Measures Taken to Reduce the Economic Problems of Inflation in Japan - Case Study Example

Japanese Economy Name: Unit: Course: Supervisor: Date of submission: Essay 2 Introduction In 1992, Japanese economy experienced a downturn that has come to be termed as the Heisei Recession. Since start of the recession, the Bank of Japan (BOJ) and the government put in place measures that tamed inflation and ensured that the economy was relatively stable (Lincoln 2011, p. 353). However, in 1997, the economy experienced inflation with the key variables to economic growth experiencing decline. This paper discusses Heisei Recession that started in 1992. The paper will review the factors leading to the recession and the measures that were taken to ensure economic prospects before the real slump of 1997 and after. Overview of the recession The Heisei era started in 1989 with high economic expectations. The main movers of the economy were the rapid growth in the real estate and stock markets. The growth rate had accelerated after 1985 and reached annual average rate of 5%. This accelerated growth did not last for long; the period starting 1990 saw the key drivers of the economy plunge and a decrease in economic production was witnessed (Hamada 2003, p.3). The growth of any economy is, marked by having more workers, capital stock creation which is realised through factories, technological advancements and office building that all point to becoming more productive. This results to a country getting more from each worker. The workers serve as the unit of capital stock thus increased output points to economic growth. In period between 1988-1993 the hours workers worked per week went down from 44 to 40 hours. This had a direct impact on the per capita income. With the eroding confidence in the economy during the period, the per capita continued which affected the economy (Hamada 2003, p.4). In addition, the stock markets and the real estates were recording a sharp decrease. This meant that the players in the sectors could not service loans and most of the commercial banks were overwhelmed with the bad debts. The economy experienced overall price level decline and deflation set in. In period between 1992 and 1993, there were clear signs that the economy had underperformed which marked the onset Heisei Recession (Fumio & Prescott 2002, p.20). The recession was mainly marked by the fall in the asset prices. According to Hamada (2002, p. 9) the fall in the asset price have a profound negative effect in any economy. This is because people who have ownership to assets are more likely to spend and can borrow against the stock portfolios of the house. Failure in the asset markets saw spending which is key mover of the economy greatly reduced. Stock market prices and the real estate slumped by over 70% between 1992 and 1993.Therefore, fall in the prices of the real estate, stock markets and the decline in the per capita were actual fuels to the Heisei Recession that can be traced in 1992 but signs of decline started in 1989 (Lincoln 2011, p.362). Measures taken to reduce the economic problems of inflation Despite of the Heisei Recession having started in the 1992, the real economic problems in Japan were experienced in 1997. This was the time there was the great recession in the Asian countries. The effect of the recession in East Asian countries added to the already recession pinch that was being experienced in Japan and a real economic problems were experienced (Mori, Shiratuka & Taguchi, 2001 p. 61). Before 1997, measures were taken to cushion economy from the effects of the Heisei Recession. (a) Stock adjustment in the aftermath of the bursting of the asset price bubbles In 1990, the bureaucrat discount rate rose to its highest to six percent. The demand components that were sensitive to the interest rate changes included the residential and the business fixed investment for both small and medium enterprises. This were the main variables to economic health, a change in either affected the economy. In 1991, there was decline in the growth of the variables that was followed by inventory adjustment started with the adjustment process for durable goods, capital stock and residential stock took place. In general, during period spanning 1991-1993, the assets price experienced the major fall and there was the rapid decline in the monetary growth aggregates. Even after hitting the peak high in 1990, the Urban Land Price Index continued to experience decline (Mori, Shiratsuka & Taguchi, 2001 p. 61). The slow down experienced in the period saw the government through the BOJ react by injecting an economic stimulus. This was a monetary easing policy in which BOJ brought down the 6% discount to 2.5%. The implementation of the monetary easing measures cushioned the economy and the economic problems such as inflation were not felt very much, in fact, Japanese residential investment started to recover as from 1993 due to the measures. The business fixed investment was not affected by the changes effected by BOJ (Takeo 2001, p.2). The depth for the needed capital stock was increased by expectation in growth shift; however, this ended up in a collapse. The balance sheet adjustments by BOJ were more felt in the small and the medium sized manufacturers. Business fixed investment in the small and medium sized manufacturers showed signs of recovery than the other sectors. This was attributable to the fact that the sectors were highly sensitive to changes on the interest rates (Mori, Shiratsuka & Taguchi, 2001 p. 68). It is debatable that the BOJ measures failed to rescue the economy inn long run. However, there were signs of economic recovery witnessed between 1994 and 1996. The period was marked by business capital stock and adjustments in inventory almost being complete. The real estate sector continued to experience decreases in the price, thus many business firms maintained the adjustments of the balance sheet. The financial institutions in which most of the under performing loans were from the real estate sector also continued to experience problem of the non-performing assets. During the period, there was collapse of some companies involved in the house loans. These were the companies and bank affiliated non banks that had embarked on aggressive lending to both small and medium sized firms within the real estate during the bubble years (Takeo 2001, p.6). Specifically in 1994, the monetary stimulus measures did revive the economy strongly. There was marked improvement in the residentoial investment. However, as noted by Takeo (2001, p. 19) the land prices continued to record price decreases, firms accelerated the balance sheet adjustments and the Japanese Yen, which was high forced some manufacturing companies to review the location basis based on global performance. These factors greatly hindered the upward movement of the economy. The factors preventing the upward movement of the economy had deep effect on the investors and the public. In 1995, there were chain of events that eroded the confidence of the economic recovery among public. For instance, there was the Great Hanshin-Awaji Earthquake, the Yen continued to appreciate amid the weak economic growth and the stock prices experienced fall. The strong Yen against the US Dollar went as high as ¥79.75 per U.S. Dollar on 19th April, 1995. It affected businesses both indirectly and directly due to the downward pressure exerted on the stock market that was already having problems. This saw a fall in the goods imported, there were many low priced manufactured goods from other Asian countries (Mori, Shiratsuka & Taguchi, 2001 p. 71). Policy Responses to Yen’s quick appreciation The economic effects of the rapidly appreciating Yen were countered by BOJ that devised measures to easy the monetary condition. The official discount rate was brought down from 1.75 to as low as 1% in April 1995. The BOJ further reduced the market interest and the discount rate was further reduced from 1 to 0.5% in April 1995 (Mori, Shiratsuka & Taguchi, 2001 p. 79). The government added to the effort by putting economic policies which were aimed correcting the appreciation of the Yen. The policy measures were aimed at influencing deregulation and imports. The Japanese government in the same year launched a stimulus package that was valued at ¥14.2 trillion. The policy measures taken by the government and BOJ had a marked success in ensuring that the economy did not stagnate and curbed possible inflation. These measures saw the economy record some positive movements in the second half of 1995 onwards. For instance, the import deregulation by the government led to growth in manufacturing companies and telecommunication sector. The fixed business investment n the second half of 1995 recorded growth, which was the record first time since 1991 (Kuttner & Adam 2001, p.96). From 1995, after the BOJ and government policies that cushioned the economy against the appreciating Yen and the fiscal stimulus by the government, there was a marked rebound in the stock prices. This restored the confidence of the investors. In 1996, the private demand increase and public investment by the government increased the fixed investment, private consumption and the accumulation of the inventory increased growth of economy which resulted to 5% annual growth (Mori, Shiratuka & Taguchi, 2001 p. 69). The deregulation measures that had positive effect on the large-scale retail businesses and the telecommunications were major contributors to the economic recovery. The disposal of nonperforming assets and loans During the period of 1994-1996, which was marked by the temporary economic recovery due to the intensive measures taken by the government and the BOJ, the financial institutions were still having the problem of he non performing assets. Small and medium sized enterprises asset value, which was mainly from the bank borrowing and other financial institutions continued to fall. This was attributable to the limited economic recovery and the land prices that continued to record decreases. For instance, there was excessive risk investment in the bank-affiliated non-banks in the high-risk real estate investment. There was need to dispose the nonperforming assets including the loans which were affecting the growth of the financial institutions (Takeo 2001, p. 8). However, due to the political issues surrounding the disposal in relation to cost of disposal and the cost the affected financial institutions were to bear, the disposal delayed. In the close of 1995, the cabinet approved ¥685 billion for the disposal of the loans and the nonperforming assets. This was approved in June 1996. This measure further stabilized the financial system of Japan and kept inflation rates on check (Mori, Shiratuka & Taguchi, 2001 p. 74). Serious recession, financial system instability, and fiscal consolidation In 1997, the economy faced copious economic drawbacks. The shocks were due to the already factors that had been building up since the start of the Heisei Recession in 1992. There were changes in government policy. The government increased the taxes in consumption, waived the special tax diminution as well altering the medical cover that increased the weight on those covered from 10% - 20%. These moves had profound effect on the consumer spending and started to erode the confidence on the recovery measures that had been taken before. The economic crisis was increased by the East Asian crisis in economy that was mainly resulting from the devaluation of the Thai baht. These happenings saw a collapse of major and significant financial institutions in Japan. Stability in financial system of the country was almost halted (Goldstein 2000, p.3). The collapse of the financial institutions reduced the confidence of the households. The partiality to consume went down. This resulted to sizeable decline in the consumption expenditure. The East Asian economic crisis affected the exports from Japan to the countries. This increased the downward movement of the economy. The reduced consumption expenditure led to fall in final demand and there was a significant shrinking of the production activities. The economy was shut in a cycle of decline. There was decline in demand, production activity declined, corporate labor income and profits also declined, decline in fixed investment and the private consumption recorded declines. From the fourth quarter of 1997, the real GDP realized negative growth which continued for five consecutive quarters due to continued declines (Mori, Shiratsuka & Taguchi, 2001 p. 64). This was the major economic problem experienced since 1992. This vicious cycle of decreases in every sector was a major setback for the efforts that the government and the BOJ had been putting in place. Media further aggravated the economic problem when it highlighted prevailing conditions; issue of the nonperforming assets that had taken almost a decade became very much recognised in the international arena. This increased the distrust from international markets that further hindered the foreign investments in the country (Hamada 2002, p. 19). Economic prospects after 1997 economic problems The fiscal policy started by the government during the temporary economic recovery changed in 1997. The government stance on the fiscal policy changed and the government opted for the adoption of the fiscal consolidation. For instance, the government increased the tax on the consumption tax. This move by the government did not yield the results that were intended. After the move, there was a regional economic crisis i.e. East Asian economic crisis. Despite of the recession having started in 1992, this was the greatest hit on Japan and real economic problems started being felt. The economy fell into deep recession and the real GDP for Japan posted negative growth for five quarters from 1997. This was due to the economic crisis in the region that saw the Japanese investors being very much concerned by financial stability of the system. This saw the consumers becoming more cautious on the spending. The function of the financial intermediary further went down and there was negative effect on the business fixed investment (Mori, Shiratsuka & Taguchi, 2001 p. 68). To maintain the prospects of the economic recovery, the government retracted expansionary fiscal measures that were put in place from 1998. This included investment in public sector and reintroduction of special tax. To restore the steadiness within the financial system, the government injected funds to the financial sector. The BOJ put in place these steps through the adoption of a zero interest rate policy. These measures reduced the decline of the economy and there were signs of the improvement by 1999 (Mori, Shiratuka & Taguchi, 2001 p. 69). Conclusion The Heisei Recession which started in 1992 affected the Japanese economic pillars especially in the real estate and stock markets. There was a marked reduction in the assets prices that reached up to a low of 70%. However, the economic experiences from 1992 were mitigated by various measures taken by the Bank of Japan (BOJ) together with the government. This saw temporary economic reprieves resulting from the solving of the structural problems and better understanding of the economic shocks that were being experienced from 1992 to 1996. This cushioned Japan from real economic problems despite of the continued fall in the land prices. However, in 1997, the changes in the government fiscal policy to fiscal consolidation, the accumulated effect of the fall in land prices and reduced investment in fixed assets coupled with the East Asian economic crisis that affected the Japanese foreign trade resulted in real economic problems in Japan. The real GDP recorded five consecutive declines and a vicious cycle of decline was witnessed in major sectors. References Fumio, H. and Prescott, E. 2002. The 1990s in Japan: A lost decade. Review of Economic Dynamics, pp. 206-235. Goldstein, M. 2000. The Asian financial crisis: Causes, cures and systematic implications. Washington, DC: Institute of International Economics, pp. 2-7. Hamada, K. 2003. The Heisei Recession: An overview. Yale University, pp. 2-39. Hamada, 2002. Nonperforming Loans versus economic recession. The Japanese Economy, 30 (1), pp. 8-21. Kuttner, K. and Adam, P. 2001. The Great Recession: Lessons for Macroeconomic Policy from Japan. 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