Is The Bank of Japan Responsible For The Lost Decade?

Lost in Finance
Is the Bank of Japan responsible for the Lost Decade?
University of Leiden, the Netherlands

Name: Maurits van der Vegt
Master: Economic History
Student-id: s0506508
Seminar: Research seminar economic history
Submission date: 18th of December 2009
E-mail: maups_adres@hotmail.com
Maurits van der Vegt Research seminar Economic History
Contents
Introduction 3
Chapter one: The quantity of money 5
Chapter two: A brief history introduction:

from high growth to a prolonged stagnation 8
Chapter three: Japan’s banks in trouble 12
Chapter four: Monetary Policy 1985-2008 21
Chapter five: Biotechnology and IT,

any signs of structural problems? 26
Chapter six: Conclusion:

revisiting Princes of the Yen 31
Bibliography 33
2
List of Graphs
Figure 1: Real GDP Growth Japan 1956 – 2008 8
Figure 2: Growth Accounting 1980 – 2004 9
Figure 3: Inflation Japan 1955 – 2008 10
Figure 4: Ratio of unemployed in labour force 1970 – 2008 11
Figure 5: Equity and asset gains Japanese main Banks 14
Figure 6: Bad Loans banking system 17
Figure 7: Profitability Japanese Banks 17
Figure 8: Credit & GDP Growth 19
Figure 9: Land prices for six metropolitan areas 21
Figure 10: Bank of Japan interest rate 1987 -2008 22
Figure 11: Monetary Aggregates 1968 -2004 24
Figure 12: Number of New Start-Up companies in Japan 27
List of Tables
Table 1: Net Income (loss) of the ten largest Japanese electronic firms 28
Table 2: Electronics Exports 28
3
Introduction
“The United Kingdom has an uncomfortable parallel with the Japanese financial system when the
Japanese economy began to recover in the mid-1990s and was unable to sustain it,” Mr. Posen said
in his speech (21 November 2009).1
“U.S. officials contemplating an exit from record fiscal stimulus are in danger of repeating mistakes
that plunged Japan into its lost decade of stagnant growth,” told Richard Koo of Nomura Research
Institute Ltd. to Bloomberg.com (22 October 2009).2
With the current crisis Japan’s Lost Decade has gained interest from all over the world. In Western
Europe and the US, we are warned that we face the same long-term stagnation as Japan did after its
bubble burst in the early 1990s. As it seems to be a grave danger there is a strong necessity to
understand what happened in Japan beyond the simple notions of stagnation and deflation.
Much research has been done already on Japan’s lasting economic problems. During the last 15 years
many observers have commented on the origins of Japan’s problems and aired possible solutions.
Most research has focused on structural problems, mostly the lack of domestic competition, or the
ineffectiveness of the governments fiscal policy. Also the Bank of Japan takes part in the blame,
especially from Richard Werner, one of its fiercest domestic critics, who published in 2003 his book
‘Princes of the Yen’, a highly popular (at least in Japan), but also a vicious book. His central
message is that the central bankers of Japan deliberately caused the late 1980s real estate bubble and
prolonging the recession during the 1990s. The reason he gives is that the experts of the Bank of
Japan were convinced that Japan needed to restructure from its dirigiste government style to a
deregulated free-market economy. Most other monetary critics, like Adam Posen and Ben Bernanke,
blame the Bank of Japan for behaving too cautious, but do not see it as the main culprit.
Richard Werner is not an unknown periphery economist as he has an already impressive background
as a scholar at the London School of Economics, the University of Oxford and the University of
Tokyo where he received his basic training. His knowledge of Asia and Japan in particular was
further strengthened by his professional work with institutions like the Asian Development Bank,
Japan’s Ministry of Finance and the Bank of Japan, among others. He is currently a professor at the
University of Southampton and was selected a ‘Global Leader for Tomorrow’ by the World
Economic Forum in Davos in 2003.
The important friction in Werner’s book is his central idea about the power of the central bank. He
more or less states that the central bank creates recessions, recoveries and most other kinds of
economic phenomenon’s. In proving his argument Werner is strongly macro-economically focused,
in which he makes money the central theme. With Werner’s dismissal of any effectiveness of fiscal
policy,3 despite the availability of empirical evidence of at least some positive effects,4 Grimes
characterizes Werner therefore as an old school monetarist.5 This also is not entirely true, as Werner
actually updates the monetarist argument (see chapter 1). He does this by borrowing the, undisputed,
1
L. Thomas, ‘Lost Decade feared for British Economy, ‘ Herald Tribune (21 November 2009) 1.
2
J. Clenfield, N. Kosaka, ‘U.S. Risks Japan-Like ‘Lost Decade’ on Stimulus Exit,’ www.bloomberg.com (22 October
2009) 1.
3
R.A. Werner, ‘Response to William Grimes,’ The Japanese Economy 31:1 (2003) 84; Werner’s argument is a little
more nuanced. He argues that without extra credit supply or quantitative easing from the central bank fiscal stimulus will
result entirely into a crowding out effect. As Werner’s argument is exactly the lack of this QE policy, fiscal policy is
therefore irrelevant.
4
A. Posen “Passive Savers and Fiscal Policy Effectiveness in Japan” Working Paper (2001) .
5
W.W. Grimes, ‘Comment on Richard Werner’s ‘The Enigma of Japanese Policy Ineffectiveness: The Limits of
Traditional Approaches, not Cyclical Policy’, ’ The Japanese Economy 31:1 (2003) 70.
4
theory of credit rationing, popularized by Stiglitz,6 to make the supply of credit the determining
factor. And therewith he attacks the Bank of Japan, by arguing that through the ‘loan growth quota’
or ‘window guidance’ they controlled supply and thus the economy. I will discuss this in-depth in
chapter one.
With the emphasis on the quantity of credit he takes away the focus from interest rates, as the market
behaviour is about quantity under the restraining condition of credit rationing, and traditional
monetary aggregates as M1 and broad money measures. To validate or dismiss his controversial
statements we should look at the credit relationship between the Bank of Japan and the real economy,
by which we introduce the banks.
This thesis will look at the role of the banks, who were responsible most financing needs in Japan,7
during the boom-bust cycle of the 1980s and 1990s. I will investigate whether the Bank of Japan
deliberately created and prolonged the Lost Decade, as Werner argues. The counter argument is that
structural problems were indeed responsible for the economic woes, as the Bank of Japan argues.
Werner uses the principals of credit rationing for formulating his thesis and rewriting macro-
economics, but the effects of credit rationing are still subject to a lively debate from
macroeconomists.8 Most of the research ignores the effects of regulations and government policy.9
Additionally to the main thesis I will argue that regulation and policy have an important effect on
credit rationing and should therefore be part of the discussion, as they are not only being ignored in
Werner’s model, but in credit rationing theories as well.
Chapter one will introduce the theoretical model as used by Werner to make his argument. We will
argue that a central item in his argument is the power of the Bank of Japan over the overall banking
system. Chapter two will give an introduction to the reader about the broader Japanese economy and
financial system during the 1980s until 2008. The third chapter will take a look at the financial
system of Japan. The Fourth Chapter will look at the several monetary policies during the economic
stagnation. In Chapter 5, I will go into two key economic sectors and their experience during this
period. In the final chapter I will conclude the argument of Werner versus the Bank of Japan.
This paper will not delve into Japan’s fiscal policies, especially its fiscal stimulus measures, as it
goes beyond the scope (monetary policy and the financial system) of this paper.
6
B.R. Frieden, R.J. Hawkins, ‘Assymetric Information and Economics,’ Physica A 389 (2010) 288; Stiglitz and
Rothschild already argued that ”some of the most important conclusions of economic theory are not robust to
considerations of imperfect information”.
7
T. Beck, R. Levine, ‘Industry growth and capital allocation: does having a market or bankbased system matter?,’
Journal of Financial Economics 64 (2002) 148.
8
See for example the above article from Frieden and Hawkins, but also J.F. Slijkerman, D.J.C. Smant, Casper G. de
Vries, ‘Credit Rationing Effects of Credit Value-at-risk, ’ Tinbergen Discussion Paper (2004); and also many other
approaches in diverse literature.
9
J.F. Slijkerman, D.J.C. Smant, Casper G. de Vries, ‘Credit Rationing Effects of Credit Value-at-risk, ’ Tinbergen
Discussion Paper (2004) 2.
5
Chapter one: The quantity of money
Werner takes ideas from credit rationing, asymmetric information, the credit creation capabilities of
banks and some macro-economic analysis to revise monetary theory and give credit supply the
central role, he thinks it should have. Therefore Werner introduces an interesting proposition about
Fisher’s quantity of money theory. We will discuss his theoretical adjustments to the original theory
first. Then we will discuss two of its consequences for the banking sector and the real economy.
1.1: Werner restating Fisher’s equation of the quantity of money

Werner builds his argument around Fisher’s quantity theory of money. This equation represents an
equilibrium relationship between the circulation of a given money stock (money (M) times velocity
(V)) and the value of the transactions which it is used to purchase (prices (P) times transactions (T)).
MxV=PxT
This equation looks simple, but defining its components proved hard. Money stock is still under
discussion and ranges from narrow definitions (only cash and central bank deposits) to broad money
(including grey areas like time deposits and other semi liquid assets). Velocity is the rate of
circulation of those money balances that are used over time to conduct transactions. Velocity is the
result of the intermediation system (golden coins or credit cards, etc).10
But beside these definition problems, it is more important to note that Fisher’s equation is part of the
classical economics paradigm. Fisher’s equation determines absolute prices in a monetized economy,
where money exists merely as a veil (although Patinkin’s rule made some adjustments to this11). The
real economy, where goods are offered and real growth is produced, acts in a Walrasian system of
relative prices.
Money growth does have an effect in this system of neutral money, but it is a temporary effect, in
which the goods market would return to the natural equilibrium.12 The basic assumption is that the
return to the natural equilibrium is caused by rising prices. Werner argues that this assumption is
based on markets always returning to equilibrium as they function with perfect information. Real
market participants do not act in an environment of perfect information and therefore Werner argues
that markets and also the credit market is a rationed market, with which he joins a growing field of
economists. His more controversial argument is that interest levels are not relevant at all and that it is
all about quantity restrictions. I think this is an oversimplification of the main argument that in
rationed markets prices do not create market clearing.13 But a lot of research in the field of credit
rationing still needs to be done, so no final assessment can be made.
Werner´s choice of credit as the prime monetary factor has implications for Fisher´s model. He
argues that instead of the difficult choice of money definition, credit is a good substitute. He takes
velocity out of his equation by changing the equation towards credit creation (instead of a stock
10
Velocity is, at least in the short term supposed to be relatively stable in order to have a stable relationship between
money and income as Milton Friedman predicted. But during the 1980s this relationship was brought down, due to
innovation (changing definitions of money) and also changing velocity. For Japan Werner shows that velocity decline
had more to do with the definition of GDP and inflation than with velocity. With rising asset prices not calculated into
GDP, but used for transactions, velocity seemed to decline (more money, stable GDP). But taking some asset related
sectors out of the money equation, velocity is relatively stable. Although not revolutionary, these findings, that are
essentially additions to mainstream macroeconomic thinking that makes Werner’s contribution really interesting.
11
M.K. Lewis, P.D. Mizen, Monetary Economics (Oxford 2000) 73-82.
12
Ibidem 84.
13
J.E. Stiglitz, E. Weiss, ‘Credit Rationing: Reply,’ The American Economic Review 77:1 (1987) 228-231.
6
equation towards a flow based equation) velocity has been removed from his model (the stock based
model of Werner does contain velocity).
Raising money supply in the classical theoretic model will lead to rising prices as the current
potential production is already fully employed. Werner tries to counter this conclusion by stating that
money growth should be credit growth that is being invested only into productive investments.
Productive investments do not result in inflation, or rising prices, so there is no return to the so-called
natural equilibrium. Instead the natural equilibrium has been put higher. Werner does not completely
shut out inflation, as price rises in the real economy through normal market pressures will still be
there. Finally, the kind of productive investment should be oriented towards higher productivity
(output per unit of input should grow) to avoid diminishing returns.
Another interesting change to this definition is that Werner splits the transactions into productive
transactions (which contain GDP) and speculative transactions (that merely relate to asset prices, but
are not incorporated in GDP). This is important, as money directed towards unproductive
investments in financial assets, will result in prices rises in asset markets and consequently in
bubbles. This is less revolutionary, as it is also implicit in the Patinkin’s Real Balance Effect where
money growth, does have effect in the Walrasian model of the real economy through commodity
prices). So Werner ends up with the following adjusted model, which states that growth in credit into
productive investments results in a growth of nominal GDP (or GDP adjusted for the price level,
where Pr refers to the GDP deflator).
ΔCr = Δ(Pr x Y)
So a rising credit supply towards productive investments should raise Y, although price rises are still
a possibility, but it is not a natural reaction.
1.2: Consequences of Werner’s restatement

In today’s monetary thinking and modelling, expectations have been added, but long term neutrality
of money is still accepted wisdom. Also in orthodox monetary thinking short term monetary
expansion can lead to growth, so if monetary expansion leads to productive investment, the natural
rate can be increased and sustainable growth can be the result. Just as Werner states. But Werner
makes quantity, not price, the determining factor. This sounds like a return to monetarism, but
through productive investments he brings in new way of looking towards the neutrality of money.
From here we run into two difficulties, which I will discuss separately. First we discuss the credit
creation or banking system and secondly ‘productive investments’.
The banking system

First, as Werner directly accuses the Bank of Japan, I will discuss how the central bank injects
money into the real economy. Here enters the banking system. Werner correctly states that credit
creation, in a fractional reserve banking system, is primarily done by the banks (central bank itself is
the other). A deposit with a bank can be lend out multiple times, as the bank only needs to keep a
fraction as a reserve, which amounts to the deposit (so $100 deposit, leads to $900 in extra loan
capacity, if the bank needs to have a 10% capital ratio requirement). This system works well if
everything is alright, but faces heavy problems when a financial crisis appears. We can identify two
problems here.
First there is the amount of bad loans in relation to the bank reserves and equity. In a sudden crisis
,with many unanticipated bad loans and low loan loss reserves, the bank needs to write down heavily
on its own equity (either direct, or through the profit and loss account), which will result in reduced
lending capacity. Another problem then also arises. With less capital, the minimum capital ratio’s
7
will be breached. So to conform to the legal structure (normally the Basel I and II norms), the banks
will have to shrink their loan portfolio to rebalance their loan-capital ratio. Instead of credit creation,
this will result in credit retraction, or better known as a credit crunch. Finally, as Basel is a risk-
weighted system, banks will do anything to avoid acknowledging higher risks. So non performing
loans will be classified as well performing loans, etc. This all leads to a sterilization of central bank
policy as its credit creation channel has been crippled. So we will look at the effects of the bad loan
problem in Japan, the reactions of the banks and the government towards this problem (chapter 3).
Furthermore we will also look into the central bank policies. What policies did they implement and if
these were effective. (chapter 4).
Productive investments
The second idea behind Werner’s proposition is the injection of credit into productive assets.
Identifying productive investment sounds easy (just invest in factories according to Werner) but
reality is more complex. Productive investment should invest into markets where there is enough
growth in demand.
Take for example a market for automobiles. An investment results in a car factory which in turn
leads to greater overall output of 10%, while the demand only grows 5%. To reach equilibrium the
prices of the cars will go down. This will result in deflationary pressures in this market. Furthermore,
as the factory is build with loans instead of equity (as this is what Werner proposes), the income of
the factory will go down as the interest payments will take a bigger part of revenues than under the
older prices. This will result in a lower overall profitability of the entire branch. The loans will carry
more risk (the risk of default goes up, as the profits go down). This will result in a downgraded loan
portfolio of the bank and the ability to lend will go down.
So the problem is to identify productive investment. This touches the subject of economic growth.
Although how economic growth should be created is still hotly debated, we can get an idea what
factors are important to economic growth. Economic history has shown that productivity growth (or
efficiency, or total factor productivity) is elementary to sustainable economic growth. Identifying
productivity in general economic data is impossible.14 Therefore we will take a look into two of the
known growth sectors of the last three decades, namely biotechnology and IT. But we are not only
interested in the performance of these sectors in Japan. One of Werner’s assumptions in his model of
credit creation is that the Bank of Japan, through the banking system, is able to identify productive
investment possibilities. Werner merely states that nothing is wrong with the real economy, so we
will look at two of important growth sectors of the last three decades (Chapter 5). How did these
businesses fare in Japan? If Werner is correct, financing constraints should have been the biggest
problems in these sectors. If the Bank of Japan is correct, structural problems within the economy
should have been the problem.
14
A.J. Alexander, In the Shadow of the Miracle: The Japanese Economy Since the End of High-Speed Growth (Oxford
2002) 42-43
8
Chapter 2: A short history introduction: from high growth to a prolonged stagnation
Before we go into detail we first describe the macro-economic situation in which Japan found itself
during the period under review. We shortly brief macroeconomic indicators like GDP growth,
productivity, unemployment and inflation.
GDP growth
Japan’s economic miracle is comparable to the wirtschaftswunder of Germany during the 1950s and
1960s. After the second World War Japan started rebuilding its economy in a catch-up mode to the
United States with a highly centralised and interventionist government. This resulted in heavy capital
investments that not only supported high growth but also stimulated productivity as investments
incorporated new technology. The high growth ratio slowed down during the 1970s to an average of
5 percent. GDP growth slowed down further in the early 1980s (the first half showed an average of 3
percent growth), but the bubble era of the second half delivered on average slightly more than 5
percent. The 1990s were bleak, with a first half of what could be seen as a ‘soft landing’ where Japan
only slightly dipped into negative figures. But, as can clearly be seen, it never really recovered
afterwards, with an average growth over the 1990s of just 0.7 percent. The 1997-98 Asia crisis was
harsh on Japan and the benefits of the dotcom bubble only gave temporary relief. Since the dotcom
crash average growth rates never went above the 2 percent, the average for the first 8 years of the
new millennium was just under 0.5 percent. Japan has had, and still hass, for almost two decades a
truly stagnant economy.
Figure 1
Real GDP Growth Japan 1956 2008
20.00%
15.00%
10.00%
percentage
5.00%
0.00%
-5.00%
-10.00%
56
58
60
62
64
66
68
70
72
74
76
78
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
year
Source: Bank of Japan
Productivity
Productivity growth is generally seen as essential to sustainable growth. The problem for economists
though is that productivity is difficult to measure. With the presented figures below the growth
accounting method is used. Productivity is the residual result of the calculation.
ΔGDP = ΔLabour + ΔLand + ΔCapital + Total Factor Productivity
Did Japan’s productivity growth continue during the 1990s? Looking at Japan, we see a country that
is known for its high quality products like cars and electronics. It is also known for efficient
9
manufacturing systems, like Toyota’s ‘just-in-time’ manufacturing and total quality management
systems.15 But these systems have been around since the early 1980s and most competitors have
adopted similar systems. Also the efficient systems are only found within competitive exporters and
then mostly within the factory instead the administrative offices. Office work (within manufacturing
companies or in other service industries) is still highly protected and not efficient. An excess of
workers ranging from 15 to 20 percent of the total white-collar work force results in a low
productivity of all in-house and purchased services, which amount to almost two-thirds of all
economic activity. 16 But the figures below also show that capital accumulation dropped significantly
during the 1995/2004 period. This might reflect the difficult financing problems for Japanese
companies, but other factors (less capital intensity in IT sector for example) might be important as
well (see chapter 5). The declining labour input has been primarily the result of less hours worked,
instead of a shrinking labour population.17
Figure 2
Growth Accounting 1980 -1995 Growth Accounting 1995 - 2004
4 4
3,5 3,5
3 3
Contribution of Contribution of
TFP Growth TFP Growth
2,5 2,5
Percentage
2 Contribution of 2
Percentage
Contribution of
capital input capital input
growth growth
1,5 1,5
1 Contribution of 1 Contribution of
labor input growth labor input growth
0,5 0,5
0 0
-0,5
-0,5
Japan US Germany UK Japan US Germany UK
Country Country
Source: EU KLEMS
15
A.J. Alexander, In the Shadow of the Miracle, 42.
16
Ibidem, 43.
17
K. Fukao, T. Miyagawa, ‘Productivity in Japan, United States and the major EU economies: is Japan falling behind?,’
EUKLEMS Working Paper (July 2007) 5
10
Inflation
Many countries have a history of problems with high inflation, like Germany’s hyperinflation of the
interbellum period. Japan only experienced relatively high inflation during the 1950s and 1960s.
During the early1970s, inflation in Japan, as in the rest of the world, was becoming a major problem.
In Japan it looked like getting out of hand with inflation reaching 23 percent in 1974. But swift
action by the government through fiscal and monetary intervention quickly reduced inflation under
10 percent. Inflation figures showed a declining trend from then onwards up to the end of the 1980s.
The early 1990s showed a temporary increase in inflation as the central bank eased monetary policy
through declining interest rates. But in 1995 Japan saw its first annual deflation. The following years
were slowly improving, but as from 1999 Japan has seen almost continuous deflation. The central
bank’s policies, with aggressive monetary tactics, like a zero interest rate policy and quantitative
easing during this period, were not successful.
Figure 3
Inflation in Japan 1955 2008
22.50%
17.50%
percentage
12.50%
7.50%
2.50%
-2.50%
56
58
62
66
70
78
82
84
86
90
92
96
98
00
04
08
60
64
68
72
74
76
80
88
94
02
06
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
19
19
19
19
19
20
20
year
Source: Statistics Office
11
Unemployment
Japan has often been accused of having an inflexible labour market, but is also being heralded for
very low unemployment figures. Japan has a very peculiar labour market system. Mostly it is known
for its life-time employment, which often includes not only this remarkable guarantee, but also items
like housing, transport, pensions, etc. In fact Japan’s social policies run through the companies.18
Government support is mostly absent. In Japan, if you become jobless or sick, your family is
supposed to look after you. This was a workable system for ages, but it had its flaws during a
downturn. First of all the company benefits of life-time employment existed only in the large
corporations. Most small companies did not have these luxurious secondary labour conditions. This
leaves out big part of the population of social security. Furthermore the social security is only there
as long as your company is around. If it goes bankrupt not only do employees lose their jobs, they
lose everything, from pensions to housing. So companies must survive from a government point of
view to fulfil their social responsibilities. Also in the small companies employees tend to work past
the official pension age, as they lack sufficient income after retirement. 19 These problems were not
visible in the standard macro-economic figures, which tend to be compared to other countries. In
which Japan looks very favourable:
Figure 4
Ratio of unemployed in labour force (% ) 1970 - 2008
12.0
10.0
Japan
8.0
percentage
United
6.0
States
4.0 Germany
2.0
0.0
19 70
19 71
19 79
19 80
19 82
19 83
19 87
19 91
19 94
19 95
19 96
19 98
19 99
20 07
20 08
19 72
19 73
19 74
19 75
19 76
19 77
19 78
19 81
19 84
19 85
19 86
19 88
19 89
19 90
19 92
19 93
19 97
20 00
20 01
20 02
20 03
20 04
20 05
20 06
year
Source: Statistics Office
18
A.J. Alexander, In the Shadow of the Miracle, 40
19
R. Minami, The Economic Development of Japan. A Quantitative study (London 1994) 209
12
Chapter three: Japan’s banks in trouble
3.1: the banking system

As Werner makes banks central to credit creation within rationed markets, I here set out the structure
of the Japanese banking system. First I will introduce the fragmentation of the banking system itself,
then I will delve into the changes of the regulatory and supervision of the system.
A fragmented system
Japan’s financial system has been formally segmented into parts that each have specific functions.
First there are the privately owned ordinary banks (with no special function). This group consists of
the large city banks, among the largest in the world, which perform mostly short-term finance of all
kinds of business, funded mostly by private depositors and the short-term financial markets. These
banks have a nationwide branch system. Secondly there are the Regional banks, which do business in
specific regions only. There are also some 90 foreign banks in Japan, which specialize mostly in
foreign currency transactions and trade finance. They are financed mostly from foreign capital
markets, as their entrance to the domestic market is still restricted (also indirectly through restrictive
tax policies20). Beside these banks there are specialized institutions which focus on long-term
financing with long-term credit banks and trust banks. Small and medium sized companies are being
financed mostly by small Shinkin banks, which are locally oriented non-profit cooperatives that only
are allowed 20 percent lending to non-members. 21 Beside these there are public entities, which
contain deposit taking Japan Post and non-deposit taking institutions that support industry (trade
finance and development finance). The largest city banks are all part of so-called financial keiretsu’s
in which they are the main bank for many manufacturers and service businesses with which they also
have cross-shareholdings. This intimate relationship has long been seen as part of Japan’s post-war
success, but have been under scrutiny since the problems in the system became apparent.22 They have
been forced by the Financial Supervisory Agency (FSA) to reduce crossholdings since 2001, when
the FSA tried to solve the non-performing loan problem. Formally the financial keiretsu has been
eliminated, informal ties though still exist.23
Changing Regulators
The banks need licences from the Ministry of Finance (MoF), which lost most supervision and
regulatory powers to the FSA between 1998 and 2000.24 The MoF was all powerful until the 1998
‘Big-Bang’ reforms. Their policy until 1997 was called the convoy-system, that effectively shut
down any competition. Interest levels were set so that the weakest bank could survive and banks
were kept in a relative size to each other to avoid disruptions. The MoF did not want any bank to fail,
which became explicit with the 1983 change to a full deposit guarantee system (now all types of
banks were part of the guarantee system, although still capped at a maximum). During the early
1980s several small changes were made, most importantly the creation of a domestic corporate bond
market. In 1989 the Basel I norms were adopted, which resulted in a range of new laws and policy
changes. During the early 1990s most new laws were adopted to strengthen the accounting rules and
transparency up to international levels. As from 1993 the MoF required banks to publish bad loan
provisions and capital ratio’s (although this first was only applied to the big city banks, the rest was
gradually implemented over the next decade). The first real signs of problems came in 1995, with the
collapse of small Jusen finance companies, which were focused on real-estate lending and hard hit by
the collapse of the bubble. It led to the first capital injection into the banking system, with forced
20
M.J.B. Hall, Financial Reform in Japan. Causes and Consequences (Northampton 1998) 9
21
Ibidem 10
22
Firms related to main bank keiretsu’s were structurally underperforming and the cross holdings made the balance sheet
of the banks vulnerable for asset shocks.
23
J. McGuire, S. Dow, ‘Japanese Keiretsu: Past, Present, Future,’ Asia Pacific Journal of Management 26 (2009) 341
24
M.M. Hutchinson, F. Westermann, Japan’s Great Stagnation. Financial and Monetary Policy Lessons for Advanced
Economies (Cambridge 2006) 11
13
mergers with strong banks taking over weak banks.25 In 1997 larger institutions collapsed and a
systemic crisis seemed imminent. So beside a major capital injection into 21 institutions, the
government also implemented major structural reform in 1998. The MoF lost its supervision powers
to the FSA and later also most regulatory powers. The central bank became independent. For the first
time also some major banks were allowed to go bankrupt, although the large Long-Term credit bank
of Japan was nationalised. The 2001 dotcom crisis made the non performing loan problem a systemic
crisis again. This resulted in additional capital injections in 2001 and 2002. But the FSA had become
stronger and more hands-on, so the FSA also pushed for consolidation of the major city banks (only
three today from twenty big banks in the past) and the divestment of the crossholdings. In 2005 the
FSA declared the bad-loan crisis to be over.26 The current financial regulatory structure is now
radically changed with clearer responsibilities that are no longer in one hand, but three competing
ones. Also the transparency in the banking sector has been improved significantly, with the
implementation of better regulation.
3.2: the evolving capital structure of the banks

The capital structure of the banks is a crucial element in the review of the banks as the Bank of
Japan’s transmission mechanism. With capital ratio’s at the centre of current regulatory practices the
amount the financial institutions can lend depends ultimately on the amount of capital.27 This capital
is defined narrowly for Tier-one capital (4%) with equity, retained earnings and disclosed reserves.28
Tier-two ratio (8%) defines capital larger with items like hybrid debt instruments, revaluations and
hidden reserves.29 The capital ratio is a risk-weighted ratio, which takes into account the perceived
risks of different loan categories. Discussions about the way to calculate risk and what kind of risk
was continuously debated and changed during the 1990s. The idea behind the Basel Accords was to
create an equal international playing field, although differences in accounting rules and tax systems
still meant inequality.30
These strict capital requirements did have some specific consequences. For example, a bank in a
benign economy will be able to be profitable and therefore it will be able to keep credit flowing as it
will be able to raise its capital base through retained earnings. But in a recession the bank will have
growing bad loans, which will normally mean the need for higher reserves. This burden on income
will be challenging in an environment where profitability will be harder to keep up anyway. The
‘Lost Decade’ made this period very challenging for Japanese banks31, where margins on loans were
low anyway (which made recovery even harder).32
Looking at the Japanese situation, the keiretsu structure meant that many Japanese banks had large
stock assets of affiliated companies on its balance sheet, as well as the standard loans to customers.
These combination of large share holdings and loans to the same companies made the Banks’
balance sheets vulnerable to sudden shocks. The compilation of the banks assets became important
after the introduction of the first Basel Accord in 1989 in Japan (The Accord was agreed upon in
1988). The Accord required risk-based capital ratio’s to be at specific minimum levels. According to
the requirements assets were categorized to their perceived risks (with domestic government bonds
as zero-risk). International banks were required to hold 8 percent of the asset values as capital. The
collapse in asset values, especially land as the collateral favourite, pushed many companies (many
25
Ibidem 12
26
M.M. Hutchinson, F. Westermann, Japan’s Great Stagnation, 13
27
H. Montgomery, S. Shimuzatani, ‘The Effectiveness of Bank Recapitalization in Japan’, Japan and the World
Economy 21 (2009) 2
28
K. Matthews, J. Thompson, The Economics of Banking (Chichester 2005) 170
29
Idem
30
Basle Committee on Banking Supervision, ‘Capital requirements and bank behaviour,’ Working Paper (1999) 1
31
R.A. Werner, New Paradigm in Macroeconomics. Solving the riddle of Japanese macroeconomic performance (New
York 2005) 153: IBRD research suggests a significant correlation between the ‘real sector’ of the economy and the
performance of the financial sector.
32
M.J.B. Hall, Financial Reform in Japan, 9
14
financial and non financial companies had tried to profit from the asset boom) into financial
problems creating non performing loans33 in the banking sector.
In order to keep the capital ratio’s up to the required level banks started to account realized gains on
assets in their profit&loss accounts.34 The banks accounted the gains in asset value during the bubble
years as unrealized. During the period between 1988 and 1996 banks primarily used these unrealized
gains, by acknowledging the value through sale of the securities35 to prop up their weak operating
profits (thereby also supporting their capital in the form of retained earnings).36
Figure 5
equity and asset gains Japanese main Banks
60
Shareholder
50
equity
40
trillion yen
30
unrealized
gains on
20 securities
10
cumulative
0
after-tax
realized gains
-10 on securities
and real
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
estate
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
year
Source: D.J. Skinner, ‘The rise of deferred tax assets in Japan’
During the same period the non performing loan problem was slowly becoming acknowledged by the
government. The banks had to disclose their non performing loans, bring capital ratios to required
international levels and also face continuously stricter accounting rules. With weak operating profits,
more downward pressure from the non performing loans, it proved hard for banks to stay solvent.37
Avoiding insolvency can be done by raising capital, but capital markets were unwilling to help (low
transparency and weak profits were not encouraging investors) and the government was unable to
help (due to very negative public opinion towards saving banks with large bail outs38). So banks
resorted to lowering the perceived risk to influence the risk-based-capital ratio. In order to keep
solvent, many banks started evergreening39 their loans and supporting struggling companies by
33
A loan is being classified as a non performing loan when at least 3 months of interest payments have not been received.
34
D.J. Skinner, ‘The rise of deferred tax assets in Japan: The role of deferred tax accounting in the Japanese banking
crisis,’ Journal of Accounting and Economics 46 (2008) 221
35
The capital gain could only be realised by selling the securities. If these gains were made on cross-holding shares banks
resorted to sale and buy back constructions to account for the unrealized gains. This was possible as most ‘bubble gains’
were unrealized and even with the crash most historic purchase valuations, which these securities were accounted for,
were lower than the market valuations.
36
D.J. Skinner, ‘The rise of deferred tax assets in Japan,’ 222
37
Idem
38
M. Wright, Japan’s Fiscal Crisis. The Ministry of Finance and the politics of public spending 1975-2000 (Oxford
2002) 32
39
Evergreening means that the interest percentage is revised downwards, often below the interbank rates or even the
lowest Bank of Japan rates.
15
giving them debt to pay interest (and thereby not become non performing). The result was that the
banks only survived, but that any new loan was used to contain the bad loan problem, instead of
pouring it into new productive investments. The transmission channel was not working, the system
had just not collapsed yet before 1995.
Banks needed higher profits to improve their capital ratio’s to restore the normal lending practices.
An opportunity did arrive with a fast growing Asian region. The move by manufacturing companies
to relocate factories to low-wage countries in the region provided the Japanese banks the incentives
to invest more overseas. The weak domestic economy also made the Japanese banks willing to invest
in the booming, and therefore highly profitable, South-East Asian economies.40 For several years this
seemed to help to offset difficult domestic circumstances for the banks.
The plight of the domestic banking sector was further put under pressure in 1996 when the MoF
announced that the accounting rules would be adjusted again with requiring shares hold by banks to
be valued by mark-to-market techniques instead of historic value (normally the acquiring price).41
With the dominant cross-holdings of the keiretsu system combined with the crash of the equity
market since 1987 many banks would becoming instantly insolvent.42 Putting money in insolvent
banks was politically not feasible, not least because in 1996 the MoF removed the cap on the deposit
insurance (effectively insuring the entire banking system) and thereby would be responsible for any
bank failure.43 The 1997 Asian crisis, pushed the fragile financial system into a panic, with total
collapse seeming imminent. The government had to solve the problem but faced public distrust of
banking bailouts.44 Therefore, in 1998 the MoF and the Ministry of Justice introduced new rules,
pushed through the parliament, about deferred tax accounting.45
The result was that banks were able to replace the, with ever declining asset values, exhausted profits
from realized gains and the overseas losses of the Asian crisis, with paper profits from deferred
taxes, and thereby staying solvent.46 This created the opportunity for the government to put capital
into the banks (they were solvent and thereby viable banks) and avoid a major banking system
crisis.47 It didn’t solve the weak capital position though. The system was still fragile and lending
capacity of the banks was just temporarily repaired with the deferred tax accounting, the bad loan
problem was still there (see chapter 3.3). The dotcom bubble offered the banks some temporary relief
with rising asset values.48 With the dotcom crash, the government had to acknowledge that in 2001
the problems could not be contained anymore. The major banks, with the biggest capital ratio
problems, were merged, with three groups remaining.49 Also new capital injections and deferred
loans by the government were put into some banks, most notably Resona, to deal with the non-
performing loan issue.50 Between 2000 and 2005 the major banks also started, at the request of the
FSA, to unwind the cross-holdings and thereby dissolving the keiretsu structure.51 In 2005 the now
40
S. Brana, D. Lahet, ‘Capital requirement and financial crisis: The case of Japan and the 1997 Asian crisis,‘ Japan and
the World Economy 21 (2009) 98
41
Idem
42
Most unrealized gains were either vanished or accounted for, so banks now had to account capital losses instead of
capital gains, which made their problems more severe.
43
D.J. Skinner, ‘The rise of deferred tax assets in Japan,’ 222
44
Ibidem 223
45
D.J. Skinner, ‘The rise of deferred tax assets in Japan,’ 219; The new regulation involving DTAs was rushed through
parliament in just 5 months.
46
Idem
47
Idem
48
R.M. Stern, Japan’s Economic Recovery: Commercial policy, Monetary Policy and Corporate Governance (New York
2003) 304
49
H. Montgomery, S. Shimuzatani, ‘The Effectiveness of Bank Recapitalization in Japan’, 7
50
N. Yamori, A. Kobayashi, ‘Wealth effect of public fund injections to ailing banks: do deferred tax assets and auditing
firms matter?,’ The Japanese Economic Review 58:4 (2007) 466-467
51
P. Mcguire, ‘Bank Ties and Firm Performance in Japan. Some evidence since FY2002,’ BIS Working Paper (2009) 1
16
responsible FSA declared the non-performing loan problem solved.52 Although still doubts about the
banks weakness linger53, their capital position was stronger then any time in the last 15 years.
3.3: Solutions to the non performing loan problem

In the previous chapter we have discussed how was dealt with problems in their capital structure. The
single most important problem seemed to be the unsolved bad loans on the balance sheets of the
financial institutions. Richard Werner does acknowledge the issue, but comes up with a rather
peculiar solution. Let the central bank buy up all the bad loans.54 He argued that the central bank, as
it can create money by just printing it, should take over the bad loans without burdening the
taxpayer. From a purely domestic economic point of view this idea might work. The bad loans,
especially the real estate loans from the bubble period, will probably never be recovered. Investing
money into these bad loans is a waste of money unless you can print money for free, as Werner
argues. The central bank simple eliminates the bad loans, the banks get rid of the of a problem and
the credit channel has been revived.
In reality though such a move would face repercussions from foreign countries as it would be
considered an unfair competitive advantage, for the banks and the companies involved. Furthermore
just buying debt frees up the banking system, but doesn’t resolve the bad loan problem. Most
corporate loans will have a relative short maturity period after which a decision needs to be taken to
roll it over or cancel the lending facility. As the evergreening already implies, the companies
involved will either need to be bankrupted or be restructured. Making these decisions, especially if
large companies might be involved, is something an undemocratic central bank should not do.55
Although the bad loans were slow to be acknowledged, the issue was addressed several times and
some action was taken. So we will now look at what the banks did to solve the problems. We start
with identifying the problem of bad loans on the banks’ balance sheet. Although this information is
not the most reliable information and susceptible to changes in accounting rules.56 The longer term
trend can give some indication about the size and development of the problem. According to
investment company Pimco, the gross bad loan problem in 1998 reached 140 trillion yen (see below
the net bad loan figures, which include write offs and provisions). The MoF published an amount of
just over 26 trillion yen, while the new FSA calculated to an amount of 76 trillion (which it later
revised downwards to 35 trillion yen) and Standard and Poor reached even 150 trillion yen, which
amounted to 30% of GDP in the same year. The banks bad loan reservations and write offs were
slow to catch on.
To show the difference in assessment, we hereby show the net bad loan assessment in trillion yen by
Pimco and the Japanese FSA. From this chart it is clear that the biggest problems existed between
1995 and 2003. The size of the NPLs in 1997 was about 5.5 percent of their total outstanding loans
(FSA calculations)57 and around 20% of GDP (FSA calculations).
Figure 6
52
Idem
53
N. Yamori, A. Kobayashi, ‘Wealth effect of public fund injections to ailing banks,’ 471; Japanese banking accounts
have not been credible. Although stricter regulations seem to have improved accounting issues, past performance still
shed doubt.
54
R.A. Werner, Princes of the Yen (New York 2003) 110
55
W.W. Grimes, ‘Comment on Richard Werner’s ‘The Enigma of Japanese Policy Ineffectiveness’, 70-72
56
M.J.B. Hall, Financial reform in Japan, 29
57
W. Watanabe, ‘Prudential Regulation and the Credit Crunch. Evidence from Japan,’ Journal of Money, Credit and
Banking 39:2–3 (2007) 639
17
bad loans banking system

100
90
80
70
Bad loans - net
(Pimco)
60
trillion Yen
50
bad loans (FSA)
40
30
20
10
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
year
Source: Pimco, Financial Supervisory Agency
The effect of the huge bad loan problems naturally also had effect on the profitability of the banking
sector. Even with the creative accounting, as explained in the previous chapter, the banks had trouble
keeping their net operating profit (without realized capital gains, extraordinary entries, but after
taking in bad loan provisions) positive.
Figure 7
Profitability Japanese Banks
6
0
Trillion Yen
-2 operating profit
net profit
-4
-6
-8
-10
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year
Source: .M. Stern, Japan’s Economic Recovery: Commercial policy, Monetary Policy and Corporate Governance
The problem with the continuing operating losses is that, with banks already struggling to reach the
minimum capital ratio’s, that the accounting tricks were necessary to limit negative effects on the
retained earnings and therefore on the capital ratio.
With low profits and limited possibility of capital increases, the Japanese banks had to deal with the
bad loans over a longer period (every year as much through the profit and loss as was possible
18
without becoming insolvent). This was not an option for the Jusen property financiers. Between 1991
and 1994 the losses in land and equity values reached 800 trillion yen or 1.5 times GDP, which
brought these so-called Jusen companies to collapse.58 After several attempts by the MoF to save the
companies, it was in 1995 decided to liquidate all remaining seven Jusen companies (60% was
eventually irrecoverable) with 685 billion yen funding by the government and the rest of the losses
taken by the banking sector.59 The monetary policy of lower interest rates did not seem to have had a
real effect on the banks’ fortunes, while the bad loan problems were far from resolved.
That the problems were not resolved became apparent in 1997 with many bank failures,60 the capital
injections that year did come from the government. The 1997 capital injection suffered from a
difficult implementation as many banks resisted capital injections, as they were afraid what the
reaction of the markets was (only 1.8 trillion yen was injected of the available 7.5 trillion yen). The
market did already catch up with the problems and from 1997 until 2000 Japanese financial
institutions faced a Japan premium in their borrowing from abroad.61 The 1998 introduction of the
FSA led to a new evaluation of the major banks capital position, which resulted in a massive
recapitalization effort and the closing of the LTCB and Nippon Credit Bank. Astonishingly these
banks had reported, just before the FSA review, that they had a capital ratio of 8%, but were found
entirely insolvent by the FSA.62 In 1999 the FSA conducted a similar review of the major regional
banks, which resulted in a new capital injection. Two banks were forced into a merger and four
banks were deemed insolvent.63
The government injected capital in three tranches between 1997 and 2000, each tranch took up to a
year to be implemented:64
1997: 1.8 trillion yen
1998: 25 trillion yen (and 18 trillion to solve the problems at the nationalised LTCB and Nippon
Credit)
1999: 7.5 trillion yen
These capital injections eliminated the Japan premium in late 1999 and the banking sector had
avoided a financial meltdown. But the deferred tax assets (see 3.3) would return to hunt the system.
In September 2002 it became clear that at all major banks the deferred tax assets made up over 50%
of the banks capital (even 88.6 percent for Mitsui Trust). A revaluation of this asset class (as required
by law after 2003) would again make several banks immediate insolvent.65 The FSA orchestrated a
merger of the top 20 banks into 5 major groupings and one bank (Resona) received a major capital
injection of 2 trillion yen.66 In June 2004 the government introduced the ‘Act of Strengthening
Financial Functions’ (active until October 2008), which allowed the government to inject public
funds in banks without an indication of systemic risk. In 2006 this resulted in a capital injection of 40
billion yen into two regional banks. With the current financial crisis, the government requested an
extension of the emergency act, but it has not passed the newly elected Diet yet.
58
K. Ozeki, ‘Responding to Financial Crisis: Lessons to learn from Japan’s experience,’ Pimco Japan Credit
Perspectives (August 2008) 2
59
M.J.B. Hall, Financial reform in Japan, 167-168
60
H. Montgomery, S. Shimuzatani, ‘The Effectiveness of Bank Recapitalization in Japan’, 3-4
61
Idem
62
R.M. Stern, Japan’s Economic Recovery, 296
63
H. Montgomery, S. Shimuzatani, ‘The Effectiveness of Bank Recapitalization in Japan’, 6
64
R.M. Stern, Japan’s Economic Recovery, 296-297; H. Montgomery, S. Shimuzatani, ‘The Effectiveness of Bank
Recapitalization in Japan’,
65
Anonymous, ‘Cabinet Fukuda Does Not Rule Out Resona-style Bailout for Other Banks’, wwwjapaninvestor.com (may
2003)
66
T. Hoshi, A.K. Kashyap, ‘Will the U.S. Bank Recapitalization Succeed? Lessons from Japan,’ NBER Working Paper
(December 2008) 13
19
With the, at least perceived by the authorities, continued need for capital injections, the financial
system still seems very fragile. Vulnerable banks are risk-averse and lending will be inherently
restricted, only exacerbating the problem. Richard Werner’s argument that the problem could easily
be solved might be true, but the solutions by the governments only saved the banking system from
dissolution, but it kept the system on a fragile footing.
3.4: the effect of banking problems on the real economy

The result of the growing bad debt problem through the 1990s combined with difficulties in keeping
the capital ratio’s up to required international standards meant that the banks were not only risk
averse, but due to their balance sheet problems and low profitability they were also not able to
stimulate credit growth. New loans were used to keep old loans from becoming non performing and
evergreening the loans resulted in declining profitability. This situation led to a credit crunch as from
1997 to 2003.67 Credit growth was low throughout the 1990s and early 2000s.
Figure 8
Credit & GDP growth Japan
30.00%
25.00%
20.00%
Percentage growth
15.00%
Domestic
credit
10.00%
GDP
current
5.00% prices
0.00%
-5.00%
59
63
67
71
75
79
83
87
91
95
61
65
69
73
77
81
85
89
93
97
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
Year
Beside large (international) companies, who were able to lend abroad, many small and medium sized
companies and the consumers had difficulty getting loans.68 While at the same time the not resolving
the bad loan problems kept financial weak companies from restructuring or going bankrupt. The
resulting overcapacity in many markets69 is at least partly responsible for the deflationary pressures.
Another effect of the weak credit growth was the continuous decline of asset prices. The land prices
kept declining throughout the 1990s with valuations in 2000 at just 20 percent of the peak levels.70
3.5: A Banking system in constant crisis mode, who is to blame?
67
W. Watanabe, ‘Prudential Regulation and the Credit Crunch,’ 642
68
M. Giannetti, A. Simonov, ‘On the real effects of bank bailouts: micro-evidence from Japan,’ ECGI working Paper
(August 2009) 4
69
M. Wright, Japan’s fiscal crisis, 29
70
K. Ozeki, ‘Responding to Financial Crisis: Lessons to learn from Japan’s experience,’ 3
20
As we have seen in this chapter the banking system has been in crisis since the early 1990s after the
real estate and equity bubbles collapsed. The bad loan problem was allowed to continue by the
government. The MoF downplayed the problem from 1990 until the FSA took over in 1998. But
without public support for bailing out the banks the MoF had little leeway and tried to solve the
problems with forced mergers, as it has done in the past (no bank will go bankrupt) and accounting
tricks. The Bank of Japan argued that it wasn’t responsible for the banks survival, which is formally
correct. But it could have taken the lead to argue for solutions and it could have offered cooperation
on these solutions. The MoF has lost many powers with the Big Bang reforms in 1998. Hesitantly at
first, the FSA between 2001 and 2005 took measures to handle the bad loan problems, at which it
succeeded at least partly. The Bank of Japan, with its newly acquired full independence, could have
been more helpful in solving this problem, but it did not do nothing, as we will address its actions in
the next chapter.
3.6: Lessons from Japan banking crisis?

Changing accounting rules and other regulations throughout the 1990s constantly renewed pressure
on the banks’ capital structure. Non Performing Loans can be accounted for in different ways and
evergreening is a way to circumvent this. Mark-to-market accounting made the system more
vulnerable to sudden collapses (like the Asian crisis) and new rules like deferred tax assets
regulations propped up the capital ratio’s. The slowness of bringing Japan up to international
standards was the result of the weak banking system, but creative accounting also made it possible to
push the problems to the future.
Although the precise effect of regulatory changes need more in-depth research sorting out window
dressing and real effects for example. What is clear from reviewing the regulatory changes is that it
did effect the capital structure from the banks. As the capital structure is central for credit creation
possibilities, it is at least clear that the regulatory framework and changes over time should be taken
into consideration by monetary policy and macro-economic analysis.
21
Chapter four: Monetary Policy 1985-2008
Before we can judge the central bank for its role during the persistent recession and deflation in
Japan we will have to look at its policies it did implement during this period. Here we will present a
brief overview of the different phases in their policy actions.
4.1: The bubble period 1985-1990

The bubble in Japan was situated in land and real estate lending and in the equity market. The causes
of the bubble given by economists are diverse. Richard Werner directly accuses the Bank of Japan
through its window guidance that pushed the banks to lend extensively to these sectors and
deliberately created the bubble. Others blame the creation of private capital markets in the early
1980s where big firms started issuing corporate bonds.71 The banks’ reaction was to push the
oversupply of loans onto the smaller companies, which primarily used land and real estate as
collateral. The oversupply of loans pushed up land prices, which created a circle of land revaluations
and new loans and inflated the bubble. Others point towards the Plaza accords which led the central
bank to oversupply liquidity to create a soft landing for the economic consequences of the expensive
yen.72
Figure 9
Land prices for six metropolitan areas
600
500
400
index (1983 = 100)
300
200
100
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
year
Source: Japan Real Estate Institute
The Bank of Japan warned for a bubble in these sectors, but was unable or unwilling to act until the
early 1990s when the credit supply suddenly dropped and the bubble collapsed. Werner argues that
the Bank of Japan by using lending levels to sectors (ie. Window guidance) pushed lending towards
real estate and other bubble sectors (land speculation and construction). These window guidance
controls are supposed to have ended early 1980s, but comments by the Bank of Japan indicated that
it only stopped using this tool in 1992. Information is though not publicly available, so further
investigation into this specific part of Werner’s accusation is not possible.
4.2: The interest tool phase one 1990-1997
71
M. Wright, Japan’s fiscal crisis 27
72
K. Ozeki, ‘Responding to Financial Crisis,’ 2
22
With the collapse of the bubble and other developing countries experiencing recession, Japan’s real
GDP growth turned negative in 1993. The Bank of Japan lowered the call rate between 1990 and
1996 from 6 percent down to 0.5 percent. Between 1993 there was a slight recovery in real GDP (see
chapter 2), but in 1995 Japan also experienced its first deflation.
Figure 10
Bank of Japan interest rate 1987 -2008
7
4 Call
percentage
Rate
0
feb-87
feb-88
feb-89
feb-90
feb-91
feb-92
feb-93
feb-94
feb-95
feb-96
feb-97
feb-98
feb-99
feb-00
feb-01
feb-02
feb-03
feb-04
feb-07
feb-08
feb-05
feb-06
month
Despite the lowering of interest rates economic growth, lending growth slowed down, while it was
also not able to stop collapsing land, real estate prices and equity valuations, something standard
economic theory predicts.73 Between 1991 and 1994 the losses in land and equity values reached 800
trillion yen or 1.5 times GDP, which brought the Jusen companies to collapse.74
4.3: Banks in crisis and the ZIRP period 1997 – 2000

The Jusen companies were relatively small financial institutions. The continuing rise in bad loans,
lower asset prices75 and low GDP growth meant the real end of the convoy system in 1997 when
several big banks were collapsing. A fragile Japanese banking system combined with the major
banks being the largest lenders to the Asian-5 countries and a currency- and financial-crisis in
Thailand, quickly spreading through the region brought the Japanese system to imminent collapse.76
After gaining formal independence in 1998, the Bank of Japan started lowering interest rates towards
zero percent, which has become known as ZIRP (zero interest rate policy). It lasted from march 1999
to august 2000. The Bank of Japan committed itself to a sustained zero interest rate policy. This
73
Lower interest rates, should stimulate money supply, which would lead to (asset) inflation
74
75
Idem
76
S. Brana, D. Lahet, ‘Capital requirement and Financial crisis,’ 100
23
commitment proved successful in lowering short and long-term interest rates to drop, which in turn
was supposed to ease deflationary pressures.77
The limited effect of the declining interest rates and the ZIRP started to gain interest from
international renowned economists. Krugman argued that Japan was experiencing a liquidity trap. He
said that due to deflationary expectations the interest rate should be negative to be effective.78 He
argued that the Bank of Japan should rise inflation expectations to 4 percent so real interest rates
would be negative (and spending instead of saving would be stimulated). The Bank of Japan argued
that it was unable to raise expectations, as it had no effective tools to raise expectations (beside its
statements). Without these possibilities it argued monetary policy would be ineffective and solutions
should come from fiscal or structural solutions.79
The low interest policy (extended with Quantitative Easing until 2006) did have positive effects in
the real economy. Not only banks suffered from high leverage, but also other companies. But partly
due to the ZIRP policies (with declining short- and long-term interest rates) companies were able to
reduce the ratio of interest payments to profit from 48% to just 15% between 1997 and 2005. Not
only because of improving profit margins or lower debt levels, but primarily due to lower interest
rates.80
77
K. Okina, S. Shiratsuka, ‘The Policy Duration Effect under Zero Interest Rates: An Application of Wavelet Analysis,’
in Japan’s Great Stagnation (Cambridge 2006) 185
78
R.A. Werner, New Paradigm, 52
79
Idem
80
24
4.4: Quantitative Easing 2001 – 2006

In 2000 another renowned monetary expert offered another solution, although Richard Werner
offered the same solution back in 1995. Ben Bernanke argued that if faced with a liquidity trap as
identified by Krugman a central bank could always pursue quantitative easing by buying all kinds of
assets.81
With the bursting of the dotcom bubble in 2000, the interest rates already near zero and deflation
becoming imbedded, the bank of Japan announced on 19 March 2001 that it would introduce
quantitative easing (QE) until deflationary pressures had subsided. Bank of Japan speeches and board
minutes also reveal a wish to help weaker parts of the banking system, as 19 banks experienced
credit risk downgrades in the month before the announcement.82 The Bank of Japan limited its QE to
rising the current account limits (from 1 trillion yen to 35 trillion yen in nine steps) with the bank and
purchases of long-term government bonds (monthly purchases from 400 billion yen to 1.2 trillion
yen).83 As can be seen in the figure below, beside M1, significant effects on broader definitions of
money never materialised.
Figure 11
Monetary Aggregates 1968 -2004
30.00%
25.00%
20.00%
Percentage change
M1
15.00%
M2 +
CDs
broad
money
10.00%
5.00%
0.00%
68
70
72
74
76
78
80
82
84
86
88
90
94
96
98
00
02
04
92
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
19
19
19
20
Year
Real GDP growth returned unimpressively with rates fluctuating between 0.9 and1.7 percent.
Inflation only really turned positive in 2008 (1.4 percent) after being flat in 2007. The current year
probably shows that deflation has returned (3rd quarter showed 2.2 percent deflation, the largest
ever84).
So again the Bank of Japan policy has failed, economic growth returned but it can be doubted if it
was due to monetary policy instead of world economic growth through rising exports.85 The Bank of
81
82
M.M. Spiegel, ‘Did Quantitative Easing by the Bank of Japan ‘Work’?,’ FRBSF Economic letter 28 (2006) 3
83
Ibidem 1-2
84
Anonymous, ‘Output, prices and jobs’, The Economist (7 November 2009) 93
85
Anonymous, ‘Japan xport growth quickens,’ International Herald Tribune (21 December 2006) 1
25
Japan claimed again that it had done everything in its power and that structural changes were
necessary.86 Depending on the success of central banks in the current crisis, especially the Fed, who
do buy different kinds of assets, either directly from the banks or on capital markets, the Bank of
Japan might be proven wrong. Deflationary pressures are abound in the U.S. and Europe, if the
central bank buying succeeds in defeating deflation and creating inflation the Bank of Japan will
have lost all credibility.
4.5: The Bank of Japan: A clouded future

According to textbook monetary economics the Bank of Japan did everything it could do. It lowered
interest rates as far as it could, it became independent, it even introduced quantitative easing. Growth
isn’t possible through monetary policy according to the Banks’ favourite neoclassical economics.
But the Bank of Japan is not without criticism, beside Mr. Werner. Adam Posen, currently board
member of the Bank of England, argued that the Bank of Japan was too passive-aggressive in its
fight against deflation that Posen concluded its experts must have another agenda.87 Probably
Bernanke’s criticism reflects reality best: “in recent years Bank of Japan officials have – to a far
greater degree than is justified – hidden behind minor institutional or technical difficulties in order
to avoid taking action.”88
But the Bank of Japan perhaps did too little (better QE) or too late (lowering interest rates between
1991 and 1995), but the banking system is in better shape as it has been since the crisis began and
companies have stronger balance sheets than before. Maybe not due to the central bank, but the MoF
and the FSA. It did fail though in stimulating growth and more importantly eliminating deflation.
Especially the deflation problem should have rendered far more aggressive action by the Bank of
Japan.
86
H.Ugai, Effects of the Quantitative Easing Policy, Bank of Japan Working Paper (2006) 5
87
88
Ibidem 308
26
Chapter five: Biotechnology and IT, any signs of structural problems?
Werner argues, as discussed in chapter one, that capital should just be directed towards productive
investments to have an economic recovery. This implies that there are no structural problems within
the economy and that the Bank of Japan is, by constraining credit growth, making a recovery
impossible. To test his hypothesis we will analyse two (global) growth sectors of the last decades,
namely biotechnology and IT. If Werner is correct, lack of capital should be the major constraint in
the growth of these sectors, but if structural problems are more important the Bank of Japan is at
least partly correct in its call for structural economic reforms.
5.1: Biotechnology
Biotechnology is an amorphous industry that brings innovations in many different industries, from
food to medicine, and even biochips and also to different chemical industries among others. It is
therefore considered to be a key industry for future economic growth.89
At the end of the 1970s it was believed that Japan would overtake the United States in economic
terms within 20 years. The Japanese national innovation system was considered very successful.90
During the 1970s the biotechnology industry was still very small, but expectations were rising and
prospects for growth were continuously being raised. Japan was seen as the country that would
benefit most, even dominate the industry.91 The reason was that large firms with vast resources led
the industry on developing and commercializing new findings.92 But early 1990s it was the United
States that had become world leader and with a completely different model of production. The small
start up firms (seen as weak during the 1970s) were the ideal link between universities and large
firms. Universities were the prime development of new ideas and the small companies were ideal in
developing products from these ideas. Large US firms proved able to absorb the small successful
companies, and mass commercialize these products, better than foreign competitors.93 Currently the
largest biotechnology firms hail from the United States or Europe, with only Takeda from Japan at
bottom top 20.94 The Japanese domestic conditions during the period were very benign. The
companies had a growing domestic market, with foreign competition locked out. Japan is the second
largest market (if Europe is not seen as a single entity) for biotechnology estimated at 2 trillion
Yen.95 This unexpected result has led to several investigations why Japan did not fulfil its promise.
During the 1970s and 1980s it was predicted that the large Japanese companies would simply buy up
the successful small American start-up companies. They were considered to have an advantage here
as it was thought they were better in commercializing developed products as they had better process
capabilities.96 Strong backing by banks was also seen as a competitive advantage to large American
firms. But commercialization of the increasingly sophisticated products meant intimate cooperation
with the start up firms and the scientists.97 Japanese companies here had a disadvantage as their
89
N. Arantes-Oliviera,’A case study on obstacle to growth of biotechnology,’ Technological Forecasting & Social
Change 74 (2007) 61-62
90
R. Kishida, L.H. Lynn, ‘Restructureing the Japanese national biotechnology innovation system’, edited C. Storz, Small
Firms and Innovation Policy in Japan (New York 2006) 111
91
Ibidem 113
92
Idem
93
Idem
94
B. van Beuzekom, A. Arundel, OECD Biotechnology statistics 2009 (Paris 2009) & C. Muller, The Biotechnology
industry in Germany and Japan, Working Paper (2001) 13
95
M.J. Lynskey, ‘Transformative technology and institutional transformation: Coevolution of biotechnology venture
firms and the institutional framework in Japan, ‘ Research policy 35 (2006) 1392
96
R. Kishida, L.H. Lynn, ‘Restructureing the Japanese national biotechnology innovation system’, 116
97
J. Probert, Global value chains in the pharmaceutical industry,’ edited C. Storz, Small Firms and Innovation Policy in
Japan (New York 2006) 87-102; Japan’s large companies were very slow to join the international development of a
fragmented value chain in the biotech industry.
27
engineering (needed for efficient process capabilities) was strong, but their scientific basis was
shallow.98 The result was that Japan was only responsible for 4.3 percent of global biotechnology
exports (US 37 percent and Germany 19.1 percent). Germany that initially faced the same problems
as Japan in its market structure, had early 1990s copied the American model of small start-ups as
links between universities and large firms.99
In Japan on the other hand large companies stopped investment in biotechnology in the early 1990s.
Capital doesn’t seem to have been important, as some companies with direct links (pharmaceuticals
and food companies) continued investments, but the overall scale went down.100 From a financing
standpoint the absence of venture capital to support biotech start-ups in Japan has been seen as a
major obstacle to biotech success.101 Support by the government has resulted in new public venture
companies and the development of a small-cap stock market with NASDAQ modelled to the German
example.102 Other problems were found at the universities. A rigid boundary between non-profit
universities and profit seeking companies stopped the development of new products as in the U.S.
and Europe.103 Several laws introduced between 1997 and 2000 took these problems away.104
The Japanese changes did have success. For example the amount of start-up companies has risen fast
after 1998.
Figure 12
Number of New Start-Up companies in Japan
90
80
70
number of new companies
60
50
40
30
20
10
0
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
Year
Source: Japan Bioindustry Association
98
R. Kishida, L.H. Lynn, ‘Restructureing the Japanese national biotechnology innovation system’, 116-117
99
K. Adelberger, ‘A Developmental German State? Explaining Growth in German Biotechnology and Venture Capital,’
BRIE Working Paper (1999) 5-7
100
R. Kishida, L.H. Lynn, ‘Restructureing the Japanese national biotechnology innovation system’, 119
101
C. Muller, The Biotechnology industry in Germany and Japan, Working Paper (2001) 19
102
M.J. Lynskey, ‘Transformative technology and institutional transformation,’ 19
103
J. Probert, Global value chains in the pharmaceutical industry 94
104
Idem
28
Other indicators include the rising patents by Japanese companies. Japan surpassed many European
countries, although Europe as a whole and the United States are still far ahead.105
Overall industry structure, government legislation seem to have been most important to the lagging
success of the Japanese biotechnology industry. Lack of capital doesn’t seem to have been the
primary problem, more the way the capital was delivered (venture capital). In the biotechnology
industry structural problems seem to have been the major issue.
5.2: The land of technology: IT in Japan

Japan and electronics are by most people seen as two sides of the same coin. With many large
Japanese firms being major players in the electronics industry. In the second half of the 1990s these
companies ran into trouble with declining market share and mostly at large firms combined with
annual losses.106 Especially the Top 10 electronics firms show that most firms have seen difficult
times, except for Canon.
Table 1
Net Income (loss) of the ten largest Japanese electronic firms in million US$
Firm 1996 1997 1998 1999 2000 2001 2002 2003 2004
Matsushita 1,228 764 107 898 376 (3,427) (160) 374 545
Sony 1,243 1,812 1,409 1,098 152 123 948 785 1,527
Fujitsu 411 46 (107) 385 77 (3,064) (1,002) 441 297
NEC 827 387 (1,190) 94 513 (2,499) (202) 364 632
Toshiba 598 60 (109) (252) 871 (2,035) 152 256 429
Hitachi 800 41 (2,652) 152 946 (3,876) 229 141 480
Canon 839 970 862 633 1,215 1,342 1,566 2,446 3,200
Mitsubishi 76 (864) (351) 224 1,131 (625) (97) 398 663
Sharp 433 202 36 253 349 91 268 539 716
Sanyo 157 101 (204) 195 366 11 (506) 119 (1,599)
Total 6,612 3,519 (2,199) 3,680 5,996 (13,959) 1,196 5,863 6,890
Source: T.J. Sturgeon, Modular production's impact on Japan's electronics industry
The loss of competitiveness was not due to a lack of R&D investment as Japan still was number one
in international comparisons (at per capita, total costs, number of R&D personnel and patents
issued).107 But Japan fell behind Europe and the United States in equipment exports.
Table 2
Electronics Exports in million US$ Average Annual
(current prices) 1990 1995 2000 Growth (95/00)
Computer equipment US 23,005 34,476 54,685 9.7

Japan 18,584 29,521 27,558 -1.4
EU 40,119 66,460 94,131 7.2
Communication equipment US 4,063 10,933 20,680 13.6

Japan 5,614 6,904 8,106 3.3
EU 9,541 26,440 69,179 21.2
Electronic components US 13,826 27,668 70,001 20.4

Japan 14,678 43,270 50,348 3.1
EU 16,330 36,393 55,972 9
Source: OECD (cited in Recovering from Succes)
105
B. van Beuzekom, A. Arundel, OECD Biotechnology statistics 2009, 75
106
R.E. Cole, D.H. Whittaker, Recovering from success. Innovation and technology management in Japan (Oxford
2006) 4
107
Idem
29
Japanese electronic manufacturers’ previous competitive advantages in quality and R&D cycle times
have been reduced or even lost. As in biotechnology the new model was one of networks of
specialist firms with loose production networks.108 Especially American firms were very effective in
creating network relationships with contract fabrication plants, who were able to produce at lower
costs. Japanese companies resisted this practice of outsourcing as it challenged Japan’s labour
practices.
But the rigid industrial structure had more consequences. Most Japanese companies focus on optimal
quality instead of price or market needs. In the electronics business its visible in the choices made by
Japanese companies. Japan has some medium sized companies that serve over 70 percent of the
world market, mostly based on quality as the competitive advantage.109 That quality not always
makes the best choice can be seen in the Japan’s local telecommunications market, which is
dominated by the NTT monopoly (largest employer of Japan; until early 1990s the worlds most
valuable company). During the late 1980s two possibilities for electronic data communication (i.e.
the internet) had surfaced. The TCP/IP principle and the ATM principle. The TCP/IP systems were
deemed unreliable (3% of data got lost in 2000), while ATM was also compatible with circuit
switches used in the public telephone network.110 The real problem came with NTT pushing all
suppliers to the ATM system and all requirements. When in 1997 it became clear that they were
unable to increase ATM speed, the Japanese telecommunications business began to recognize it had
bet on the wrong standard.111 It took another two years for NTT to stop R&D on the ATM system,
but by this time the Japanese industry, led by NTT, had not only lost the standard war, but it also had
no investments in supporting equipment (with Cisco the great beneficiary).
Another electronics branch that was in trouble during the 1990s was the Japanese semiconductor
industry. Between 1975 and 1985 Japan semiconductor industry grew to take 80% of the world
market (reducing the US from 100 percent in 1975 to under 20 percent in 1985). After 1988 their
share market came into a constant decline (while the US has kept a steady 20 percent), mostly due to
competition from Korea and Taiwan. The Japanese companies in 2004 still had a technologic
advantage, but they lost sight of cost competitiveness.112 Japanese manufacturers produced high
quality semiconductors, while its foreign competitors lowered quality (who wants a 25 year
guarantee on its lap-top chips?) to levels that suppliers wanted at far lower costs. Foreign competitors
sometimes also prolonged the lifetime of old equipment if quality improvements were not necessary
(for specific, low quality market segments for example).113 These choices lowered the cost of
production, while Japanese manufacturers always switched over to the best available equipment.114
Japanese producers of electronics themselves rank wrong management choices as the most important
reason of lost market share and competitiveness.115 Capital is again not listed as the most pressing
problem, contrary, capital investment was rather too high than too low.
5.4: Credit allocation & structural problems

Productive investments in the two mentioned sectors were not as clearly visible and easy to
implement as Werner suggests. Japanese companies were too slow to adjust to changing market
108
Ibidem 6
109
Anonymous, ‘Invisible but indispensible’, The Economist (7 November 2009) 67-69; Products of these Japanese
companies have guaranteed lifetimes of very long duration, mostly 25 years.
110
R.E. Cole, ‘The telecommunication industry: A turnaround in Japan’s global presence,’ in R.E. Cole, D.H. Whittaker,
Recovering from success. Innovation and technology management in Japan (Oxford 2006) 36
111
Ibidem 37
112
T. Yunogami, ‘Technology management and competitiveness in the Japanese semiconductor industry,’ edit. D. Hugh,
R.E. Cole, Recovering from success (Oxford 2006) 74
113
Ibidem 80
114
Idem
115
Ibidem 84
30
conditions. Low competitiveness and wrong management choices created difficult conditions for
Japanese companies and stifling growth in these sectors. Not only did Japan lose market share, it did
loose it to almost anyone. The Koreans and Taiwanese took the lower end of the market and the
Europeans and the Americans outperformed the Japanese in the higher end of the market.
The examples given in this chapter of course do not extrapolate to the whole economy. But these two
sectors are also important export sectors. These export sectors, if in good condition, would have been
less impacted by the domestic problems and might have improved overall Japanese growth figures.
With export sectors failing and domestic sectors entrenched in highly regulated and uncompetitive
sectors without growth perspectives116 the need for structural change was a good call.
116
A.J. Alexander, In the Shadow of the Miracle, 225-226
31
Chapter six: Conclusion: revisiting Princes of the Yen
Richard Werner specifically attacks the Bank of Japan for creating the bubble and the Lost Decade in
Japan. Starting with Werner’s first accusation, I have to conclude that it is hard to verify if the Bank
of Japan deliberately created the bubble, as Werner based his argument on the use of a mechanism
that did exist, but for which data is not available for public scrutiny. The Bank of Japan, then still not
legally independent, can be blamed for letting the bubble get this big. Although we have seen many
bubbles before and after in other countries, so specifically blaming the Bank of Japan for this bubble
seems a bit exaggerated.
Richard Werner has modified macroeconomic models on an insightful and thought provoking
manner, although you need to read his second book, New Paradigm in Macroeconomics, to fully
comprehend this element. He disqualifies mainstream macroeconomics for having lost reality and
focusing on models that do not illustrate reality. He himself, though, is also gifted with the all
encompassing belief in econometric modelling and a subjective view of the real economy. But beside
the hyperbolic language of Werner his novel use of credit rationing, through Fisher’s quantity
equation, is an interesting way of bringing credit rationing effects into mainstream theory.
By blaming the Bank of Japan he focuses mainly on general macroeconomic factors. But as can be
seen in the presiding chapters economic performance is more than these general factors. The
proposals that the Bank of Japan could solve the banking crisis overnight lacks reality, although in
theoretic terms Werner might be right, if we ignore moral hazard. But the Bank was not responsible
for the financial health of the banking system, but the Ministry of Finance and the FSA. And they
hesitated and, at least, share responsibility with the Bank of Japan for the endurance of the abysmal
performance.
The Bank of Japan is to blame for the persisting deflation throughout the 1990s and early 2000s.
Werner correctly argued back in 1995 that the Bank of Japan could buy any asset it liked to prop up
the economy and avoid deflation. It should have been clear to bank officials that the interest
mechanism was not working. Either due to the banking crisis or to inherent problems in the power of
the interest mechanism as argued by Werner. The Bank of Japan made two very strange decisions,
which were against mainstream wisdom. Even as monetary economics has a strong belief in the
effects of expectations, it didn’t want to set an inflation target. Also its Quantitative Easing policy
was not as aggressive as was publicly expected and advised by many international experts. Japan’s
politicians should question the Banks independence as many highly respected experts are very
critical of the banks policies (including B. Bernanke, S. Stiglitz, A. Posen, among others). It is
disturbing that a central bank accepts a 15 year recession just because it wants structural reform.
What these reforms should entail the Bank of Japan have never explained in detail, beyond
stimulating competition and other general remarks.
If anyone has doubts about the push for structural reform the following comment by the spokesman
of the Bank of Japan, governor Hayami in 2001:
“Hayami is convinced that Japan needs to undergo radical corporate restructuring and banking
reforms before it can recover – and that he has a duty to promote this… Mr. Hayami’s passion for
reform also has a flavour of austerity. On paper, most economists – and politicians – think it would
be sensible to offset the pain of restructuring with ultra-loose monetary policy. But Mr. Hayami fears
that if he loosens policy to quickly, it would remove the pressure for reform’117
117
32
But Werner himself is too eager to accept the easy solution of his own model. Just push credit
towards productive investments to let the economy grow. The Bank of Japan was wrong to use
monetary policy to create a crisis in order to push for structural reforms, they were not entirely
wrong as parts of the economy were in need of structural reform. Productive investments needs more
than simple effective credit allocation. Sometimes structural reform is needed.
The Princes of the Yen is a misleading title as it unduly focuses only on the Bank of Japan, while the
Ministry of Finance, which Werner even defends, is at least as guilty for not solving the banking
crisis.118 As Werner shows with his second book, though, macroeconomics and therefore monetary
policy is in need for a revision. As I indicated with the scope on banking regulation and its effects I
hope that these new models won’t overlook policy effects.
All in all, Werner is correct in his analysis that the Bank of Japan did too little to solve the economic
problems of Japan, especially its lacklustre policies towards eliminating deflation. But the Bank of
Japan governors are correct that Japan faced structural economic impediments to growth, which was
a task for Japan’s politicians to solve.
118
M. Wrigth, Japan’s Fiscal Crisis, 137-158
33
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36

Is The Bank of Japan Responsible For The Lost Decade?

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Lost in Finance

Is the Bank of Japan responsible for the Lost Decade?

University of Leiden, the Netherlands

Chapter one: The quantity of money 5

Chapter two: A brief history introduction:

Chapter three: Japan’s banks in trouble 12

Chapter four: Monetary Policy 1985-2008 21

Chapter five: Biotechnology and IT,

Chapter six: Conclusion:

Figure 1: Real GDP Growth Japan 1956 – 2008 8

Figure 2: Growth Accounting 1980 – 2004 9

Figure 3: Inflation Japan 1955 – 2008 10

Figure 4: Ratio of unemployed in labour force 1970 – 2008 11

Figure 5: Equity and asset gains Japanese main Banks 14

Figure 6: Bad Loans banking system 17

Figure 7: Profitability Japanese Banks 17

Figure 8: Credit & GDP Growth 19

Figure 9: Land prices for six metropolitan areas 21

Figure 10: Bank of Japan interest rate 1987 -2008 22

Figure 11: Monetary Aggregates 1968 -2004 24

Figure 12: Number of New Start-Up companies in Japan 27

Table 2: Electronics Exports 28

Chapter one: The quantity of money

1.1: Werner restating Fisher’s equation of the quantity of money

1.2: Consequences of Werner’s restatement

The banking system

Chapter 2: A short history introduction: from high growth to a prolonged stagnation

Source: Bank of Japan

ΔGDP = ΔLabour + ΔLand + ΔCapital + Total Factor Productivity

Source: Statistics Office

Source: Statistics Office

Chapter three: Japan’s banks in trouble

3.1: the banking system

3.2: the evolving capital structure of the banks

Source: D.J. Skinner, ‘The rise of deferred tax assets in Japan’

3.3: Solutions to the non performing loan problem

bad loans banking system

Source: Pimco, Financial Supervisory Agency

3.4: the effect of banking problems on the real economy

Source: Bank of Japan

3.5: A Banking system in constant crisis mode, who is to blame?

3.6: Lessons from Japan banking crisis?

Chapter four: Monetary Policy 1985-2008

4.1: The bubble period 1985-1990

Source: Japan Real Estate Institute

Source: Bank of Japan

4.3: Banks in crisis and the ZIRP period 1997 – 2000

4.4: Quantitative Easing 2001 – 2006

Source: Bank of Japan

4.5: The Bank of Japan: A clouded future

Chapter five: Biotechnology and IT, any signs of structural problems?

Source: Japan Bioindustry Association

5.2: The land of technology: IT in Japan

Computer equipment US 23,005 34,476 54,685 9.7

Communication equipment US 4,063 10,933 20,680 13.6

Electronic components US 13,826 27,668 70,001 20.4

5.4: Credit allocation & structural problems

Chapter six: Conclusion: revisiting Princes of the Yen

Arantes-Oliviera, N., ’A case study on obstacle to growth of biotechnology,’ Technological

Beuzekom, B. van, A. Arundel, OECD Biotechnology statistics 2009 (Paris 2009)

Lewis, M.K., P.D. Mizen, Monetary Economics (Oxford 2000)

Lynskey, M.J., ‘Transformative technology and institutional transformation: Coevolution of

Matthews, K., J. Thompson, The Economics of Banking (Chichester 2005)