We here in Ireland know too well the short term consequences of a spectacular financial boom and bust. In recent weeks we have been led to believe that our economic woes have hit rock bottom and are on the rebound. We have restored competitiveness, ask especially in labour costs, physician and have expanded our export market further. The signs suggest a return to normal economic activity in the medium term.
Japan experienced its very own financial meltdown, following a stock market and real estate bubble bursting in the early 1990s. After the Second World War Japanese politicians put policies in place that coerced the public to save their income. As banks built up large deposits, credit became more readily available and at cheaper prices. Combining cheap money with deregulation and expansionary central bank policies resulted in large capital investment and financial speculation. The “maddening of crowds” became evident as people became over-confident and more bullish in their investment decisions. The bubble reached full volume in December 1989, and popped soon after in 1990.
The aftermath of Japan’s financial collapse has become a textbook topic. The economy has never fully recovered, with many commentators referring to the last 20 years as “Japan’s lost decades”. In the most recent global turmoil, central banks and policy makers have done their upmost to avoid the catastrophic mistakes made by their Japanese counterparts in the 1990s.
In order to curtail the asset price bubble, the central Bank of Japan (BOJ) hiked nominal interest rates in 1989 – which was the first domino in a line leading to financial turmoil. Having increased rates, the BOJ was then reluctant to lower them in response to the collapse of the economy. Keynesian economics suggests that in times of crisis monetary policy should lower interest rates in order to stimulate economic demand. When the BOJ eventually decided to follow this approach, they found that their policy had no effect. According to Paul Krugman, Japan had fallen into a liquidity trap. This occurs when the public saves large amounts of money in fear of deflation or lack of economic demand. It is diagnosed by a combination of near-zero interest rates and ineffective monetary policy – both features were presen
t in the Japanese case.
Alongside the BOJ policy failures, the government continued to prop up insolvent banks with vast amounts of money (sounds similar – right?). With effectively unlimited sovereign financing, the Japanese banks continued to lend at very low rates and did little to deal with their insolvent debtors. Commentators coined the term “zombie bank” to describe this unsustainable business model. While the Irish government bailed out our own banks in 2008, they did so with very clear conditions attached which aimed to restructure troubled loans, provide real economic benefits to the SME sector and wide ranging management changes. Japanese policy makers took 8 years to finally deal with their zombie banks, in a large scale industry consolidation in 1998.
Over the last 20 years Japan has experienced an unusually long period of stagflation – almost constant decreases in prices. The government has built up an enormous level of national debt, reaching 230% of GDP in 2011, with a budget deficit of 9.7% in 2012. Most of this has been financed domestically, utilizing the large stock of private savings. However, with a large ageing population and a desire to return to economic growth, policy makers are desperately trying to revitalise the economy.
In December the country voted in a new Prime Minister, Shinzo Abe, who had signaled a desire for the BOJ to double its inflation target from 1% to 2%. Inflation targeting is a process used by central banks, where they set a target and adjust monetary policy in order to achieve their goal. It is thought to bring economic stability. In Japan’s case it is hoped to end a period of stagnation and lost opportunity.
Alongside this “bold” monetary policy, Abe recently announced a $116bn economic stimulus which “will be the first of a unified policy package” that he promises to “implement strenuously.” The third element of “Abenomics” will come later this year with measures intended to increase Japan’s economic potential, which has diminished by a substantial amount over the last two decades.
Abe and his economic policies have received differing comments in the public media. If they fail, Japan will face an increasing debt burden with no economic green shoots in sight. If Abe succeeds, he may become the final paragraph in the textbook chapter on Japan’s infamous economic woes.
