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IV. Revisiting Japan's Lost Decade IV. Revisiting Japan’s Lost Decade his chapter discusses Japan’s experiences with distress may be called for given the significant Tits banking crisis in the 1990s and the potential downside risks that remain. In all these areas, implications for resolving the current global crisis. Japan’s experiences provide a rich array of lessons Drawing on insights from a recent IMF seminar that could guide policy responses. (Box 4.1), the chapter revisits the Japanese fiscal, Accordingly, the chapter asks: monetary, and financial sector policy responses through the lens of the present turmoil. In doing so, x Based on Japan’s experience, can fiscal policy be it draws possible lessons for policymakers today, used to stimulate the economy and, if so, what including in Asia, as they attempt to stabilize their measures are likely to work? Looking ahead, economies and orchestrate a recovery. how concerned should policymakers be about Japan’s crisis was successfully resolved and most risks to medium-term fiscal sustainability? of the public funds deployed were recovered, but x How successful was Japan in easing credit not before a “lost decade” of stagnation and conditions and fighting deflation using prolonged deflation. While today’s policy challenges unconventional monetary policies? are compounded by the complexity of the distressed assets involved and the global scope of the crisis, x In the financial sector, what strategies did Japan they are in many ways similar to the problems Japan use to clean up bank and debtor balance sheets had to confront. Therefore, Japan’s eventual and to restore lending? How were the fiscal success—and early difficulties—in overcoming its costs of these interventions managed and what crisis could provide useful insights. were the key lessons in designing an exit strategy? The results are likely to be of interest to a range of economies. They apply most directly to the United States and other advanced countries whose financial Background: Stylized Facts from sectors are at the epicenter of the crisis. However, Japan’s Lost Decade given unprecedented real and financial spillovers, Following unprecedented run-ups, Japan’s stock various aspects of the policies discussed are and real estate markets collapsed in the early 1990s. becoming increasingly relevant more broadly, After an extraordinary bull market that saw share including in Asia. Fiscal policy has assumed center prices rise almost threefold in only four years, the stage in the region, with most economies planning stock market plunged in 1990. Notwithstanding significant stimulus packages to combat large output some intermittent upswings, the gains during the gaps. On the other hand, with deflationary pressures bubble were given up entirely over the next 12 years, emerging and credit markets impaired, traditional with most of the decline occurring in the first two monetary policy may be reaching its limits and and a half years after the crash. In 1991, the central banks may need to resort to unfamiliar credit property market also started to falter: after tripling easing measures. And although financial and between 1985 and 1990, prices gradually slid back to corporate sectors in Asia have been generally their initial level by the early 2000s (Figure 4.1). resilient, contingency plans to deal with heightened –––––– Note: The main authors of this chapter are Kenneth Kang, Murtaza Syed, and Kiichi Tokuoka. 59 ©International Monetary Fund. Not for Redistribution REGIONAL ECONOMIC OUTLOOK: ASIA AND PACIFIC Box 4.1. IMF Seminar on Japan-U.S. Parallels: Summary of Proceedings1 Through most of the 1990s and early 2000s, Japan grappled with a financial crisis in many ways reminiscent of the turmoil affecting the United States today. Both crises originated in the bursting of asset bubbles fueled by excess liquidity, lax financial regulation and irrational exuberance. The asset collapse spread to other financial markets, raising liquidity and solvency concerns for systemically important institutions and weakening growth. Addressing these concerns required unprecedented intervention to stabilize financial markets, while cushioning adverse feedbacks through supportive macroeconomic policies. Motivated by these parallels, the IMF organized a seminar in March 2009 to discuss Japan’s experience and the potential implications for resolving the financial difficulties facing the United States today. In his opening remarks, Anoop Singh (IMF) discussed some key similarities between the two crises—in terms of their origins, evolution, and policy challenges—while noting that the present crisis was moving much faster, was global in scale, and involved more complex assets. He stressed that while a strong policy response had so far allowed the United States to fast-forward its way through the first half of Japan’s lost decade, some of the more difficult challenges still lie ahead. In particular, Japanese history suggests that a post-bubble recession is much harder to combat than a cyclical downturn and that the detrimental effects on growth can be long lived. In this context, a speedy and strong U.S. recovery was likely to hinge on continued success in financial and macroeconomic policies, as well as longer-term reforms to raise productivity. Credit Easing: The Bank of Japan's Approach Participants acknowledged that the precise transmission channels of unconventional monetary policies are considerably uncertain, but warned against falling behind the curve: x Although policy rates have approached the lower bound in many advanced economies, Hiromi Yamaoka (IMF Office of the Executive Directors) pointed out that a number of unconventional policy tools can still be used. The Bank of Japan’s experience suggests that these include influencing expectations by committing to keeping policy rates low for an extended period, expanding the size of the central bank balance sheet, or changing its composition by purchasing financial assets with longer maturities or credit risks. However, the extent to which credit easing worked in Japan remains highly uncertain and it was not a substitute for policies to fix the financial system. x Vincent Reinhart (American Enterprise Institute) suggested that there were four channels through which credit easing could work: (1) supporting the prices of certain assets; (2) complementing fiscal policy; (3) encouraging the expansion of bank balance sheets through reserve creation; and (4) influencing expectations. There could also be an exchange rate channel, although there was little evidence about the effects on currencies, especially when credit easing was being attempted globally. Unconventional policies are also much harder to explain to the public, are open to political interference, and can be difficult to unwind. However, these limitations were not an excuse for inaction, and he urged the U.S. Federal Reserve to continue taking a range of aggressive measures. Japan’s Fiscal Stimulus in the 1990s: Did It Work? Participants were split on the impact of Japan’s fiscal stimulus, but generally agreed that some degree of activism was needed to support the economy while the health of the financial system was restored: x Takatoshi Ito (University of Tokyo) discussed the empirical difficulties of assessing the effectiveness of fiscal policy in Japan, including quantifying the fiscal impulse and the unobservability of the counterfactual. Some ______ 1 IMF seminar on “Japan’s Policy Response to its Financial Crisis: Parallels with the U.S. Today” (March 19, 2009). See www.imf.org/external/np/seminars/eng//2009/jpn/index.htm for supporting materials. 60 ©International Monetary Fund. Not for Redistribution IV. REVISITING JAPAN’S LOST DECADE empirical work suggests that fiscal policy helped to prevent a complete meltdown of the economy but was constrained by packages containing relatively small “real water.” However, others point out that fiscal policy— hampered by low multipliers and Ricardian effects—could not prevent the economy from sliding into stagnation. Despite these controversies, he noted that the scale of the present crisis calls for a response in targeted areas to increase productivity and long-term growth—such as the environment, medical care, and education in Japan—with attention to debt sustainability. x Adam Posen (Peterson Institute) argued in favor of fiscal activism, particularly given that conventional monetary policy was close to its limits. However, if private demand was not supported by resolving the problems of the financial system and a restructuring of the economy toward productive sectors, the effects of fiscal stimulus were likely to be short-lived. In addition, he noted that most of the current debates on the effectiveness of fiscal policy—specifically on tax cuts versus public works spending, temporary versus permanent tax cuts, and Ricardian effects—were overly simplistic. For a productive dialogue, he felt that there was a need to move beyond clichéd labels and focus on the nature of the policies themselves, as in recent work by IMF staff.2 Resolving Japan’s Banking Crisis: Strategies Adopted and Fiscal Cost Participants agreed that the United States may be repeating some of Japan’s early mistakes, arguing for forceful actions to encourage loss recognition, restructure distressed assets, and recapitalize viable institutions: x Takeo Hoshi (University of California, San Diego) argued that by providing money to banks without assessing their financial conditions and capital needs, the United States was guilty of some familiar mistakes.
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