear signs and low significance levels. The response of
Consumption shock on Output is clearly positive and statistically significant at the 5% level. Fiscal
shock was not a potent or direct force for Japan’s recovery, but might well have played an indirect
role through Investment and Consumption in the private sector. The leftmost column in Figure 3
shows that Public debt shocks on Investment and Consumption have a positive impact and are
statistically significant at the 5% level24.
Second, consider the results of the monetary policy shock. The bottom row in Figure 4 shows the
accumulated responses of Money supply shock, Export shock, Investment shock, Consumption
shock, and Output shock, respectively, on Output. Money supply shock on Output is positive, but has
no effect at a significant level. Export shock and Investment shock could not yield significant results,
either, though the signs of their response were positive. Of particular importance in the response of
Consumption shock, which has a positive effect on Output at the 5% significance level. Money
supply by the BOJ, it turned out, was not the sure and fundamental cause of Japan’s recovery, though
we must remind ourselves that fiscal shocks played an indirect role via the private sector in upswing
phase. As shown in the leftmost column in Figure 4, Money supply shocks on Investment and
Consumption are positive and statistically significant at the 5% level. In contrary to the fiscal shocks,
Money supply shock on Export is positive and statistically significant.
Having clarified the responses of Money supply shock, I will now focus on Bank rate shock,
another indicator of monetary policy. The bottom row in Figure 5 shows the impact of shocks on
Output. The response of Bank rate shock on Output is negative, and significant at less than 5%. An
inverse relationship between the interest rate and real output is consistent with the general economic
theory. Export shock has a negative, and Investment shock a positive effect on Output. However, the
significance levels of both are less than 5%. As with the previous case, the response of Consumption
shock on Output is clearly positive and statistically significant at the 5% level. As with fiscal policy,
Bank rate shock may have played an indirect role via Investment and Consumption. The leftmost
column in Figure 5 shows that Bank rate shock on Investment and Consumption have a negative
impact at the 5% significance level25.
24
In general economic theory, crowding out is posited to occur when increased government
borrowing, a kind of expansionary fiscal policy, reduces investment spending. The increased
borrowing crowds out private investment. However, I can confirm that Public debt shocks on
Investment have a positive impact in Figure 3. Originally, crowding out was related to an increase in
interest rates resulting from the borrowing, but private investment could increase in the 1930s
because of a low interest rate policy.
25
The break from gold in December 1931 might have affected Japan’s economy regardless of fiscal
and monetary policy. The assassination of Korekiyo Takahashi on February 26 might also have had
an impact. Therefore, I consider a dummy variable that equals 1 if the sample period is from
December 1931 to January 1932 and 0 otherwise, as well as a dummy variable that equals 1 if the
sample period is from February 1936 to March 1936 and 0 otherwise. I confirmed that including
dummy variables in the model did not alter the regression results.
12
Additionally, to examine the robustness of the VAR model, I estimated Model 5 using the real
effective exchange rate (REER) instead of Export and Model 6, a six-variable VAR, using REER and
the whole-sale price index (WPI) instead of Output. Under the alternative settings of Model 5, the
Consumption shock and REER shock on Output yield significant results. Even excluding the impact
of the increase in exports from the yen’s depreciation, I could confirm that the depreciation affected
economic recovery, simultaneously initiated by the private sector, in the 1930s. This result is
consistent with Shibamoto and Sizume (2011)26. I also confirmed that the response of the REER and
monetary policy shocks on WPI, in Model 6, was statistically significant at the 5% level. Here, the
private sector’s impact on prices was significant as usual. Finally, I set the starting point of the
sample period in January 1926. The extended sample period yields the same results.
4.2. Variance decomposition
While impulse response functions trace the effects of a shock to one endogenous variable onto the
other variables in the VAR, variance decomposition separates the variation in an endogenous
variable into its component shocks to the VAR. Thus, variance decomposition provides information
on the relative importance of each random innovation in affecting the variables in the VAR. Let us
attempt to compare the impulse response and variance decomposition results to confirm the role of
the private sector in Japan’s economic recovery in the 1930s.
Table 5 summarizes the results of variance decomposition. The numbers are the percentages of the
impact of shocks on output for each horizon. Models 1 and 2 show that fiscal policy shock
respectively explains 9.0% and 14.1% of the fluctuations in output after 24 months. Export shock
has only a slight impact on real output in Models 1 and 2. Most important, I find that the
private-sector shocks explain a large part of output fluctuations. The contribution of private-sector
shocks to the upturn in real output after 24 months was about 28.8% in Model 1 and 19.6% in Model
2.
As shown in the lower part of Table 5, Models 3 and 4 indicate the impact of monetary policy
shock to real output for each horizon. I find that monetary policy shock explains only 6.6% in Model
3 and 2.9% in Model 4 after 24 months. The contribution of export shock to output in the upswing
phase is less than 4% in both models. A large part of the fluctuations in real output is explained by
private-sector shocks, similar to the results of Models 1 and 2. The impact of private-sector shocks to
real output is around 25%. From these results in Table 5, I confirmed that, relative to the contribution
of policy measures, the private sector’s impact on real output was significant. Furthermore, export
shock had the lowest impact in all cases. Overall, the results indicate that the revival of private
26
Eichengreen and Temin (2003) contended that the abandonment of the gold standard was crucial
for the economic recovery of the 1930s. Shibamoto and Sizume (2011) showed that inflation
expectations played a significant role in the dynamics at work.
13
consumption and an increase in investments stimulated the Japanese economy in the 1930s.
5. Conclusions
The literature on the Japanese economic recovery after the Great Depression forms three strands of
research. The first emphasizes the role of Takahashi’s deficit spending. The second strand sheds light
on the monetary policy effects. The third concerns the role of the private sector, which has not been
properly investigated so far, although often mentioned as a minority opinion in conventional studies.
While considering the contribution of the private sector, this paper reassesses the link between the
policy measures and their effect on output and, in turn, the recovery phase of the 1930s. It shows that
neither fiscal policy nor monetary policy had a consistent or potent effect on output but the private
sector, notably consumption, accounted for a large part of output fluctuations in Japan. The study
also points out that the response of export shock on output is unclear unlike the conventional
studies27. Finally, it shows that both fiscal and monetary policies have indirect effect on output via
the private sector.
These findings have implications for the general debate on the driving forces behind the Japanese
recovery in the 1930s. A key conclusion is that the recovery was initiated by the private sector and
driven by the pump-priming effect of policy measures. The Japanese lifestyle has significantly
changed over the years with the increase in urbanization since the 1920s due to population growth.
This led to the emergence of a mass consumption society in the 1930s. The resultant increase in
private expenditure on consumer goods, leading to expansion in the volume of money in circulation
drove the Japanese economic recovery after the Great Depression.
27
A common belief is that exports had a positive effect on the economy in the 1930s. Although I
failed to recognize a significantly positive effect from an increase in exports, I found an inflation
effect induced by the yen’s depreciation in an additional test. Of course, this needs to be verified
further.
14
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17
Figure 1. Comparison of output and prices during the Great Depression
Output index
Wholesale price
Notes: Both time series are log-transformed.
Table 1. Export percentage for each destination
Year
1910
1920
1929
1937
1940
Asia
0.41
0.51
0.43
0.52
0.68
North America
0.32
0.30
0.44
0.22
0.17
Europe
0.24
0.10
0.07
0.11
0.05
Other
0.03
0.08
0.06
0.14
0.09
Source: Meiji ikō honpō shuyō keizai tōkei (1996: 290-296)
Table 2. Inducing effects of aggregate demand on GDP (at 1931-1936 prices, in millions of yen)
Consumption
Private investment
Government spending
Export
Import substitution consumption
An increase in aggregate demand
1,663
1,157
501
2,067
235
Inducing effects of aggregate demand
3,181
3,026
974
4,585
551
Source: Tominaga (1986: 328)
Table 3. Augmented Dickey-Fuller test
Intercept
Trend and Intercept
None
Spending
-2.64(2) *
-9.57(0)***
0.87(4)
***
Public debt
-2.30(4)
-7.72(0)
0.71(4)
Money
-0.18(0)
-0.14(0)
0.88(0)
∆
-11.56(0)***
-11.3(0)***
-11.55(0)***
Bank rate
-1.50(1)
-2.37(1)
-2.16(1)**
***
***
-9.28(0)
-9.27(0)
-9.00(0)***
∆
Export
-1.09(0)
-1.45(0)
0.42(0)
-13.19(0)***
-13.40(0)***
-13.23(0)***
∆
**
*
Investment
-3.17(1)
-3.36(1)
0.07(2)
Consumption
-0.09(2)
-0.31(2)
1.01(2)
∆
-12.09(1)***
-12.25(1)***
-12.04(1)***
Output
0.84(0)
-1.47(0)
3.82(0)
∆
-12.45(0)***
-12.67(0)***
-2.29(0)**
Note: The figures in parentheses are lag lengths based on the Schwarz information criterion.
18
Table 4. Phillips-Perron Test
Intercept
Trend and Intercept
None
Spending
-5.49(6)***
-9.84(5)***
1.70(36)
***
Public debt
-5.96(4)
-7.82(3)***
0.73(21)
Money
-0.42(6)
-0.29(6)
0.80(6)
-11.63(6)***
-11.85(6)***
-11.63(6)***
∆
Bank rate
-1.42(5)
-2.43(5)
-2.07(5)**
***
***
-9.39(3)
-9.38(3)
-9.21(4)***
∆
Export
-0.84(3)
-1.12(5)
0.52(6)
-13.25(4)***
-13.62(6)***
-13.28(4)***
∆
***
***
Investment
-4.86(6)
-5.13(6)
0.22(18)
Consumption
-1.15(1)
-1.77(0)
0.81(8)
-17.66(2)***
-18.18(4)***
-16.85(1)***
∆
Output
1.17(3)
-1.47(0)
4.00(1)
∆
-12.54(2)***
-12.68(1)***
-11.44(6)***
Notes: The figures in parentheses are Newey-West bandwidths according to Bartlett Kernel.
Table 5. Variance Decomposition
Model 1
Horizon
6months
12months
18months
24months
Fiscal
Policy
9.40%
9.05%
9.19%
8.98%
Exports
2.90%
4.83%
7.79%
8.74%
Model 2
Private
sector
20.55%
27.98%
28.54%
28.77%
Fiscal
Policy
13.14%
13.60%
14.11%
14.05%
Private
sector
19.99%
24.17%
25.12%
25.32%
Monetary
Policy
2.03%
3.12%
2.97%
2.94%
Model 3
Horizon
6months
12months
18months
24months
Monetary
Policy
5.08%
6.23%
6.71%
6.62%
Exports
2.20%
2.40%
3.34%
3.74%
Exports
1.68%
4.33%
5.14%
5.37%
Private
sector
12.24%
18.69%
19.51%
19.60%
Model 4
Note: The private sector consists of Consumption and Investment.
19
Exports
2.54%
2.86%
3.90%
3.98%
Private
sector
19.66%
24.02%
25.36%
25.83%
Figure 2. Impulse Responses (Model 1)
20
Figure 3. Impulse Responses (Model 2)
21
Figure 4. Impulse Responses (Model 3)
22
Figure 5. Impulse Responses (Model 4)
23