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Japan’s Bubble Economics 285 Fall 2000 Prof. Michael Smitka Two key causes • Management geared for high growth Interacting with • Macroeconomic policy mistakes As a result... • Interest rates were 0% • Firms overborrowed • Projects that earned a mere 0% passed muster • Banks overlent • Collateral or track records were enough • Asset prices proved unrealistic • Projects didn’t earn 0% ex post • Banks couldn’t collect on their loans Japan’s Case - high-growth underpinnings of a bubble - • Management had no need for financial controls – project selection was easy – failure was hard / recessions were few & far between • But pricing long-lived assets was hard – Real estate grew faster than economy – Stock prices grew faster than economy – Growth industries grew very fast indeed!! Why the “bubble”? - the lending side • Change undermines rules of thumb for banks – Change in types of industry / borrowers – Change in strategic environment / flow of funds – Change in regulatory environment • Mistakes are made … – … and a shock produces crisis Growth Dynamics • Transition out of agriculture – Fast productivity growth in industry – Urbanization! • Household formation • Infrastructure, housing • But it’s a one-time transition! – And eventually ends Slowdown • Industry no longer needs funds • 1970s: 10% of GDP swing in under a decade!! • But households keep saving • Past savings were when incomes were low • So accumulated wealth was modest • So people needed to keep saving to fund old age • Who then will borrow this funds? • Paradox of Thrift!! Shifts in Japanese Savings Flows I (business) 1961-65 17.0 1966-70 16.7 1970 19.6 S (business) S -I 5.2 -11.7 8.7 -8.0 10.7 -8.9 I (household) S (household) S -I 2.8 12.1 9.2 4.3 12.0 7.7 S - I Private -2.5 I (Center S & Local) T -G T -G+S-I 1971-75 15.2 4.0 1976 8.8 1976-80 8.3 2.7 1981-85 8.5 1986-92 11.1 2.3 -8.8 -11.2 0.8 -8 -5.7 2.9 -5.5 4.5 12.8 8.3 4.0 16.4 12.4 7 19.9 12.9 6.1 17.1 11.0 2.8 13.6 10.8 1.3 11.6 10.3 -0.3 -0.6 1.2 4.9 5.3 5.3 1.5 5.5 6.9 1.4 5.7 6.6 0.9 5.7 7.6 1.9 6.9 6.7 -0.2 6.5 2.3 -4.2 7.5 2.4 -5.1 6.8 3.6 -3.2 6.4 8.3 1.9 -1.1 0.6 1.3 1.0 0.7 0.3 2.0 3.4 The Primary Shock 1970 vs 1976 • Corporate investment fell 10% of GDP • Savings rose! • Banks were left to scramble Interregnum • Japanese fiscal deficits – created a new borrower for banks – MOF policy stopped that by 1982 • Reagonomics: US consumption boom – Export-led growth from 1982 – Appreciation / Plaza Accord stopped that from 1986 Secondary Shock • Bad macro policy – Easy money from 1986 – “Japan as Number One” psychology • Just as banks sought new borrowers – Real estate … and more real estate! – Small business – Also international loans Shocks, continued • “Bubble” economy – Stock prices doubled – Urban real estate prices rose even more • Fiscal policy mistakes accentuated – On-again, off-again policy built up debt • Regulatory policy errors accentuated – Banks allowed to make more bad loans Stock market - today’s market is no higher than in 1986!! - Today’s Dilemmas • Monetary policy doesn’t work • Interest rates can’t be pushed below 0% • But prices are falling ==> real rates are positive • Banks (rightly) fear bad assets • Outstanding loans are shrinking! • Money growth is of cash… • “Liquidity Trap” • If monetary policy doesn’t work, how about fiscal?? ZIRP Interest Rates Current lending rates: Short-term prime rate: Long-term prime rate: 1.5% 2.25% Credit Creation & Money Fiscal Policy • Repeated fiscal packages • Short-term policies are discounted by consumers • Higher temporary incomes are counteracted by stagnant consumption • Credibility lost • Permanent tax cuts?? • Huge deficits already - 7% of GDP • Demographic “old age” boom looms • No room left to add fiscal stimulus? Predictions • Japan will underperform growth elsewhere • Safety valve: exports? • Real wages / labor costs remain high • Must have counterpart capital flows • Global capital markets are crippled • Can’t sustain large trade surpluses / capital deficits • Firms engaging in DFI - doesn’t help domestic GDP • J will permanently underperform OECD