Tuesday, October 21, 2008

Japanese Financial Crisis

  • Boom and Bust in Housing Market
  • Boom and Bust in Stock Market
  • Too much bad Lending and Defaulted Debts held by banks
  • Economic Growth Ground to a Halt
Sound familiar?

Actually, this time we are not discussing the current UK / US financial crisis, but, the Japanese crisis which began in 1990 and led to a 'lost decade' - over 10 years of a stagnating economy. On the one hand it is foreboding for what could happen in the West. On the other hand, it could be instructive for what we need to avoid.

Why Japan Experienced Economic Crisis.

  1. Late 1980s, excess liquidity in the financial system caused an asset and stockmarket bubble. People with spare cash bought assets and shares causing them to rise. However, in the last 1980s, the Japanese monetary authorities were worried about inflation and so doubled interest rates. They were then slow to reduce them.
  2. This caused a fall in house and share prices, which lasted 10 years. It is one of the longest bear markets on record.
  3. Higher interest rates and slumping asset values caused an increase in loan defaults.
  4. Loan defaults were compounded because Japanese banks had made a series of bad lending decisions.
  5. The Japanese economic miracle was based on a strong degree of government intervention. IN some respects this worked very well. But, the downside is that the government tried to protect declining, inefficient industries / firms.
  6. When the crisis came, banks were encouraged to continue lending to firms, even if on verge of bankruptcy. In other words, the decision to bailout declining / inefficient firms masked the problem but didn't deal with the underlying issues.
  7. There was a failure to acknowledge the true extent of the problem, hoping asset prices would rebound (they didn't)
  8. Inflation expectations fell to negative. Deflation made normal demand side policies ineffective.

Government / Monetary Authority Response

  • Cut interest rates to 0%
  • Increased government spending to try and increase aggregate demand.
  • There was a reluctance to increase money supply, because even when Japan had deflation, they held an unwarranted fear of inflation.
  • It was not until 2005, that Japan finally managed to have positive inflation expectations through quantitive easing. This led to first periods of real positive growth.

However, these demand side policies failed to stimulate the economy. Because
  • Deflation. With prices falling, people wanted to delay buying. Even 0% interest rates were sufficient to encourage consumers to spend. It was a classic liquidity trap. Deflation also increased the real burden of debt increasing problems for firms, consumers and banks.
  • Government spending poorly targeted.
  • Falling asset prices caused a powerful negative equity effect.
Economic Consequences of Japan's Economic Crisis
  • Long Period of stagnant Growth
  • Rise in Unemployment. Unemployment was almost unheard of in the post war period. The official figure suggests unemployment of 5%. But, this hides a lot of disguised unemployment.
  • Rise in inequality. Issues such as homelessness have become a real problem.
  • National Debt has risen to 180% of GDP.

What Can We Learn from Japanese Crisis?

  • Cutting interest rates and higher government spending are not guaranteed to kickstart an economy if structural problems remain.
  • Asset booms and busts can be very destabilising. But, people and governments tend to ignore them. It is easy to convince ourselves in our case it is not a bubble.
  • Government support for ailing firms often only prolongs the agony.

1 comment:

claire said...

Nice article!
I liked reading it.
Thanks for sharing it.