Rethinking Japan’s “Lost Decade”: some Post-Crisis Reflections Yoshio Okubo Vice-Chairman, Japan Securities Dealers Association (JSDA) here are many parallels and similarities in the financial systems. Deleveraging has been prevalent aftermaths of financial crises. What distin- and seems to have increased in the last four years. Tguishes the current state of the world econo- To cope with liquidity crises and deflationary im- my four years after the global economic crisis from pacts, central banks have resorted to bold non-tra- the situations of previous crises and from Japan’s ditional policies and expanded their balance sheets “Lost Decade”? What can this imply for the world on an unheard of scale. No signs of reversing these economy in the future? policies are likely for the foreseeable future in the United States, Europe or Japan. Rather, the policy The Crisis and its Long Aftermath debate is mostly focused on whether we need an- other round of monetary expansion. The bold and Four years have passed since the outbreak of the unconventional monetary policies are affecting the global financial crisis. World financial markets foreign exchange markets and the relative com- now seem to have regained a measure of stabil- petitiveness of countries as well is creating an un- ity from its immediate aftermath thanks to swift precedented environment for policymakers. At the and forceful policy actions taken by many govern- same time, many countries have sharply increased ments and central banks working in concert. The their public debt in response to the financial crisis sense of panic has certainly subsided and the des- and from high spending and lackluster tax reve- perate pessimism has been gradually replaced by nues. Efforts to contain public sector debt are be- cautious optimism. There seems to be more con- ing made in those countries, but progress seems fidence now on the policy actions that should be slow given the need to sustain demand in addition taken, although differences still exist among poli- to the political and social difficulties that any fiscal cymakers over the speed and the magnitude with reform would entail. which they need to be implemented. The initiatives to reform the financial system to prevent future Under these circumstances, the core function of crises were launched globally, mostly in the G-20 the financial system of allocating scarce risk-tak- framework. Remarkable progress has been made ing capital for the future growth of the economy on many fronts, including in strengthening banks’ seems constrained everywhere, and the role of the capital adequacy standards and dealing with sys- financial system is overshadowed by the need for tematically important financial institutions. All of securing financing for the public sector. these developments are brightening prospects for the world economy. Implementation Challenges Rising The current state of the world financial system, While financial crises are caused by similar under- however, is far from normal. While global eco- lying factors, the past four years revealed that there nomic growth has been helped by the buoyant are three major aspects that have made this global economic development of emerging market econ- financial crisis distinctly different from previous omies, the growth of developed economies seems financial crises. These factors will continue to pose still hampered by the suboptimal health of their significant challenges to policymakers not only at THINK TANK 20: New Challenges for the Global Economy, New Uncertainties for the G-20 54 the current juncture but also over the foreseeable A weakness in the financial system impacts the longer-term horizon. The implication of these fac- real economy, as credit becomes dangerously tight, tors will affect the way the financial system will consumer confidence plunges, and unemployment evolve and will impact the performance of the surges. The deterioration of the real economy, in world economy in the long run. turn, adversely affects the soundness of financial institutions and increases the risk of a serious vi- First, the financial system has clearly shifted from cious cycle. No country is immune to these effects. a bank-based to a market-based system. A market- The initial complacency is replaced by the loss of based financial system allows fair and flexible al- pride and humility. Governments and financial in- location of risk and returns, and efficient alloca- stitutions are responding quickly and boldly, but tion of capital and sustainable economic growth. it takes considerable time for these efforts to bear It brings about enormous benefits to the economy fruit, testing the political will of policymakers and by strengthening financial freedom and inclusion, the patience of voters. allowing entrepreneurship to flourish. At the same time, under the market-based system, the poten- The second aspect relates to the cost and responsi- tial ability of debtors to repay, regardless of wheth- bility of resolving financial crises. With the emer- er they are corporate, household or sovereign, is gence of highly integrated financial markets, it has quickly assessed by the markets and reflected in become much more complicated to assess the real market prices. This encourages prompt corrective burden borne by various stakeholders as it involves action, contributing to the stability of the financial much greater cross-border implications. When the system under normal circumstances. When a cri- financial crisis hit Japan about a decade ago, the sis hits, however, it leads to swift deterioration in Japanese government declared that Japan would the quality of the balance sheets of creditors and not be the one to trigger a global financial crisis. causes concomitant liquidity problems, particular- The crisis was largely a banking sector crisis and ly for banks. Even in the cases where borrowers are the government effectively succeeded in contain- concentrated in specific sectors or countries, the ing the impact within its own borders. The cost of impact spreads across the globe instantly through resolving it was also shared mostly within Japan’s rapid balance sheet effects and strains in liquid- borders. In the context of the current crisis, how- ity positions. Any potential vulnerabilities of the ever, it seems extremely difficult for any country to financial system are exposed much more quickly make such a declaration. The crisis in Europe is a than a decade ago, compounding the challenges to glaring example of this difficulty, not just because policymakers. of the single currency but also because of the very high degree of economic integration. The European crisis highlighted this point. In the immediate wake of the global financial crisis in The solution for today’s financial crisis requires 2008, blame was directed at the United States. Crit- a far more systematic and globally consistent ap- ics made a number of points, including reckless proach. In the aftermath of any financial crisis, the lending by mortgage companies, excessive bor- post-crisis political situation is prone to creating rowing by consumers, and inadequate oversight by an environment in which populist policy actions regulatory agencies. However, it became immedi- are appealing. Tensions arise between the desire of ately clear that the crisis exposed the weaknesses policymakers to appear tough and forceful to in- and vulnerabilities in the financial systems every- troduce drastic changes on the one hand and the where and especially in Europe, where the impact desire to be supporters of “traditional values” on turned into an unprecedented crisis of confidence. the other in the face of entrenched public expecta- The underlying fiscal imbalances and differences tions. In addition, the resolution of today’s crisis in- in internal economic fundamentals within Europe volves a far more complex international dimension. became clear. Tensions arise between the need to take a globally THINK TANK 20: New Challenges for the Global Economy, New Uncertainties for the G-20 55 coordinated and consistent policy approach and developed countries. In countries where public the desire to address the concerns of domestic vot- funds were used to deal with the critical crisis situ- ers. It may be tempting to blame other countries ation, criticism has become particularly harsh and for domestic problems and take unilateral actions hostile toward policies to enhance the role of mar- at a time when international coordination is indis- ket mechanisms. Efficient, transparent and open pensable. While the collaborative approach is being capital markets, which have long been accepted actively pursued in the G-20, the European Union, as an indispensable engine for economic growth the Financial Stability Board and various interna- and development, are now viewed with a measure tional bodies, there are also many policy actions of skepticism. While the criticism toward market being taken or proposed that have not fully taken systems may be exaggerated in many instances, account of broader international implications. the anxieties and uncertainties are real and cannot easily be dispelled over a short span of a few years, The third aspect is that the conflict between policy particularly for the deeply affected segments of the objectives is becoming more evident and acute, population. often polarizing politics and creating gridlock and further delaying needed actions. Ideologies have Is it right then to blame the market-based system? become more important in the political arena