Many describe the 1990's in Japan as the "lost decade". After the real estate bubble popped, the stock market went through a precipitous decline. Japan faced a banking crisis and an ongoing problem of nonperforming loans as the the balance sheet of companies and consumers were destroyed. Could we be following the same economic debacle?
I would like to believe that we have learned some lessons from the Japanese experience, but when we compare policy choices it seems like we are following many of the same paths. Granted the paths available to policy-makers are limited, but we seem to be employing the same playbook as the Japanese. Our reaction time is faster and we may have a greater clarity on what we can do but we may end with the same fate as our Far East brothers, a long and prolonged slowdown.
Some argue that the bubble in Japan was caused by structural change from bank deregulation and monetary easing. These same arguments are being used in the US as the cause for the housing bubble. Loose regulation and monetary easing from Greenspan are viewed as the key ingredients for the current problem.
Fiscal stimulus was the main driver for helping the economy after the real estate bubble collapse. The form of the stimulus was through massive public works projects which tried to help rebuild the infrastructure of Japan. This ballooned the deficit in Japan so that total government debt is well over 100% of GDP. The top rating for government debt was lost, and many of the projects took the form of "bridges to nowhere" or pork-barrel spending. Given the high savings rate in Japan, the debt did not crowd out private spending and drive rates higher. Private investment came to a standstill because the banking crisis left many financially poor institutions standing. Fiscal policy as key driver was not effective in solving a liquidity trap issue.
The second part of the solution was to help with the non-preforming loan problem. Unfortunately, the banking regulations did not force the closure of institutions and actually allowed banks to carry bad loans for too long. Allowing loans not to be marked down caused massive uncertainty concerning the viability of financial institutions. The US has done a better job of addressing this issue but write-downs and closing of viable institutions has to increase to cleanse the financial system. Using TARP funds to prop-up poor financial institution may not be the best policy response.
The Japanese monetary authority pricked the bubble by tightening credit. Once the economic fall-out occurred, the Bank of Japan cut rates down to zero, but this was not enough. The Bank of Japan then began a policy of quantitative easing to re-inflate the economy and to help banks gain liquidity. The policy was conducted on a massive scale but it took years to get liquidity back into the system and allow for some positive growth. Quantitative easing does not work if there is not a change in confidence by financial institutions. We are seeing the impact of zero rates still not causing banks to lend.
The lessons from Japan are applicable to the US. The reversal of a bubble takes time. There are no quick fixes in an economy that has to delever. In Japan, the problem took years to fix. The US has the advantage that we can learn from the mistakes and take a number of policy initiatives at the same time as opposed to the Japanese who seemed to work more sequentially. The number one lesson may be to help fix balance sheet for banks, corporations and individuals. In the short-run, this means market to market effectively the assets on the balance sheet. and adjusting the cost of liabilities. What must be avoided is "fallacy of composition" problem. If everyone fixes their balance sheets, then the overall economy is harmed.
There are also significant differences between the US and Japanese experiences. First, the US does not have the same problem of population aging which has affected the potential GDP in Japan. Second, the US may have a higher productivity because there is more flexibility in the US economy. Finally, the potential for innovation has been greater in the US. Unfortunately, these are intangible solutions which cannot be easily changed by government policies. If fact, there is the potential for more harm than good through policies which cut productivity or innovation.
By comparing Japan's lost decade with our lost economy we can reduce the change of repeating the same issues, yet it looks like we will be following some of the same policy paths.
I would like to believe that we have learned some lessons from the Japanese experience, but when we compare policy choices it seems like we are following many of the same paths. Granted the paths available to policy-makers are limited, but we seem to be employing the same playbook as the Japanese. Our reaction time is faster and we may have a greater clarity on what we can do but we may end with the same fate as our Far East brothers, a long and prolonged slowdown.
Some argue that the bubble in Japan was caused by structural change from bank deregulation and monetary easing. These same arguments are being used in the US as the cause for the housing bubble. Loose regulation and monetary easing from Greenspan are viewed as the key ingredients for the current problem.
Fiscal stimulus was the main driver for helping the economy after the real estate bubble collapse. The form of the stimulus was through massive public works projects which tried to help rebuild the infrastructure of Japan. This ballooned the deficit in Japan so that total government debt is well over 100% of GDP. The top rating for government debt was lost, and many of the projects took the form of "bridges to nowhere" or pork-barrel spending. Given the high savings rate in Japan, the debt did not crowd out private spending and drive rates higher. Private investment came to a standstill because the banking crisis left many financially poor institutions standing. Fiscal policy as key driver was not effective in solving a liquidity trap issue.
The second part of the solution was to help with the non-preforming loan problem. Unfortunately, the banking regulations did not force the closure of institutions and actually allowed banks to carry bad loans for too long. Allowing loans not to be marked down caused massive uncertainty concerning the viability of financial institutions. The US has done a better job of addressing this issue but write-downs and closing of viable institutions has to increase to cleanse the financial system. Using TARP funds to prop-up poor financial institution may not be the best policy response.
The Japanese monetary authority pricked the bubble by tightening credit. Once the economic fall-out occurred, the Bank of Japan cut rates down to zero, but this was not enough. The Bank of Japan then began a policy of quantitative easing to re-inflate the economy and to help banks gain liquidity. The policy was conducted on a massive scale but it took years to get liquidity back into the system and allow for some positive growth. Quantitative easing does not work if there is not a change in confidence by financial institutions. We are seeing the impact of zero rates still not causing banks to lend.
The lessons from Japan are applicable to the US. The reversal of a bubble takes time. There are no quick fixes in an economy that has to delever. In Japan, the problem took years to fix. The US has the advantage that we can learn from the mistakes and take a number of policy initiatives at the same time as opposed to the Japanese who seemed to work more sequentially. The number one lesson may be to help fix balance sheet for banks, corporations and individuals. In the short-run, this means market to market effectively the assets on the balance sheet. and adjusting the cost of liabilities. What must be avoided is "fallacy of composition" problem. If everyone fixes their balance sheets, then the overall economy is harmed.
There are also significant differences between the US and Japanese experiences. First, the US does not have the same problem of population aging which has affected the potential GDP in Japan. Second, the US may have a higher productivity because there is more flexibility in the US economy. Finally, the potential for innovation has been greater in the US. Unfortunately, these are intangible solutions which cannot be easily changed by government policies. If fact, there is the potential for more harm than good through policies which cut productivity or innovation.
By comparing Japan's lost decade with our lost economy we can reduce the change of repeating the same issues, yet it looks like we will be following some of the same policy paths.
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