LCC The Holy Grail of Macroeconomics Discussion

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I’m working on a economics multi-part question and need an explanation and answer to help me learn.

First choose one book to report on; read the book and allow potential questions to arise in your mind as you read..identify the page & paragraph that triggered your inquiry (if using Kindle or some version of book with no page #’s just cite a sentence in the reading that prompted your question). You need 20 questions with reference for each. No definitions (Look it up!). Eliminate questions already resolved. Ask questions you really want to ask. Second: vocabulary…define 15 economics or business terms that appear in the reading. You can use text to define or any technical website that features economic or business terms. Avoid ask.com You might want to Google for possible websites. As you know the internet is changing all the time. Third part of assignment is to select a significant paragraph that you think is important…write it out and cite location; Finally, Do a chapter by chapter breakdown of main points per chapter…If you just lump it together without chapter by chapter format you lose points. Word count for this section is minimum 325 words and maximum 625 words. Students should demonstrate creative & critical thinking skills in overview of book content.

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The Holy Grail of
Macroeconomics:
Lessons from Japan’s Great Recession
The Holy Grail of
Macroeconomics:
Lessons from Japan’s Great Recession
Richard C. Koo
WI LEY
John Wiley & Sons (Asia) Pte. Ltd.
Copyright © 2008 by John Wiley & Sons (Asia) Pte. Ltd.
Published in 2008 by John Wiley & Sons (Asia) Pte. Ltd.
2 Clementi Loop, #02-01, Singapore 129809
All Rights Reserved
No part of this publication may be reproduced, stored in a retrieval system, or
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2 Clementi Loop, #02-01, Singapore 129809, tel: 65-6463-2400, fax: 65-6463-4605,
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This publication is designed to provide accurate and authoritative information with
regard to the subject matter covered. It is sold with the understanding that the
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should be sought.
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Library of Congress Cataloging-in-Publication Data:
ISBN 974-0470-82387-3
Typeset in 10.5/14 point, Hiroshige Book by Superskill Graphics Pte. Ltd.
Printed in Singapore by Saik Wah Press Ltd.
10 9 8 7 6 5 4 3
To my mother
Amy Koo Ma
Contents
Acknowledgments
ix
xi
Preface
Chapter 1 Japan’s Recession
1
Chapter 2 Characteristics of Balance Sheet
Recessions
39
Chapter 3 The Great Depression was a
Balance Sheet Recession
85
Chapter 4 Monetary, Foreign Exchange, and
Fiscal Policy During a Balance Sheet
Recession
Chapter 5
Yin and Yang Economic Cycles and
the Holy Grail of Macroeconomics
125
157
Chapter 6 Pressure of Globalization
185
Chapter 7 Ongoing Bubbles and Balance Sheet
Recessions
221
Appendix: Thoughts on Walras and Macroeconomics 253
Index
279
Acknowledgments
This book would not have been possible without the help of
many people. In particular, clients and employees of Nomura
Securities, who made me think deep and hard about the
problem of the Japanese economy and what it means for the
world were of immense help in shaping my ideas. The fact that
they had their money in Japan meant that they never allowed
me to go off on a tangent.
I have also benefited from countless discussions with
Mr. Robert McCauley, a former colleague at the Federal Reserve
Bank of New York who is now with the Bank for International
Settlements. His extensive review of my manuscript was
invaluable. Frequent exchange of ideas with Mr. Shosaku
Murayama, who headed the research department of the Bank
of Japan until recently and is now the president of Teikoku
Seiyaku Co., was also helpful. Professor Takero Doi of Keio
University also helped me understand the latest developments
in academia. Any mistakes in the book are, of course, mine
and mine alone.
In the actual preparation of the book, I benefited greatly
from the support provided by Mr. Hiromi Yamaji, executive
vice president of Nomura Securities.
My secretary, Ms. Yuko Terado, helped me with the
preparation of the text of the manuscript. My assistant,
x Acknowledgements
Mr. Masaya Sasaki, not only produced the graphs and provided
the numerical data but also assisted me in locating professional
articles and historical materials that are used here. Their
dedicated help is the only reason I was able to write this quasiacademic book while working full-time as the chief economist
of Nomura Research Institute. They both worked very long
hours in order to get the book out on schedule. I cannot thank
them enough for their efforts.
I am also grateful to Toyo Keizai, the publisher of the
initial Japanese version of this book, and Mr. Chris Green, who
not only translated the Japanese original beautifully, but also
added valuable nuggets to make the text easier to understand
for English-speaking audiences.
Finally, I wish to thank my wife, Chyen-Mei, and our
children, Jackie and Rickie, for enduring my absence on so
many weekends and holidays. I am truly indebted to them.
Preface
Ben S. Bernanke, the current Federal Reserve chairman and
a highly acclaimed academic economist, wrote in 1995 that
“to understand the Great Depression is the Holy Grail of
macroeconomics,” but that “we do not yet have our hands on the
Grail by any means.” He added that “not only did the Depression
give birth to macroeconomics as a distinct field of study, but… the
experience of the 1930s continues to influence macroeconomists’
beliefs, policy recommendations, and research agendas.” Indeed,
since the publication of Keynes’ General Theory in 1936 ushered
in the era of macroeconomics, various explanations have been
offered for the depression in an endeavor that, in Bernanke’s
words, “remains a fascinating intellectual challenge.” It remains
a fascinating challenge, because it has not been explained to this
day how things had gotten so bad for so long after the October
1929 stock market crash.
With that in mind, I will argue that Japan’s “Great Recession”
of the past fifteen years, to use Adam Posen’s term, has finally given
us the clue to understanding how the Great Depression unfolded
in the U.S. more than seventy years ago. Although history never
exactly repeats itself, I believe that there are sufficient similarities
between the two extended downturns to suggest that the forces
that weakened the effectiveness of traditional macro policies, and
lengthened the recessions were the same in both cases. It also
seems that the same negative force has been operating, albeit on a
xii The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession
much smaller scale, in both the U.S. and German economies after
the bursting of the IT bubble in 2000, and again in the U.S. after
the subprime crisis that erupted in 2007.
To highlight the similarities between the two prolonged
recessions that happened in two different countries more than
seventy years apart, this book begins by analyzing what happened
to the Japanese economy. It starts with the Japanese economy not
only because the author lived through the recession, and was an
active participant in the policy debate during the past fifteen years,
but also because Japan offers a far more comprehensive pool of
data to draw from than the Depression-era U.S. Furthermore,
understanding why Japan’s economy slowed so suddenly in the
1990s after being so powerful until the very end of the 1980s is a
fascinating intellectual challenge in its own right.
In doing so, I use the “balance sheet recession” concept
first presented in English in my earlier book Balance Sheet
Recession: Japan’s Struggle with Uncharted Economics and its
Global Implications (John Wiley & Sons [Asia], 2003). It is a new
concept in the sense that unlike neoclassical macro theory, which
assumes that private-sector corporations are always maximizing
profits, it assumes that some companies may respond to daunting
balance-sheet damage by minimizing debt. After explaining the
exact mechanism of the extended slowdown in Japan, I move on
to see whether the same mechanism was operative in the U.S.
seventy years ago. The analysis is then extended to cover the
recent episodes, including the U.S. subprime crisis.
This book was written with two main objectives and one goal.
First, it seeks to analyze the current state of the Japanese economy
and the outlook for the future. Chapters 1 and 2 are devoted to this
purpose. Although I believe that the ongoing economic recovery
in Japan is real, policymakers need to keep a close eye on risks
that are highly specific to this type of recovery.
My second and far more ambitious objective is to incorporate
the legacy of Japan’s long recession into the body of macroeconomic
theory. Chapters 3 to 5 are devoted to this objective. This section
extends and generalizes the balance sheet recession theory, and
compares and contrasts it with conventional economic thought.
The ultimate goal of this exercise, of course, is to use the lessons
learned from the Great Depression and Great Recession in fighting
similar economic problems that are brought about by the bursting
of asset-price bubbles, especially the U.S. subprime fiasco.
Preface xiii
Chapters 3 and 4 delve into research on the Great Depression
by academic economists over the past thirty years. It was necessary
to go back to the Depression because, as Bernanke’s statement
at the outset makes clear, so much of macroeconomics has been
influenced by what happened during it.
In particular, economists from around the world advised the
Japanese authorities to fight the recession with ever more drastic
monetary accommodation. They based their recommendations on
the past twenty-five years of research into the Depression, which
has concluded that the Depression was caused by the failure of
monetary policy and that the subsequent recovery of the U.S.
economy was also made possible by a change in the policy stance
of the Federal Reserve.
From my vantage point on the front lines of Japanese financial
markets, these policy recommendations seemed utterly unrealistic,
because the demand for funds from Japanese businesses has
dried up completely even with zero interest rates. In my debates
with these economists, however, I realized that no constructive
discussion could occur until I proved that some of the “lessons”
from the Great Depression that underpin their views are themselves
wrong. If it can be shown that the Great Depression was, as was
the Japanese recession, a balance sheet recession, and that this
was why monetary policy was powerless to fight it, conventional
economic theory will have to undergo some major changes.
To prove this, I had to venture into the tiger’s lair, and
what I found there was surprising. Examining the data from
the perspective of demand for funds, I discovered one indicator
after another that supported the balance sheet recession
hypothesis. Even the classic survey of U.S. monetary history
by Anna Schwartz and Milton Friedman, who were the first
to argue that the Great Depression could have been avoided
through the proper application of monetary policy, and who
long championed monetary policy’s primacy, contained many
passages supporting the view that the Great Depression was
actually a balance sheet recession.
While the readers will be the ultimate judges, I believe that
America’s Great Depression, as was Japan’s Great Recession,
was a balance sheet recession triggered by businesses striving to
minimize debt. As in Japan, the problem lay in a lack of demand
for loans in the private sector, and not in a lack of funds supplied
by the monetary authorities.
xiv The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession
Chapter 5 brings everything together and argues that there are
actually two phases to an economy, the ordinary (or yang) phase
where private sector is maximizing profits, and the post-bubble (or
yin) phase where private sector is minimizing debt or otherwise
obsessed with repairing damaged balance sheets. It goes on to
argue that the two are linked in a cycle. The distinction between
the yin and yang phases also explains why some policies work
well in some situations but not in others. The resultant synthesis
provides the crucial foundation to macroeconomics that has been
missing since the days of Keynes.
Chapter 6 is about the pressure of globalization and global
imbalances. Although these issues are not directly related to
balance sheet recessions, they are nonetheless making the conduct
of monetary policy difficult in many countries.
Chapter 7 is about ongoing bubbles and balance sheet
recessions, with a special emphasis on the U.S. subprime problem.
The U.S. economic downturn brought about by the subprime
fiasco is a version of a balance sheet recession, with many of its
unpleasant characteristics. It is also a highly dangerous recession
in that so many financial institutions on both sides of the Atlantic
have been badly damaged by the fiasco. Although no quick
recovery is possible with so much damage to household and bank
balance sheets, the lessons we learned from Japan during the past
fifteen years can be put to good use to minimize the recovery time
for the U.S. economy.
The appendix is my little contribution to the debate on
how best to incorporate the use of money into the conventional
neoclassical framework. This section also challenges some of the
fundamental notions of modern economics.
Keynes responded to the tragic events of the Great Depression
by inventing the concept of aggregate demand. But even he was
unable or unwilling to break away from the most basic, long-held
assumption of economics: that businesses everywhere and always
seek to maximize profit. The Keynesian revolution ultimately ran
aground because its proponents never realized that their fiscal
policy recommendations worked only in the yin phase when
businesses are striving to minimize debt.
The concept of balance sheet recession crosses the line that
Keynes himself was unable or unwilling to cross, and allows for
the possibility that companies may, sometimes seek to minimize
debt. By doing so, it fully explains economic phenomena such as
Preface xv
the liquidity trap and extended recessions for which no convincing
explanation has previously existed. It also complements and
augments the conventional theories by clearly indicating when
monetary and fiscal policy are most effective, as well as when they
are most counterproductive. The synthesis of economic theories
so obtained may well be the Holy Grail of macroeconomics we
have been searching for since the 1930s.
The balance sheet recession concept has been developed on
the back of the Japanese people’s suffering and sacrifices during
the past fifteen years. Although a high price was paid, this concept
should be of great assistance to countries seeking to formulate a
policy response to bubbles and their aftermath, the balance sheet
recession. In the meantime, I look forward to assistance and
criticism from fellow economists to refine this theory, and make
it a more useful tool, so that Japan’s painful experience might be
transformed into a beneficial legacy for the world.
Richard C. Koo
March 2008
CHAPTER
Japan’s Recession
The recovery in Japan’s economy is real, and the signs of an end
to the fifteen-year recession are finally here. But it is important to
remember that both fundamental and cyclical factors affect the
economy. It is only in the former area—those unique problems
Japan has struggled with over the past fifteen years—that a
genuine recovery is evident. Cyclical or external factors, such
as exchange-rate fluctuations, pressures from globalization,
especially from China, and financial turmoil in the U.S., also
play a role. So although recent data give cause for optimism
on the fundamental side, Japan will remain subject to cyclical
fluctuations and external pressures.
Chapter 1 sets out to identify the kind of recession Japan has
been through, and Chapter 2 examines the ongoing recovery in
detail. Global as well as cyclical economic trends are discussed in
Chapters 6 and 7.
1. Structural problems and banking-sector
issues cannot explain Japan’s long recession
Japan’s recovery did not happen because structural
problems were fixed
Much has been said about the causes of Japan’s fifteen-year
recession. Some have attributed it to structural problems or
2 The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession
to banking-sector issues; others have argued that improper
monetary policy and resultant excessively high real interest rates
were to blame; and still others have pointed the finger at cultural
factors unique to Japan. It is probably safe to say that among
non-Japanese observers, many journalists and members of the
general public subscribed to the cultural or structural deficiency
argument, while academics subscribed to the failure of monetary
policy argument. Meanwhile, those in the financial markets
subscribed to the banking problem argument as the key reason
for the Japanese slowdown.
Those in the structural camp included former Federal Reserve
chairman Alan Greenspan,’ who argued that Japan’s inability to
weed out zombie companies must be the root cause of the problem,
and former Prime Minister Junichiro Koizumi, whose battle cry
was “No recovery without structural reform.” Although the term
structural reform could mean different things to different people,
the reform Koizumi and his economic minister Heizo Takenaka
had in mind was the Reagan—Thatcher-type supply-side reform.
They pushed for supply-side reforms because the usual demandside monetary and fiscal stimulus had apparently failed to turn the
economy around. Late former Prime Minister Ryutaro Hashimoto,
who resigned in August 1998, also pushed for structural reform as
a means to get the economy going.
Structural problems were also blamed for the five-year
German recession lasting from 2000 to 2005, the nation’s worst
slump since World War II. That the German economy responded
so poorly to monetary stimulus from the European Central Bank
(ECB) when other eurozone economies responded favorably
supported arguments in favor of structural reforms in Germany.
Among those in the academic camp, Krugman (1998) argued
that deflation was the root cause of Japan’s difficulties, even
adding that how Japan entered into deflation is immaterial.2 To
counter the deflation, he pushed for quantitative easing and
inflation targets. This approach of not dwelling on the nature
of deflation and jumping right into possible remedies was
followed by Bernanke (2003), who argued for the monetization
of government debt, and Svensson (2003) and Eggertsson (2003),
who recommended various combinations of price-level targeting
and currency depreciation. These academic authors argued
in favor of more active monetary policy because the past three
Japan’s Recession 3
decades of research into the Great Depression by authors such
as Eichengreen (2004), Eichengreen and Sachs (1985), Bernanke
(2000), Romer (1991), and Temin (1994) all suggested that the
prolonged economic downturn and liquidity trap seen at that time
could have been avoided if the U.S. central bank had injected
reserves more aggressively.
Although all of these arguments have some merit, that
prolonged recessions are extremely rare suggests that something
must have been very different about this one. It is therefore
critically important to identify the main driver of the fifteen-year
recession. In doing so, I will first try to dispel some myths about
what happened to Japan during the past fifteen years, and, in
the process, examine the applicability of each of- the preceding
arguments in detail. I will start with the structural and banking
arguments because they will lay a foundation for evaluating the
remaining monetary policy and cultural arguments.
The slogan “no recovery without structural reform” was made
popular by former Prime Minister Junichiro Koizumi, who stepped
down in September 2006. I will be the first to admit that Japan
suffers from numerous structural problems—after all, I provided
some of the ideas that went straight into the U.S.-Japan Structural
Impediments Initiative that President George H.W. Bush launched
in 1991.3But they could not be the primary reason the nation
remained in recession for so long. I do not for a moment believe
that an earlier resolution of these problems would have jumpstarted the Japanese economy. Nor do I think that the privatization
of the highway corporations and the post office, the two primary
“structural reform” achievements of the Koizumi era, had anything
to do with the economic recovery we are seeing today.
How do we know that structural issues were not at the heart
of Japan’s long recession? To answer this question, it is first
necessary to understand the characteristics of an economy beset
by structural problems.
The attempt to seek structural explanations for economic
problems is not really old. It was U.S. President Ronald Reagan
and British Prime Minister Margaret Thatcher who first argued
that the conventional macroeconomic approach of managing
aggregate demand would not solve the economic problems faced
by the two countries in the late 1970s. At the time, Britain and
the U.S. were veritable hotbeds of structural malaise: workers
4
The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession
frequently went on strike, factories produced defective products,
and American consumers had begun buying Japanese passenger
cars because the locally made alternatives were so unreliable.
The Federal Reserve’s attempt to stimulate the economy with
aggressive monetary accommodation led to double-digit inflation,
and the U.S. trade deficit steadily expanded as consumers gave
up poorly made domestic goods for imports. This weighed on the
dollar, and aggravated inflationary pressures. Higher inflation, in
turn, caused a further devaluation of the dollar. When the Fed
finally raised interest rates in a bid to curb rising prices, businesses
began to put off capital investment. Such was the vicious cycle in
which the U.S. became trapped.
Structural problems point to supply-side issues
In an economy beset by structural problems, frequent strikes
and other issues prevent firms from supplying quality goods at
competitive prices. Such an economy typically has a large trade
deficit, high inflation, and a weak currency, which lead to high
interest rates that dampen the enthusiasm of businesses to invest.
Its inability to supply quality goods and services stems from
micro-level (i.e. structural) problems that cannot be rectified by
macro-level monetary or fiscal policy.
But mainstream economists at the time believed that the
problems faced by the U.S. and Britain could be solved through
the proper administration of macroeconomic policy. Many
mocked the supply-side reforms of Reagan and Thatcher as
“voodoo economics,” arguing that these policies were little more
than mumbo-jumbo, and that Reagan’s arguments should not be
taken at face value. Most economists in Japan also held supplyside economics in contempt, deriding Reagan’s policy as “cherryblossom-drinking economics.” This appellation came from the
old tale of two brothers who brought a barrel of sake to sell to
revelers drinking under the cherry trees, but ended up consuming
the entire cask themselves, each one in turn charging his brother
for a cup of rice wine, and then using the proceeds to buy a cup
for himself.
Although I was 100 percent immersed in conventional
economics in the late 1970s as a graduate student in economics
and a doctoral fellow at the Fed, I supported Reagan because I
Japan’s Recession 5
believed that America’s economic problems could not be solved
by conventional macroeconomic policy, and instead required a
substantial expansion of the nation’s ability to supply goods and
services. I still believe that the decision I made at that time was
correct. The British economy was undergoing similar problems,
and there, too, Prime Minister Thatcher pushed ahead with
supply-side reforms.
When Reagan took office, the U.S. suffered from double-digit
inflation and unusually high interest rates: short-term rates stood
at 22 percent, long-term rates at 14 percent, and 30-year fixed-rate
mortgages at 17 percent. Strikes were a common occurrence, the
trade deficit was large and growing, the dollar was plunging, and
the nation’s factories were unable to produce quality goods.
Japan’s economy suffered from a lack of demand
Japan’s economic situation for the past fifteen years was almost a
mirror image of that of the U.S. and Britain in the 1980s. Shortand long-term interest rates and home-mortgage rates fell to the
lowest levels in history. With the exception of a September 2004
strike by the professional baseball players’ union, there has been
almost no industrial action in the past decade. Prices have fallen,
not risen. And until recently overtaken by China and Germany,
Japan boasted the world’s largest trade surplus. Furthermore, the
yen was so strong that in 2003 and 2004 the Japanese government
carried out currency interventions totaling Y30 trillion a year, also
a record, to cap its rise.
All these data underscore that Japan’s economy was
characterized by ample supply but insufficient demand. Japanese
products were in high demand everywhere but in their home
market. The cause was not inferior products, but rather a lack of
domestic demand.
At the corporate level, Japan’s increasingly robust corporate
earnings have gained much attention recently. Yet most of these
profits derive from exports, with only a handful of companies
gleaning substantial profits from the domestic market. Because
domestic sales remain sluggish in spite of heavy marketing efforts,
more and more businesses are allocating managerial resources to
overseas markets, which boosts foreign sales and adds to the trade
surplus. In short, for the past fifteen years Japan has been trapped
6 The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession
in a set of circumstances that are the opposite of those faced by
the U.S. twenty-five years ago. There has been more than enough
supply but not enough demand. So while structural problems did
exist, they should not be blamed for the long recession. Exhibit
1-1 compares current Japanese economic conditions with those
existing in the U.S. twenty-five years ago.
Exhibit 1-1. Structural problems cannot explain Japan’s economic
malaise
Japan’s Great
U.S. during Reagan
Recession
era
0%
-22%
-1.5%
-14%
Home mortgage rates
-3-4%
-17%
Labor issues
None
Frequent strikes
Prices
Deflation
Double-digit inflation
Balance of trade
World’s largest
Deficit
Short-term interest
rates
Long-term interest
rates
surplus
Exchange rate
Massive intervention
to stem yen’s rise
Falling sharply
Basic economic
Adequate supply but
Adequate demand
conditions
not enough demand
but not enough
supply
Note: Home mortgage rates are for 30-year fixed mortgages.
Source: NRI.
Japan did not recover because banking sector
problems were fixed
It has also been argued that the banking sector was chiefly
responsible for the recession. According to this argument, problems
in the banking sector and the resultant credit crunch choked off
Japan’s Recession 7
the flow of money to the economy. However, if banks had been
the bottleneck—in other words, if willing borrowers were being
turned away by the banks—we should have observed several
phenomena that are typical of credit crunches.
For a company in need of funds, the closest substitute for a
bank loan is an issuance of debt on the corporate-bond market.
Even though this option is available only to listed companies,
more than 3,800 corporations in Japan could have issued debt
or equity securities on the capital markets if they were unable to
borrow from banks.
But nothing of the sort was observed during the recession.
The topmost graph in Exhibit 1-2 tracks the value of Japanese
corporate bonds outstanding from 1990 to the present. Since 2002,
the aggregate value of bonds has been steadily declining—in other
words, redemptions have exceeded new issuance. Ordinarily, this
scenario would be unthinkable with interest rates at zero. Even if
we allow the argument that banks for some reason refused to lend
to their corporate customers, the companies themselves make the
decision whether to issue bonds. If firms sought to raise funds, we
should have witnessed a steep rise in the amount of outstanding
corporate bonds. In the event, however, the amount outstanding
of such debt fell sharply.
Additional evidence undermining this oft-heard argument is
provided by the behavior of foreign banks in Japan, which unlike
their Japanese rivals faced no major bad-loan problems after the
collapse of the late-1980s bubble otherwise known as the Heisei
bubble. If inadequate capital and a raft of bad loans did leave
Japanese banks unable to lend despite healthy demand for funds
from Japanese businesses, foreign banks should have enjoyed
an unprecedented opportunity to penetrate the local market.
Japan traditionally has a reputation as a tough nut for foreign
financial institutions to crack because the choice of banker is so
heavily influenced by corporate and personal relationships. If
Japanese banks had actually been unwilling to lend, we should
have witnessed a significant increase in lending to Japanese
corporations by foreign banks, as well as a proliferation of foreign
bank branches across the country. But this was not the case.
Before 1997, foreign banks needed authorization from the
Ministry of Finance for each new branch in Japan. This requirement
was eliminated as part of the “Big Bang” financial reforms of
1997, making it possible in principle for foreign banks to open
8
The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession
branches whenever and wherever they saw fit. But this change
did not lead to a surge in the number of foreign bank branches in
Japan. Although a few foreign lenders have expanded their share
of the consumer-loan market, the middle graph in Exhibit 1-2
shows that loans outstanding at foreign banks in Japan have
grown negligibly over the past dozen-odd years and actually fell
sharply during several periods. This suggests that the inability
of troubled Japanese banks to lend was not a bottleneck for the
Japanese economy, since foreign banks were not expanding their
loan business either.
A third objection to the argument that banking-sector problems
caused the recession is offered by the interest rates charged by
banks. Many small-and-medium-sized enterprises (SMEs) and
other unlisted companies lacking access to the capital markets
must rely on the banks for their funding needs. If banks—again
because of inadequate capital or bad-loan problems—were
constrained in their ability to lend to these companies, market
forces should have driven up lending rates. If there were few
willing lenders but many willing borrowers, borrowers should
Exhibit 1-2. Financial indicators are not consistent with
the credit crunch argument
The corporate bond market was shrinking
Economic
recovery
Corporate bonds outstanding (% y-y)
90
The market share of foreign banks was falling…
60
Lending by Japanese branches of foreign banks (% y — y)
30
0
—30
And lending rates fell steadily
Average lending rate of
Japanese banks (%)
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
Source: Bank of Japan, Average Contracted Interest Rates on Loans and Discounts
and Principal Assets and Liabilities of Foreign Banks in Japan; Japan Securities Dealers
Association, Issuing, Red