As this graph shows, once Japan’s real estate and stock market bubbles burst in the early 1990s (the so-called post-bubble period), the country’s real GDP began to fall dramatically. This prolonged downturn lasted nearly 25 years.
Why has Japan been in a prolonged recession?
- Japan’s “Lost Decade” was a period from around 1991 to 2001 when the country’s formerly booming economy slowed significantly.
- The Bank of Japan (BOJ) raised interest rates to temper the real estate market, which contributed to the economic slump.
- While a credit crunch was brewing, the BOJ’s policies produced a liquidity trap.
- Using public funds to rebuild bank balance sheets and preventing deflation and inflation from producing stagnation are among the lessons learned from Japan’s “Lost Decade.”
When was the last time Japan was in a slump?
According to a government panel, Japan’s latest recession lasted 19 months from May of last year, when the economy was in its worst fall on record as a result of the coronavirus pandemic’s early impact.
The latest downturn of the world’s third-largest economy began in November 2018, when its exports bore the brunt of a growing U.S.-China tariff battle, according to a Cabinet Office panel of economists who retrospectively estimate the length of economic expansion and contraction.
Was Japan affected by the global financial crisis of 2008?
It’s been ten years since Lehman Brothers went bankrupt in September 2008. The surprise exit of the investment bank, as we all know, drove the world economy into a deep recession, which was already feeling the effects of the subprime mortgage crisis.
Japan escaped the financial consequences of the subprime mortgage crisis relatively unscathed. It was due to the fact that Japanese banks did not have a large number of RMBS and CDOs in their portfolios. In this regard, Japan never experienced a financial crisis during this time.
The Japanese economy, on the other hand, was hit by a severe and rapid downturn. In fact, the loss in real GDP was far higher than that of the United States, which was the source of the crisis.
In this month’s essay, I’d like to look back on Japan’s experience during the 2008 financial crisis and explore the factors that contributed to it.
Larger drop in GDP than in the United States
Figure 1 depicts the GDP profile before and after the fall of Lehman Brothers, which we will refer to as the “Lehman shock.” Using 100 as the real GDP in 2008Q1, it can be shown that Japan’s real GDP plummeted considerably more steeply than the US’s, and that it has also been longer to recover to its pre-Lehman shock level.
When we look at Figure 2, which shows the real GDP growth rates of the two countries over the same time, we can observe the disparity in the impact of the Lehman shock. In 2008Q3, 2008Q4, and 2009Q1, real GDP declined by -1.3 percent, -2.3 percent, and -4.9 percent, respectively. The decline in real GDP in each of the three quarters was greater than the decline in real GDP in the United States over the same time period.
Significant fall in exports
Figure 3 examines the contribution of exports to real GDP during the period to determine the cause of the substantial reduction in real GDP. It demonstrates that the reduction in real GDP in 2008Q4 and 2009Q1 is primarily due to a drop in real exports in both quarters.
The following factors are said to have contributed to Japan’s dramatic decline in real exports:
First, the financial crisis in the United States increased household worry about future economic prospects, causing them to delay purchases of non-essential items such as automobiles and electrical equipment. Because these products and their parts were Japan’s principal exports to the US, it resulted in a significant drop in Japanese exports.
Second, the yen has been appreciating since the start of the subprime mortgage crisis, which intensified following the Lehman bankruptcy. In June 2007, the yen/dollar exchange rate was above 124, but it rose to 108 in August 2008, before falling below 90 by December. During this time, such a rise in the value of the dollar deterred exports.
Third, the financial market deadlock that followed the Lehman bankruptcy reduced trade finance availability. The decline in finance hampered international trade.
The drop in Japanese exports during the time, which was part of the Great Trade Collapse, had a significant impact on Japanese industry and workers. Because of the composition of Japanese exports, this was especially true. The items that were impacted were those that were supported by a wide range of sectors that provided intermediate goods. The drop in exporting sectors’ production eventually resulted in a drop in production in those industries as well.
It was especially significant in the case of automakers, whose exports accounted for 17.1% of overall exports in 2007, shortly before the crisis, and 37.0 percent of those were to the United States (Figure 4). The crisis lowered total automobile exports to 48.7% of their value in 2009, a 51.3 percent decrease (Figure 5).
Aside from the substantial drop in exports, the motor vehicle sector had the greatest impact on other industries: according to the input-output chart for Japan, a drop in one unit of production in the motor vehicle producing industry reduces three units of production economy-wide: It had the greatest impact on total production of all Japanese industries.
Reduced motor vehicle exports had a severe impact on the economy as a result of these factors, resulting in a significant drop in real GDP.
In contrast, limited impact on employment
While the Lehman shock had a huge impact on real GDP, it had a relatively small impact on employment. In stark contrast to the United States’ quick growth in unemployment from 5.0 percent at the beginning of 2008 to 10.0 percent at its high (October 2009), Japan’s rise was from 3.9 percent at the beginning of 2008 to barely 5.5 percent at its peak (July 2009). The increase in the rate was significantly different and absolutely opposite of what would be expected based on the impact on real GDP, as shown in Figure 6.
The fundamental reason for the disparity is Japan’s lifetime employment structure. Japanese companies are often hesitant to lay off employees and make every effort to retain them on the payroll.
Simultaneously, following the Lehman shock, the government aided businesses by easing the requirements to qualify for the employment adjustment subsidy program: the program subsidized a portion of the wage that a firm must pay (3/4 for large firms and 9/10 for small and medium-sized firms after March 2009) if the firm keeps workers on the payroll despite the fact that there may be no work to do, by training them or giving them time off.
Figure 7 demonstrates that both the number of covered workers and the overall amount of subsidies paid to enterprises began to rise in early 2009, peaking in August (in the case of number of workers) or September (in the case of total subsidies) (in the case of subsidies paid). It should have aided in keeping the unemployment rate in Japan low throughout this time.
Overcoming the vulnerability
The 2008 Lehman Brothers bankruptcy exposed Japan’s economy’s vulnerability to foreign shocks. The fundamental reason for this was the weakening of domestic demand, particularly individual consumption.
However, it was bolstered by a unique feature of the Japanese industrial system, in which the automobile industry holds a significant stake. On the one hand, exports had a significant impact on the production of motor vehicles, while on the other hand, the manufacture of motor vehicles had a significant impact on the production of other industries.
The experience shows that stronger domestic demand and a more diverse industrial structure are required to be more resilient to external shocks. The lack of progress over the last ten years shows that we still have a long way to go on these fronts.
What was the length of Japan’s Lost Decade?
- The term “Lost Decade” originally referred to a nearly ten-year period of slow to negative economic growth in Japan’s economy in the 1990s.
- Stagnant development in the years after 1991 has earned the period following 1991 the moniker “Japan’s Lost Decades” (plural).
- The main causes of the Lost Decade are thought to be misguided government actions following a real estate bubble.
- The first decade of the twenty-first century in the United States, which was marked by two stock market disasters, is sometimes likened to Japan’s Lost Decade.
Why is Japan so indebted?
The Japanese public debt is predicted to be around US$12.20 trillion (1.4 quadrillion yen) as of 2022, or 266 percent of GDP, the largest of any developed country. The Bank of Japan holds 45 percent of this debt.
The collapse of Japan’s asset price bubble in 1991 ushered in a long period of economic stagnation known as the “lost decade,” with real GDP decreasing considerably during the 1990s. As a result, in the early 2000s, the Bank of Japan embarked on a non-traditional strategy of quantitative easing to inject liquidity into the market in order to promote economic growth. By 2013, Japan’s public debt had surpassed one quadrillion yen (US$10.46 trillion), more than twice the country’s yearly gross domestic product and already the world’s highest debt ratio.
Japan’s public debt has continued to climb in response to a number of issues, including the Global Financial Crisis in 2007-08, the Tsunami in 2011, and the COVID-19 epidemic, which began in late 2019 and has consequences for Tokyo’s hosting of the 2020 Summer Olympics. In August 2011, Moody’s downgraded Japan’s long-term sovereign debt rating from Aa2 to Aa3 due to the country’s large deficit and high borrowing levels. The ratings drop was influenced by substantial budget deficits and government debt since the global recession of 2008-09, as well as the Tohoku earthquake and tsunami in March 2011. The Yearbook of the Organisation for Economic Co-operation and Development (OECD) noted in 2012 that Japan’s “debt surged above 200 percent of GDP partially as a result of the devastating earthquake and subsequent reconstruction efforts.” Because of the growing debt, former Prime Minister Naoto Kan labeled the issue “urgent.”
What is causing Japan’s economic downturn?
The Bottom Line: Japan’s Future As the new year begins, Japan has both cyclical and structural issues. Global supply chain bottlenecks and labor market frictions are cyclical issues for the country, which continue to put downward pressure on its economy as it attempts to recover from the global recession.
Is Japan’s economy ever going to recover?
According to Tanaka, the currency market is another source of concern for the Japanese economy. Although the current depreciation of the yen versus the US dollar benefits export-oriented automakers and chip-related industries, it represents a headwind for Japan because of its reliance on natural resource imports such as crude oil, he added.
Transportation and restaurant industries, which have already been impacted severely by the pandemic, are large consumers of crude oil and may continue to be squeezed, he said.
Even while the Japanese economy is expected to rebound to pre-pandemic levels in early 2022, it will take a year or more to return to its recent peak, which occurred in the April-June quarter of 2019, before to the increase in the consumption tax to 10% from 8% later that year.
“The fundamental goal for the Japanese economy in 2022 will be to achieve a ‘with-corona’ new normal, striking a balance between keeping the economy operating and preventing infections,” Sakai of Mizuho said.
Why does Japan have no inflation?
Rising producer costs have not yet filtered through to consumer prices, owing to entrenched expectations built up over decades of low or no inflation. Import price rises are notoriously difficult for domestic businesses to pass on to consumers. At a news conference in October, Bank of Japan Governor Haruhiko Kuroda blamed this hesitancy on habits developed during the country’s recurring periods of deflation. Companies have a compelling motivation to oppose hikes. Kikkoman, a soy sauce manufacturer, announced a 4-10 percent price rise starting February last week. In America, such an event might go unnoticed. However, it became national news in Japan.
Another important reason is Japan’s sluggish consumer recovery. The third quarter of the year saw a drop in private spending, which is now 3.5 percent lower than it was at the end of 2019. In Japan, spending on durable goods, which accounts for majority of the country’s inflation, has been virtually unchanged over the previous eight years.
The second paragraph is right; Japan’s low inflation is due to a lack of consumer spending. (While I prefer to concentrate on NGDP, the two aggregates tend to move in lockstep.)
Low inflation is unavoidable in Japan due to the lack of NGDP growth. The rumored “Firms’ “reluctance” to raise prices (stated in the first paragraph) has no bearing on Japan’s low inflation. It’s a mistake to mix together causes with symptoms. (On the other hand, in America, people complain about “price gouging” by oil firms, which is also false.)
It is theoretically feasible that enterprises’ hesitation to raise prices will result in decreased inflation, at least temporarily.
Assume the BOJ raises Japanese NGDP at a rate of 5% per year for the next few years.
If Japanese companies refused to raise prices, real GDP would rise at a rate of 5% each year.
However, at some point, you will run out of workers, and the rate of increase in real output will be unable to continue.
However, this is not the case in Japan, where NGDP growth has been minimal since the late 1990s.
The lack of Japanese inflation since 1996 can be explained entirely by slow NGDP growth (i.e. tight money).
There’s nothing left to explain from Japanese firm pricing behavior after accounting for near-zero NGDP growth.
PS. Take a look at the graph again.
It displays NGDP levels rather than growth rates.
This graph is one of the most perplexing in the history of modern macroeconomics.
By the way, Japan’s overall population in 2020 will be roughly the same as it was in 1996, implying that per capita NGDP will remain unchanged.
Imagine not getting a raise for the next quarter-century!
(In actual terms, Japan has done OK, but in comparison to countries like the United States, Australia, and Germany, its performance has been a bit disappointing.)
Why did the global financial crisis affect Japan so hard?
Even while Japan’s relatively strong financial system originally limited the direct impact of the global financial crisis, it was severely impacted. The severe collapse in industrial production that followed was undoubtedly caused by a number of variables, but the article emphasizes the significance of global deleveraging’s contractionary effect on the actual economy. In this climate, Japan was particularly susceptible due to structural changes in its trade and industrial systems over the previous decade. As a result of these structural changes, Japanese output became substantially more susceptible to output shocks in the advanced markets of the United States and Western Europe, according to vector autoregression research.
There were two parts to the structural alterations. First, highly income-elastic industrial supplies, capital goods, and consumer durables accounted for over 90% of Japan’s exports. Despite the fact that rising Asia is Japan’s largest export market, the majority of its purchases from Japan are intermediate items utilized in the manufacturing of final goods for the United States and Western Europe. Second, during the early 2000s, Japan’s trade dependence has intensified, as demonstrated by a rising export-to-GDP ratio and a shrinking non-tradable sector share. Though rising trade openness is a normal feature of economic globalization and regional integration, the way this process had unfolded left Japan particularly exposed to a negative demand shock from abroad.
Policymakers might stimulate the export of completed goods to rising Asia by forming a regional free trade agreement to make Japan more resilient to external shocks. In order to boost domestic demand, the social protection system must be enhanced to minimize household worry about the future; a more liberal immigration policy should also help re-energize private investment in an aging society. Further deregulatory measures in the more regulated non-tradable products sector are required to promote better resource allocation; a significant removal of constraints in agriculture, particularly regarding the corporatization of production, would be particularly beneficial. With limited fiscal space, these steps will aid in the creation of an environment conducive to private investment driven by final domestic demand.
In 2009, what happened to Japan’s economy?
On an annualized basis, real GDP decreased a further 12.4% in the first quarter of 2009 compared to the previous quarter, the greatest drop ever. On top of the drop in exports, this was attributed to a drop in domestic capital investment and consumption. The crisis’ repercussions had spread to domestic demand.