Japan's Economic Crisis: Causes, Deflation, and Recovery

Introduction

Japan has been in its worst recession since World War II. The country's economy slowed dramatically in the early 1990s after the asset-price bubble economy of the 1970s and 1980s. This paper takes a detailed look at what caused Japan's economic crisis and the subsequent problems related to declining Gross Domestic Product (GDP), failed stimulus packages, banking inefficiencies, ineffective interest rate policies, deflation, currency devaluation, and Japan's aging population. Given a consideration of all these factors, the paper then makes recommendations most likely to have a positive impact in rejuvenating Japan's struggling economy. The paper concludes that Japan's best course of action includes raising its nominal GDP by increasing its monetary base, engaging in massive bank restructuring, using inflation targeting techniques, and putting distressed real estate and other foreclosed collateral on the market.

Causes of Japan's Economic Crisis

Japan has been in recession for more than ten years. The economy that dazzled the world with growth of ten percent in the 1960s, five percent in the 1970s, and four percent in the 1980s slowed to zero in the 1990s and became stuck there — despite the government spending 100 trillion yen to create jobs and kick-start growth. Stimulus packages have not worked, and as a result: Japan's deficit, due to massive spending, is the highest of the G7 nations; the finance minister describes the situation as "near collapse"; the banking sector is tottering under the weight of $102 billion in bad loans; the stock market is at a sixteen-year low; and unemployment and bankruptcies are at record highs.^[1]

Growth slowed markedly in the 1990s largely because of the after-effects of overinvestment during the late 1980s and Japan's response of using contractionary domestic policies intended to wring speculative excesses from the stock and real estate markets. Government efforts to revive economic growth have met with little success and were further hampered in 2000–2002 by the slowing of the U.S. and Asian economies.^[2] Japan is now suffering from zero interest rates, deflation, a slowdown in economic performance, troubled financial structures, massive government debt, and an aging population.

Failed Stimulus Packages and Rising Public Debt

In early 1990, the Bank of Japan raised interest rates and squeezed credit — but it was done too abruptly. As a result, the stock exchange soon lost half its value and property prices dropped by sixty to eighty percent. The banks, finding themselves with a mountain of bad debt, drastically cut back credit. This in turn led to the collapse of thousands of small and medium-sized companies. All of this created a profound sense of shock, contributing to negative growth. The unemployment rate of 5.4 percent in 2002 stood higher than at any point since 1953.^[3]

Conclusion

Japan's best course of action includes raising its nominal GDP by increasing its monetary base, engaging in massive bank restructuring, using inflation targeting techniques, and putting distressed real estate and other foreclosed collateral on the market. These structural reforms, taken together, offer the most credible path out of the prolonged stagnation that has gripped Japan's economy since the early 1990s. Piecemeal and temporary policy measures have repeatedly failed; only deep, sustained structural change can restore confidence, restart lending, reverse deflation, and return Japan to stable economic growth.