The “Lost Decade” is a term widely used to address Japan’s stagnation period throughout the 1990s, and even last until the current days of the 21st century. Due to its unique characteristics and severe consequences, experts recommend developed countries, as well as soontobedeveloped countries to study the Lost Decade in depth to prevent it from reoccurring, as well as learning invaluable lessons for policy making and macroeconomic planning. This paper focuses exclusively on analyzing Bank of Japan’s monetary policy during 19912001. Using a series of literature review, a few implications are brought up to suggest to other countries. Firstly, the Bank of Japan has made a serious mistake to tighten the monetary policy in the early 90s to control the economic bubble, but adopted expansionary fiscal policy to attempt to deal with stagnation, resulting an even worse deflation. Secondly, it had several correct policies to deal with deflation, such as zerobound interest rate and quantitative easing. However, some researches suggest that the Bank did not do enough to lift the economy out of inflation, and alternative strategies such as longterm inflation targeting can be considered.
FOREIGN TRADE UNIVERSITY FACULTY OF INTERNATIONAL ECONOMICS *** International finance report japan's monetary policy from 1991 to 2001 an in-depth analysis - TCHE414 Instructor: Assoc., Prof., PhD Mai Thu Hien Hanoi, June 2023 TABLE OF CONTENT ABSTRACT INTRODUCTION .2 Topic Overview 2 Research Rationale .3 Method of Research Overall Structure CHAPTER I RESEARCH BACKGROUND The Lost Decade Causes Aftermaths The Bank of Japan’s (BOJ) response CHAPTER II RESEARCH METHOD 11 Theoretical Framework 11 1.1 Literature Review as a Research Method 11 1.2 Different Methods of Literature Review 13 Method Specification .14 CHAPTER III LITERATURE REVIEW .18 Literature Review .18 Implications 23 CHAPTER IV CONCLUSION AND IMPLEMENTATION 24 Conclude the paper 24 Policy Implementation .26 REFERENCE 28 Group ABSTRACT TCHE414 The “Lost Decade” is a term widely used to address Japan’s stagnation period throughout the 1990s, and even last until the current days of the 21 st century Due to its unique characteristics and severe consequences, experts recommend developed countries, as well as soon-to-be-developed countries to study the Lost Decade in depth to prevent it from reoccurring, as well as learning invaluable lessons for policy making and macroeconomic planning This paper focuses exclusively on analyzing Bank of Japan’s monetary policy during 1991-2001 Using a series of literature review, a few implications are brought up to suggest to other countries Firstly, the Bank of Japan has made a serious mistake to tighten the monetary policy in the early 90s to control the economic bubble, but adopted expansionary fiscal policy to attempt to deal with stagnation, resulting an even worse deflation Secondly, it had several correct policies to deal with deflation, such as zero-bound interest rate and quantitative easing However, some researches suggest that the Bank did not enough to lift the economy out of inflation, and alternative strategies such as long-term inflation targeting can be considered INTRODUCTION TCHE414 1 Topic Overview The 1990s period of the Japanese economy was shrouded by disappointing economic performance, reflected through a sluggish GDP growth rate and economic recession The International Monetary Fund’s publication “Japan’s Lost Decade: Policy for Economic Revival” showed that from 1993 to 2003, Japan’s real GDP was only 1% on average, outperformed by the majority of other OECD countries and was only a quarter than that recorded in the 1980s Due to deflation, Japan’s nominal GDP seemed even worse with the GDP level of 2001 approximately equated the 1995 level, indicating a 6-year stagnation (Tim Callen, Jonathan David Ostry, 2003) This was termed “The Lost Decade” (Fumio Hayashi, Edward C Prescott, 2002) This recession’s effect lingered for the next 25 years According to an Asia Development Bank Institute’s research in 2015, Japan’s real GDP had been declining consistently, with the growth rate never reached anywhere near the pre-crisis level A more concerning characteristic was that the real GDP growth rate was frequently negative, reaching below -10% in quarter of 2008 – coinciding with the Financial Crisis (Naoyuki Yoshino, Farhad Taghizadeh-Hesary, 2015) Figure 1: Japan’s real GDP and real GDP growth rate (Naoyuki Yoshino, Farhad Taghizadeh-Hesary, 2015) TCHE414 Although this period contained many issues for exploration and discussion, this paper shall primarily analyze Japan’s monetary policy Monetary policy, as the International Monetary Fund defines, is the adjustment of money supply through a variety of actions conducted by the Central Bank, with the purpose of controlling price, inflation and managing economic fluctuations (IMF, 2017) The Europe Central Bank put it as “decisions taken by central banks to influence the cost and availability of money in an economy” (ECB, 2021) In the United States, monetary policy are the actions and communications of the Federal Reserves to achieve “maximum employment, stable prices and moderate long-term interest rates” (Monetary Policy, 2023) In summary, the following articles will define monetary policy as: actions and communications adopted by a monetary authority to adjust money supply, and therefore control price, inflation and employment rate within an economy Monetary policy is typically divided into contractionary policy and expansionary policy Contractionary policy tries to limit the money supply or government spending, usually to control inflation, slow short-term economic growth and control consuming and spending behavior Expansionary policy, on the other hand, is the government’s attempt to increase the money supply to stimulate economic growth and increase employment Research Rationale The research is done due to the special characteristics exhibited by Japan’s 19912001 period It marks the beginning of a lengthy era of decline in Japan, lasting until this very day This, according to Asian Development Bank, is the reason why China, European countries and the US should study the case carefully to prevent the same to happen to them (Naoyuki Yoshino, Farhad Taghizadeh-Hesary, 2015) Furthermore, studying Japan’s monetary policies specifically is crucial to understand the faults in their execution and utilization, therefore serves as valuable lessons for banks and financial institutes for their future actions Method of Research This paper shall apply literature review as a research method The writers will collect, summarize and analyze professionally written papers on Japan’s 1991-2001 monetary policies, how they came to be, their effects, what they did right and wrong, and TCHE414 the experience drawn from them The result should serve as brief case-by-case lessons that might imply certain course of action for policy makers Overall Structure The paper will be divided into sections The first part is Introduction, which has stated the overview, rationale and methodology of the paper Next, the Research Background will provide a more detailed description of Japan’s 1991-2001 period: how it occurred, the causes of Japan’s fall from grace, the aftermath of the crises it faced, and the Bank of Japan’s (hereafter abbreviated as BOJ) response using monetary policies After that, the Research Method will be specified in order for the Literature Review to be done Literature Review will be done by collecting papers, interviews, articles and researches done by professionals on BOJ’s monetary policy during the period, summarizing them before analyzing the content of said papers for lessons, experience and implications from the result Finally, the writers will draw a conclusion and briefly summarize the paper and give some policy implications CHAPTER I RESEARCH BACKGROUND TCHE414 1 The Lost Decade The term "Lost Decade" is frequently used to refer to the 1990s in Japan, a decade marked by economic stagnation and one of the longest-lasting economic crises in history Some versions also include later decades; for example, the years 1991 to 2011 (or even 1991 to 2021) are commonly referred to as Japan's Lost Decades The phrase "the Lost Decade" was first used to describe the protracted economic catastrophe that Japan experienced in the 1990s After World War II, Japan's economy grew rapidly, reaching its peak in the 1980s with the highest per capita gross national product (GNP) in the world During this time, Japan's export-driven development attracted investors and fueled a trade surplus with the United States Japan joined other major international countries in the Plaza Agreement in 1985 to help reduce global trade imbalances Japan began a period of loose monetary policy in the late 1980s in accordance with this agreement Increased speculating, a soaring stock market, and skyrocketing real estate valuations were all results of this loose monetary policy The Japanese Financial Ministry increased interest rates in the early 1990s when it became clear that the bubble was about to burst Ultimately, the stock market plummeted and a debt crisis started, slowing economic development and ushering in what is now known as the Lost Decade Japan's gross domestic product (GDP) averaged 1.3% throughout the 1990s, much less than that of the other G-7 nations.Savings by households grew However, because there was no corresponding growth in demand, the economy experienced deflation Between 1991 and 2001, Japan’s once red-hot economy was in trouble An asset bubble had formed in both its housing and stock markets, and when the Bank of Japan implemented a series of steep interest rate hikes as a way to tame inflationary pressures, you could almost hear the bubble pop Japan’s stock market tanked, and asset prices fell Several big banks, which were overleveraged with speculative investments, either failed outright or needed to be bailed out by the government Businesses folded, and unemployment rose Japan became mired in a decade-long recession TCHE414 The country was actually experiencing a liquidity trap: It seemed like1 everything Japan’s central bank did to help didn’t work Interest rates were cut, but fearful for the future, Japan’s citizens sat on their savings instead of spending them Causes A lot of it had to with how Japan’s businesses were structured They followed the traditional concept of the keiretsu, a close-knit network of business interests centered around a main bank These groups took majority shareholder interests in one another instead of being financed through stocks or bonds, and as such, this “socially controlled” investment provided the perfect conditions to nurture, test, and perfect new ideas before they were brought to the larger market Throughout the 1970s and 1980s, the Japanese Ministry of International Trade & Industry allowed easy credit to the keiretsu, in addition to a period of protection from foreign competition, so that their businesses would have time to become cost-effective production powerhouses Once they gained dominance in their respective industries, the businesses would embark on export programs, which is how Japan’s electronics, computer, automotive, and aircraft industries grew so quickly Growing hand-in-hand with Japan’s successful businesses was a booming stock market The Nikkei Stock Average hit an all-time high of 38,916 on December 29, 1989 In addition, real estate grew incredibly valuable—commercial land prices rose over 300% between 1985 and 1991, and it was said that one square mile in Tokyo’s government center was worth more than the entire state of California A bubble had formed; that was plain to see As asset prices grew, so did speculation, particularly in real estate, which was financed largely by corporate stock profits Banks were lending and not looking twice Sometimes, collateral was not even required Depositors thought they were in safe hands because Japan’s banks were backed by the government, and in turn, the banks believed the government wouldn’t let them fail, so they bundled these deposits into packages of ever-higher rates of interest and risk, and sold them to speculators TCHE414 the Bank Worried about inflationary pressures, and attempting to quell the bubble, of Japan began a series of steep interest rate increases from 2.5% to 4.25% at the end of 1989, and then to 6% in 1990 But since rising rates made borrowing more expensive, speculators quickly defaulted on their investments Several of Japan’s biggest keiretsu banks began to fail, threatening to take entire industries down with them The stock market nosedived By December 1990—just one year from its all-time height—the Nikkei had lost over 43% of its value Aftermaths The consequences and challenges stemming from the lost decade were wideranging and had lasting impacts on multiple facets of the Japanese economy and society One of the most notable aftermaths was persistent deflation, a phenomenon characterized by a sustained decline in prices Deflationary pressures had a detrimental effect on consumer spending and business investment, hindering economic recovery and making it difficult for policymakers to stimulate growth The persistently low inflation environment also created a unique policy challenge, as traditional monetary tools became less effective in combating deflationary trends Moreover, the lost decade witnessed a protracted period of economic stagnation and slow growth, commonly referred to as "Japan's lost growth potential." The Japanese economy struggled to regain momentum, facing structural impediments such as a decline in productivity growth, limited structural reforms, and a lack of robust domestic demand These challenges further exacerbated the economic downturn and required innovative policy responses to reignite economic activity and restore confidence The financial sector also experienced significant upheaval during the aftermaths of the lost decade Many companies faced financial distress and were compelled to undergo rigorous restructuring efforts to survive These restructuring measures often involved layoffs, cost-cutting initiatives, and corporate mergers and acquisitions, aimed at enhancing efficiency and promoting corporate resilience While these actions contributed to the long- term stability of the financial system, they also had adverse social implications, including increased unemployment and income disparities TCHE414 policies Additionally, the Japanese government implemented expansionary fiscal and increased public spending to stimulate the economy and counter the effects of the lost decade However, this approach resulted in a substantial increase in government debt, leading to long-term fiscal challenges and potential implications for future generations Balancing the need for fiscal stimulus with long-term sustainability became a critical concern for policymakers during this period The aftermaths of the lost decade also influenced societal attitudes and behaviors The economic hardships experienced during this era led to shifts in consumer behavior, with individuals adopting more cautious spending habits and reassessing their priorities Furthermore, the lost decade underscored the importance of structural reforms to address underlying issues within the Japanese economy These reforms encompassed a wide range of areas, including addressing demographic challenges, promoting labor market flexibility, encouraging entrepreneurship, and fostering innovation Given the multifaceted nature of the aftermaths of the lost decade, extensive research has been conducted to comprehend the causes, consequences, and lessons learned from this challenging period Scholars, economists, and policymakers have undertaken comprehensive analyses to extract valuable insights that can inform policy formulation, guide economic recovery strategies, and promote sustainable development in Japan and beyond Understanding the repercussions of the lost decade is instrumental in shaping effective policy responses, fostering economic resilience, and mitigating the risks associated with prolonged periods of economic stagnation The Bank of Japan’s (BOJ) response The Bank of Japan (BOJ), as the central bank of Japan, played a pivotal role in responding to the challenges posed by the lost decade Recognizing the need to address the economic downturn and mitigate deflationary pressures, the BOJ implemented a series of monetary policy measures and initiatives aimed at stimulating the economy and promoting price stability These policy responses sought to address the unique circumstances of the lost decade and support the recovery of Japan's economy One of the key measures employed by the BOJ was the adoption of a zero interest rate policy In an effort to encourage borrowing and investment, the central bank reduced