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Japan’s 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

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Japan’s Bubble

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  1. Japan’s Bubble Economics 285 Fall 2000 Prof. Michael Smitka

  2. Two key causes • Management geared for high growthInteracting with • Macroeconomic policy mistakes

  3. 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

  4. 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!!

  5. 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

  6. 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

  7. 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!!

  8. Shifts in Japanese Savings Flows

  9. The Primary Shock1970 vs 1976 • Corporate investment fell 10% of GDP • Savings rose! • Banks were left to scramble

  10. 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

  11. 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

  12. 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

  13. Stock market- today’s market is no higher than in 1986!! -

  14. 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??

  15. ZIRP

  16. Interest Rates Current lending rates: Short-term prime rate: 1.5% Long-term prime rate: 2.25%

  17. Credit Creation & Money

  18. 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?

  19. 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

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