The Fundamentals of the Japanese Economy
Ryoichi Imai
International Student Center, Kyushu University
September 19, 2002
Contents
The course explores the fundamental issues of the Japanese economy.
Japan achieved the outstanding economic performances among advanced countries until 1990. After the crash of the 'bubble economy' in late 1980s, Japan dove into the economic slump that has continued for more than ten years.
What is the engine that dragged the economy down for such a long time? Some people say that Japan simply suffers from the low demand. On the contrary, others argue that the inefficiency of the supply side lowers the future prospects of the economy. Which one is the correct assessment?
The course is not intended to provide any direct answer to the question. Instead, it provides basic analytical tools and viewpoints that are crucial to the current debates of the Japanese economy, to students with various backgrounds.
Organization, Attendance, and Other Requirements
This course consists of one 90-minute session over the course of 15 weeks. The course begins with the instructor's lecture. Through the lectures along the course, the participants are expected to be familiarized with analytical tools and viewpoints. The last several sessions before the final exam are saved for the participants' presentation of one of the reading materials listed below, or their original work.
Satisfactory class attendance is essential. The minimum attendance requirement is to be specified.
The participants are required to be accustomed to construct their own arguments on the logically consistent ways of thinking. So it is crucial to fully understand the basics of modern economics, although they are not expected to posses any knowledge about the subject before the class starts.
None.
Class Discussion 20%
Presentation 40%
Written Final Examination 40%
1.The Neoclassical Growth Theory
It is necessary to start our journey to the Japanese economy with a review of the Neoclassical Growth Theory. The growth rate of national income is decomposed into the growth rates of capital, labor, and technology. The accumulation of physical capital through investments, and that of human capital through education, are important engines for growth. However, their roles are limited only to the catch-up periods of the economy. In the long-run, creation of new knowledge, or innovation in short, is the only engine for economic growth. Those fundamental properties of modern economic growth are well captured by the Neoclassical Growth Theory. The rapid growth of Japan in 1960s is interpreted mainly as its transitional process to more advanced economies such as the United States or the Europe Union.
Readings: Lecture Notes. Ito [1992], Ch. 3 Hayashi and Prescott [2001].
2. The Neoclassical Perspective to the Growth Miracle of Japan and Asia
In 1990s, the extraordinary rapid growth of China and South-East Asian economies induced the western intellectuals to regard the emergence of Asian economies as a 'Miracle'. However, some leading economists point out that the Asian economic growth has been simply brought by the accumulation of capital and labor, and technological progress has played only a limited role.
Readings: Krugman [1998], Ch. 11.
3. The 'IT Revolution' and Its Economic Impacts
In late 1990s, people were enthusiastic to admire the great achievement of the ICT (Information and Communication Technology) and expected the golden age of long-lasting economic growth to come ahead. However, the 'internet bubble' of the global stock markets crashed in 2000.
The Japanese economy had been suffering from the economic recession caused by the Asian financial crisis that burst out in summer 1997. The boom in the stock market in the United States provided it a chance of recovery from the recession. However, the slowdown of the US economy interrupted the recovery process and dragged down the economy.
Why did the 'IT Revolution' fail to be the engine of sustainable economic growth in the US as well as in Japan?
Readings: Gordon [2000]
4. Basic Macroeconomic Models (1): The IS-LM Analysis and the Liquidity Trap
Let us get back to your macroeconomics textbook and learn the IS-LM model, in order to understand the basics of the policy discussion in Japan.
Paul Krugman argues that the Japanese economy is suffering from the 'liquidity trap', in which the central bank is unable to stimulate investment and consumption because it cannot reduce the nominal interest rate below zero. The liquidity trap was pointed out for the first time by John Maynard Keynes. His prescription for the remedy of the trap is to increase the government spending. Is it also a useful suggestion for today's Japan?
Readings: Lecture notes. Any macroeconomics textbook.
5. Basic Macroeconomic Models (2): The Mundell-Fleming Model and Foreign Exchange Market Intervention
The Mundell-Fleming model is an open-economy version of the IS-LM analysis. It explores the relationships between GDP, the interest rate, and the foreign exchange rate. Although the model was developed in late 1960s, it still provides many useful insights into international macroeconomic issues today. The fiscal and monetary policies significantly affect GDP as well as the control of currency exchange rates.
In fall 1999, the yen appreciation was an obstacle to the full recovery of the Japanese economy. The bank of Japan was requested to take some decisive actions that were effective to prevent the yen appreciation. The distinction between sterilized and non-sterilized foreign exchange rate intervention is a key for the full understanding of the monetary policy controversy at that time.
Readings: Roubini. Any macroeconomics textbook
6. The Asian Crisis and the International Currency System
In April 1997, the government of Japan reduced government spending and increased the consumption tax rate from 3 to 5 percent. In the Mundell-Fleming model, a reduction of government spending or an increase in tax rates, leads to the currency depreciation. In fact, the yen depreciated down to 146 yen per dollar in August 1998, when the Asian economies were seriously damaged by the financial crisis, which bursted in May 1997.
Martin Feldstein argues that the government of Japan intentionally took the shrinking fiscal policy, which caused the yen depreciation at that time, and the weak yen was an indirect factor to cause the Asian Currency crisis. Does this claim make sense?
Readings: Feldstein [1997]. Krugman, Paul [1999].
7. The Deflationary Pressure of the Yen Appreciation on the Japanese Economy
Ronald McKinnon and Kenichi Ohno argue that the continuing yen appreciation is the main reason why Japan has been suffering from the economic slump since 1990. The yen appreciation has forced firms to reduce the production costs beyond their sustainability, and creates the ever-lasting deflationary pressure on the whole Japanese economy.
The authors recommend that the US and Japanese governments agree on the target range of the dollar-yen exchange rate. However, economists in the main stream doubt the enforceability of any agreement on the currency exchange rate targeting between advanced countries such as the US and Japan.
Readings: McKinnon and Ohno [1997].
8. The Bubble Economy and Its Collapse
The Japanese economy of the second half of the 1980s is commonly characterized as the "bubble economy".
Starting in 1986, the prices of assets (land and stock) doubled and then tripled within a few years. The Nikkei 225, which is the most popular stock price index, increased from 13,000s in December 1985 to 39,000s in December 1989. The price index for commercial land in six metropolitan cities tripled between 1986 and 1990.
The bubble started to burst in early 1990. The land price index declined by 70 percent through the end of 1990s. The Nikkei index fell down to 9000 in September 2002.
Readings: Cargill, Hutchison, and Ito [1997]
9. The controversy on the main source of the economic slump
There is a controversy on the role that the bubble and its collapse played in the slump of the Japanese economy in 1990s. Some authors criticizes the Bank of Japan for not moving sooner to stop asset prices from increasing further, and not taking necessary policies to stimulate the economy in the slump. They also blame the Ministry of Finance for its reluctance to clean up the mess of the bad loans that piled up during the course of the collapse. In other words, these authors consider the weak financial system as the main source of the slump.
The other authors focus on the real aspects of the economy. They claim that the main source of the long-run slump is a bunch of "structure problems", such as the inefficient government intervention into the private sectors, the inflexible corporate personnel practices including lifetime employment and the seniority-based wage system, and the over-investment in the public capital such as bridges and highways in the rural areas.
10. The "bad loan" problem
It is widely argued that the increasing 'bad loans' (, non-performing loans) is the main source of the economic slump of Japan since 1990. In fact, the Japanese banks have financially supported those inefficient firms, which continue to yield losses and accumulate debts.
Recently, the government finally urged the banks to clean up the bad loans. However, the final clearance of the bad loans is expected to create a large unemployment through the bankrupts of the firms. The increasing unemployment is expected to produce more bad loans through the slowdown of the economy.
Readings: To be announced.
11. Monetary Policy and the Inflation Targeting
Deflation is the most serious problem of the Japanese economy today. It is not the nominal interest rate, but the real one, that affects the firms' investment decision. The real interest rate equals the nominal interest rate less the expected inflation rate.
Today, though the nominal interest rate is close to zero, the real interest rate is strictly above zero, since the Japanese economy suffers deflation. To cause positive inflation is the fastest and the most effective way to stimulate the economy. It is mainly the central bank's role to control the price level. Therefore, it is argued that the Bank of Japan (BOJ) should announce a certain target of the price level or the rate of inflation, and do their best to realize it.
However, it is hard to create expected inflation by traditional tools available to BOJ. Now that the short-term interest rate is already zero, and the long-term rate is below 2%, there is almost no opportunity cost of holding the cash. No matter how large the money supply were supplied, people simply would hold that money, without spending them in any real commodities and assets. Therefore there is little hope to create inflation in the present environment .
Therefore, it is desirable for BOJ to make some untraditional policy decisions. For example, it is suggested to buy commercial papers (CP), corporate bonds, stock indices, and real estate funds, etc. However, many authors are against those policies by the various reasons.
Readings: Lecture Notes.
12: Public Investment and Tax Cuts
In order to stimulate the weak economy, the central and regional governments of Japan repeatedly implemented the policy packages consisted of increasing government investment and tax cuts. As a consequence, the governments piled up outstanding debts up to 666 trillion yen (5 trillion US dollars), without any remarkable sign of economic recovery.
The world has still requested the government of Japan to take more effective policies to stimulate the economy. However, there is a risk that the increasing government debts are rejected by the security markets.
Even if increasing national debts is desirable, here emerges the next question: Should the government increase public investment further, or reduce tax?
Increasing public investment results, by definition, in the rise of the GDP. However, the accumulation of undesirable and unused public capital will be the additional increase of the liability of the future generation. If further increase in public investment is inefficient, cutting taxes is a more desirable option.
Readings: To be announced.
13. Students' Presentation (1)
14. Students' Presentation (2)
All the course participants are required to present at least one of the readings listed below, or their original work.
15. Final Examination
Cargill, Hutchison, and Ito [1997], The Political Economy of Japanese Monetary Policy, MIT Press.
Dore, Ronald [2000], Stock Market Capitalism: Welfare Capitalism : Japan and Germany versus the Anglo-Saxons, Oxford University Press
Dornbusch, Rudiger [2000a], Keys to Prosperity, MIT Press.
Dornbusch, Rudiger [2000b], Fewer Monies, Better Monies on his Homepage.
Feldstein, Martin [1997], Japan's Folly Drags Asia Down, Wall Street Journal, November 25, 1997
Flath, David [2000], The Japanese Economy, Oxford University Press.
Gordon, Robert [2000], "Does the 'New Economy' Measure Up to the Great Inventions of the Past ?," Journal of Economic Perspectives, vol. 14 no. 4
Hoshi, Takeo and K. Kashyap [2001], Corporate Financing and Governance in Japan, MIT Press.
Imai, Ryoichi [2002], Lecture Notes, to be uploaded on the Homepage
Ito, Takatoshi [1992], The Japanese Economy, MIT Press.
Krugman, Paul [1998], Pop Internationalism. MIT Press.
Krugman, Paul [1999], The Return of Depression Economics, Norton.
McKinnon, Ronald I., and Kenichi Ohno [1997], Dollar and Yen, MIT Press.
Porter, Michael E. and Hirotaka Takeuchi [1999], "Fixing What Really Ails Japan," Foreign Affairs, May/June 1999.
Roubini, Nouriel [2002], Global Macroeconomic and Financial Policy Site
Additional readings to be added.