Download Bubble

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