Japan’s Policy Response to its Financial Crisis: Parallels with the U.S. TodayOpening remarks by Anoop Singh
Director, Asia and Pacific Department, International Monetary Fund
At an IMF Seminar
Washington DC, March 19, 2009
1. It is a great pleasure for me to welcome you to this seminar. These are truly extraordinary times. As we gather here today, the world stands on the cusp of the most severe recession in decades. I hope that our discussions this morning will contribute to the policy debate, and help efforts to orchestrate a recovery.
2. The dramatic interplay between collapsing asset prices, a dysfunctional financial system and weakening economic activity that we are currently witnessing in the U.S. echo events that took place in Japan, the world’s second largest economy, during the 1990s. Japan’s crisis was successfully resolved and most of the public funds deployed were recovered, but not before a “lost decade” of economic stagnation and prolonged deflation. Some scars have been longer lasting still, as reflected in persistently lower growth and the huge public debt burden.
3. Motivated by this sense of deja vu, today’s seminar aims to draw parallels between policies adopted during Japan’s banking crisis and those that are needed to get the U.S. out of its prevailing turmoil. By revisiting the Japanese experience through the lens of the current crisis, we hope that our discussions will help draw lessons that could be brought to bear on key questions that policymakers in the U.S. and other countries face today.
4. Some may find it curious that in searching for a way forward, we are actually proposing to look back, and that too at an episode that may have very little in common to the current crisis. It is certainly true that there are some important differences:
• First, while both crises were fueled by easy credit and weak regulation, Japan’s bubble appears to have been much larger, with the run up in asset prices in the five years preceding the crisis roughly 3 to 4 times bigger than in the U.S..
• Second, in keeping with a typical banking crisis, Japan’s troubles involved overborrowing by firms. The U.S. crisis is more uncharacteristic, in that it reflects household profligacy.
• Third, the immediate impact was much less dramatic in Japan. Growth slowed sharply but the economy did not shrink on an annual basis until 1998, 7 years into the real estate bust. By contrast, the U.S. fell into recession within 6 months of the housing downturn.
• Fourth, as a related point, the policy response has been much quicker in the U.S.. Within 16 months, the Fed had slashed interest rates from their peak to near 0; the BoJ took 9 years. The U.S. is already into a second and sizable fiscal stimulus package; meaningful and sustained ones were a while coming in Japan. And whereas the U.S. began injecting public money to recapitalize banks within a year after the bubble burst, it took Japan 8 years to do so.
5. In less than 2 years, the U.S. appears to have fast forwarded its way through more than half a dozen years of the Japanese crisis. As a result, many people expect the U.S. economy to also rebound much quicker. If this comes to pass, the U.S. would have avoided most of the pain that Japan endured, in waiting almost twelve years for a lasting recovery to emerge.
6. It seems, then, that some may be excused for wondering whether there are any real parallels. But are the two situations really that different and is the prognosis for the U.S. economy necessarily so much more benign? Unfortunately not. There is in fact a very real risk that the recovery may not be as rapid or as strong. Consider the following cautionary signs:
• First, despite unprecedented actions, financial market stresses remain high and economic activity continues to fall. In many ways, the current phase of the crisis closely resembles Japan after 1997, when the successive failure of several banks and securities houses paralyzed financial markets and led to a systemic banking crisis. It still took another 5 years for a sustained recovery to take hold. So while the U.S. may have leapt its way through Japan’s initial troubles, we do not seem to be out of the woods yet.
• Second, asset markets remain highly volatile amid persistent deleveraging, with no sign of a bottoming out yet in the housing market. Tellingly, Japan’s recovery was only possible once the excesses of the bubble period had been shed and land prices stopped declining.
• Third, the true extent of losses in the financial system remains uncertain and write-downs are still underway. Delays in credible loss recognition severely held back Japan’s recovery.
• Fourth, a post-bubble recession can undermine the long-term growth potential of the economy as risk repricing, deleveraging and financial restructuring dampen investment and curtail credit. Such forces appear to have been at play in Japan: even after a sustained recovery took hold in the early 2000s growth rates were only about half the 4 percent rate pre-crisis level achieved during the 1980s.
7. The truth is that a speedy and strong U.S. recovery depends critically on policy successes. It is contingent on fiscal stimulus having a meaningful impact, the success of the Fed’s new credit easing measures, and steps to stabilize house prices and stem the tide of foreclosures. Most crucially, it hinges on new policy measures to revive the financial sector that address the core problems of growing bad assets and lingering uncertainty about bank solvency. Over the longer tem, reforms to raise productivity will be needed to prevent a lasting hangover.
8. Fortunately, these are some of the areas where parallels with Japan could prove to be most useful. A post-bubble recession is much harder to combat than a cyclical downturn, with normal policy tools tending to lose potency. Moreover, its legacy can live on well after a recovery takes hold, threatening to lock the economy into a permanently lower growth trajectory. While the policy challenges facing the U.S. are compounded by the complexity of the distressed assets that need to be restructured and the global scope of the crisis, they are in essence very similar to those Japan had to confront after 1997.
9. Against this backdrop, Japan’s responses appear highly relevant in the search for policies to overcome the present crisis. During the course of this seminar, you will hear participants ask how successful the Bank of Japan was in implementing unconventional approaches to ease credit conditions once interest rates fell to their zero bound? With regard to fiscal policy, based on Japan’s experience, they will ask what measures can be used to stimulate the economy and how should risks to debt sustainability be assessed, particularly given that potential growth could fall? And in the financial sector, the important questions concern the strategies used by Japan to rehabilitate banks and restore lending and the key elements in designing a successful exit strategy?
10. I hope that Japan’s experiences will provide some insights to help address these and other critical questions facing the U.S.. In fact, similar challenges are increasingly confronting other parts of the globe. The stakes could not be higher. Can the world economy be prevented from slipping into a lost decade? My sense is that a lot will depend on the extent to which policymakers can learn from the policies that Japan employed, but I do not want to prejudge what you are about to hear.Thank you, and I look forward to what promises to be a fascinating seminar.