Japan\'s Economic Crisis the Economic

Japan's Economic Crisis

The economic crisis had a profound effect on the Japanese economy. When the real estate bubble burst, real estate values plummeted, economic growth stopped, spending slowed and the country eventually became caught in a deflationary spiral. Moreover, government debt increased, consumer savings increased and eventually the economic system was overhauled to spur a return to growth.

Initially, the most significant impact on the economy of the crisis was the steep reduction in real estate values. The collapse of the real estate market brought real estate values down 85% from their peak levels at the height of the bubble. This resulted in a loss of an estimated $15 trillion in wealth (Kuhn, 2008). The Japanese had invested freely prior to the bubble bursting, with the sense that more money could always be acquired. However, the crash brought about a credit crunch.

One outcome was that the Japanese people stopped spending, and started saving instead. Asset values had plummeted so much that consumers felt the only way to preserve wealth was to save it. Consumer savings rates increased significantly over this period, adding $14 trillion to savings. Private consumption rates dropped from an average of 3.6% growth between 1983-92 to an average growth rate of 1.2% from 1993-2001.

The government had already lowered interest rates to near zero. By 1996 the discount rate was 0.5% and by 1999 3-month paper paid just 0.1%.

However, the credit crunch had rendered lenders unwilling to lend (Burkett, et al., 2003). Even if they had been willing to lend, there was little demand even at the low rates. The real estate bubble, fuelled in part by low rates, had made Japanese hesitant to invest. The result was a deflationary spiral and a liquidity trap.

The traditional means of spurring investment - the lowering of interest rates - had failed in Japan. Deflation had spurred savings. Consumers expected prices to drop, so put off purchases waiting for this to happen. Moreover, they had low expectations of future earnings (Krugman, 1998). Part of this lack of confidence arose from concerns about Japan's aging population, which threatened to suppress future output to levels below the current ones.

Yet, Japan's economy did not collapse entirely. Demand was soft, but GDP did not fall below levels at the peak of the real estate bubble (Kuhn, 2008) on account of government spending and the export market. Domestic demand, however, had softened, which was a sufficient blow to the economy. Massive government spending kept the unemployment rate below 6% throughout the crisis, and this softened the decline in domestic demand (Burkett et al., 2003).

As the crisis dragged onwards, it became apparent that significant economic restructuring was necessary to spur a renewal of growth. The old keiretsu system with its strong government backing was no longer able to protect the economy. Employment for life and other inefficiencies valued by the Japanese public were becoming threatened. This had the effect of shocking consumer confidence, but the corporate world became stuck, knowing that the systems would need to be changed but seemingly unwilling to make those changes. The banking system would need to be purged of its bad debts. That the economic crisis in Japan lasted so long was a result of resistance to making the necessary structural changes in order to modernize the economy. These structures, designed to bring Japan strong economic growth, had lost much of their value in the wake of the economic crisis.

These structural issues contained the Japanese economic crisis mainly to the Japanese market, but there were some impacts on the global economy. In the aftermath of the Asian economic crisis in 1997, Asian economies were in need of leadership. Japan was the region's largest economy but was in no position to provide that (Noland et al., 1998). Japan had pledged aid; with a weak yen this aid was insufficient to restore balance to Asia's other crisis-stricken nations. The impacts were also felt in the United States, particularly in sectors such as automobiles where the two countries have strong trade ties. Japan's weakness, however, remained primarily a Japanese issue (Krugman, 1998).