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New Paradigm in Macroeconomics Solving the Riddle of Japanese Macroeconomic Performance New Paradigm in Macroeconomics Solving the Riddle of Japanese Macroeconomic Performance Richard A. Werner New Paradigm in Macroeconomics “an ambitious attempt to shape the terms of the economic debate over Japan’s decade-long post-bubble economic stagnation.” William Grimes, Boston University “What a wonderful read! ... Werner develops a simple and elegant model based on empirical observations but sufficiently abstract, and one that stands up to empirical testing impressively well. The potential implications are huge. His findings have become influential with those interested in the real world of (Japanese) finance.” Dirk Bezemer, Imperial College, University of London “Werner has done an excellent job of showing the difficulties and conundrums faced by neoclassical theory when confronted with Japan’s recent (and older) performance ... Werner’s analysis of banking and credit-money creation, in particular, offers new insights into the enigmas of Japanese capitalism. This is a book that will be read by many more than Japan specialists.” Costas Lapavitsas, SOAS, University of London Also by Richard Werner: PRINCES OF THE YEN, JAPAN’S CENTRAL BANKERS AND THE TRANSFORMATION OF THE ECONOMY New Paradigm in Macroeconomics Solving the Riddle of Japanese Macroeconomic Performance Richard A. Werner © Richard A. Werner 2005 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published in 2005 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world. PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 978-1-4039-2074-4 ISBN 978-0-230-50607-7 (eBook) DOI 10.1057/9780230506077 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Werner, Richard, 1967– New paradigm in macroeconomics : solving the riddle of Japanese macroeconomic performance / Richard A. Werner. p. cm. Includes bibliographical references and index. ISBN 978-1–4039–2073–7 (cloth)—ISBN 978-1–4039–2074–5 (paper) 1. Japan – Economic conditions – 1989– 2. Neoclassical school of economics. 3. Macroeconomics. I. Title. HC462.95. W47 2004 339Ј.0952—dc22 2004058396 10987654321 14 13 12 11 10 09 08 07 06 05 Contents Acknowledgements vii List of Tables and Figures ix List of Abbreviations and Acronyms xii Part I Introduction 1 Prologue: Searching for a New Kind of Economics 3 1 Japanese Economic Performance During the 1990s 29 Part II Enigmas: Challenges to the Traditional Paradigm 35 2 The Enigma of the Ineffectiveness of Fiscal Policy in the 1990s 37 3 The Enigma of the Ineffectiveness of Interest Rate Policy in the 1990s 49 4 The Enigma of Japan’s Long Recession 78 5 The Enigma of the Ineffectiveness of Structural Policy 91 6 The Enigma of Economic Growth 103 7 The Enigma of the Velocity Decline 114 8 The Enigma of Japanese Asset Prices 134 9 The Enigma of Japanese Capital Flows in the 1980s 139 10 The Enigma of Japanese Bank Lending 143 11 The Enigma of Banking and its Recurring Crises 149 Part III Explanations: Applying the New Paradigm 155 12 Solving the Enigma of Banking and Money 161 13 Credit, Money and the Economy 181 14 Explaining the Velocity Decline 201 15 The Determinants of Growth 207 v vi Contents 16 The Cause of the Asset Price Bubbles and Banking Crises 226 17 The Determinants of Japanese Capital Flows in the 1980s 238 18 Why Fiscal Policy Could Not Work 246 19 Monetary Policy in the 1990s and How to Create a Recovery 261 20 Monetary Policy in the 1980s: How Bank Credit was Determined 267 Part IV The Goal of Macroeconomic Policy 295 21 Banking Reform 297 22 The Goal of Fiscal, Structural and Monetary Policy 307 23 A New Kind of Economics 321 24 A New Vision of Macroeconomic Policy 336 Notes 342 Bibliography 381 Index of Authors 411 Index of Subjects 414 Acknowledgements I am grateful for the generous advice and support I received during the lengthy gestation period of this book. I have received much advice from my thesis advisers at Oxford, Dr Jenny Corbett and Dr Tim Jenkinson, as well as Mr Nicholas Dimsdale. In addition, I have benefited greatly over the years from many comments by academics and professional economists that are too numerous to mention. Nevertheless, I would like to thank those who provided particularly valuable advice or support during various stages of the research, namely Prof. Robert Z. Aliber, Prof. Jonathan Batten, Dr Joerg Bibow, Prof. Craig Freedman, Prof. Charles A. E. Goodhart, Dr James Gordon, Prof. Harald Hagemann, Prof. Harukiyo Hasegawa, Prof. Walter Hatch, Prof. Declan Hayes, Prof. Glenn Hook, Dr Tobias Hoschka, Dr Tim Jenkinson, Prof. Nobumitsu Kagami, Prof. Keimei Kaizuka, Dr C. H. Kwan, Prof. Paul McNelis, Dr Mark Metzler, Dr Bori Minakovic, Prof. Grayham Mizon, Prof. Stephen Nickell, Prof. Yukio Noguchi, Dr Marcus Noland, Prof. Hirohiko Okumura, Prof. Hugh Patrick, Prof. Hank Pruden, Prof. Ghon Rhee, Prof. Ryuzo Sato, Dr Christopher Scott, Prof. Sir Nicholas Stern, Prof. Joseph E. Stiglitz, Prof. Steve Thomas, Prof. Kazusuke Tsujimura, Dr Peter Warburton and Prof. Kozo Yamamura. I owe a special thanks to those who have taken it upon themselves to read the entire typescript, namely Hideo Fujiki and Suminori Sakurai of the PHP Research Institute in Tokyo, T. J. C. Cooke, Dr Frank McGroarty, Dr Costas Lapavitsas and especially Dr Dirk Bezemer. Charles Goodhart has also kindly read the book and provided support and much stimulus for improvement, for which I am very grateful. I am also indebted to the many discussants of the relevant papers that I presented at international conferences, especially those most closely resembling chapters in this volume, namely at the 1993 Royal Economic Society Annual Conference, University of York, the 34th Annual Conference of the Money, Macro and Finance Research Group (MMF, 2002) at Warwick University and the 36th Annual Conference of the Money, Macro and Finance Research Group (MMF, 2004) at the Cass Business School. The international conferences in Europe, Japan and the Asia-Pacific region at which parts of this book were presented – and improved thanks to stimulating comments from participants – are unfortunately too numerous to mention. I am also grateful to the anonymous referees of those papers that have been published. The views expressed in this book are, however, mine. I am also grateful for the research support received during various stages of this research project by the Bank of Japan, the Citicorp Foundation, the Commission for the European Union, the ESRC, the Japan Development Bank, the Japan Foundation, the Japanese Ministry of Education, the Krupp vii viii Acknowledgements Foundation, the Ministry of Finance’s Institute for Monetary and Fiscal Studies, the Nomura Research Institute and the Profit Research Center Ltd. The highly supportive environment of Linacre College, the former Institute of Economics and Statistics at Oxford, the University of Tokyo, as well as the collegiate support at Sophia University, Tokyo and the University of Southampton have also furthered the completion of this work. I would like to thank my editor Amanda Hamilton and her efficient team at Palgrave Macmillan for her professional guidance and enthusiasm for this project. I also would like to thank the publishers of previous versions of parts of this book, usually in the form of articles, for permission to reproduce parts, usually in much modified form, especially Blackwell Publishers Ltd, the East Asian Economic Association, Duncker und Humblot and M. E. Sharpe. Many of the graphics and all of the econometric calculations were produced with the user-friendly PC-Win and PC-Give Version 10.0 software, or its predecessors since Version 7. Over the years, many research assistants have contributed to this study, foremost among them Yoko Minami and Jenny Alf, whose excellent work deserves particular mention. I have also benefited from the great enthusiasm shown by many of my former and current students at Sophia University and the University of Southampton and would like to thank them for their sup- port. Finally, all insights that I may have contributed I owe to the Lord, who is my Light (Psalm 27). R. A. W. Note on the representation of personal names The ordering of first names and surnames follows the conventions of the English language. List of Tables and Figures Tables 1.1 Key indicators of macroeconomic performance in Japan during the 1990s 31 2.1 Fiscal stimulation packages and supplementary
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