Difficulties of Japan in Overcoming Deflation in the Last Decades - Essay Example

Deflation in Japan: A dis on the difficulties of Japan in overcoming deflation in the last decade Client’s of Deflation in Japan: A discourse on the difficulties of Japan in overcoming deflation in the last decade Introduction Deflation is experienced when demand decreases, creating a need for lowered pricing. The problems that result from this scenario are that one, stimulus that can occur through a lowering of policy rates is curtailed, and two, prices that are falling would suggest increases in real debt burdens on businesses and private parties. This would create added risks to of widespread defaults with a further negative interaction between the real economy and the financial sector (International Monetary Fund 2009, 23). Japan has been experiencing a period of deflation since the 1990’s that has caused havoc within their economic system. On 29 December 1989, the Nikkei peaked at 38, 916 after a five year return of 237%. The rate in June of 2008 was at 14, 354 which is a startling 63% lower than the 1989 figure (Harrison 2008). According to the International Monetary Fund (2006), Japan was experiencing recovery from its previous declining position, but by 2009, the International Monetary fund showed recognition that the economic downturn of 2008 had stifled progress and the deflation was still a pervasive issue. As Shown in the graph examples in figure 1, both the real estate market and the stock market have shown steady deflationary trends since 1990. There have been a series of attempts to remedy the problem of deflation in Japan. These attempts include fiscal expansion, reduction of interest rates, Yen depreciation, and finally a zero interest rate program followed by a quantitative expansion program (Greenwood 2010). Unfortunately, these programs have all been ineffective in providing relief from the ongoing deflationary period. Greenwood (2010) states that the lack of recovery is due to poor political and economic leadership, an unwillingness to adopt unorthodox strategies, mistakes at the technical level, and the appearance of a “balance sheet recession”. Fig. 1 Fiscal Expansion and Reduction of Interest Rates An expansionary fiscal policy adopted by a government is marked by measures that are taken in order to create increased economic stabilization through governmental policies intended to create economic stimulus. In 1981, Yasuhiro Nakisone, Prime Minister of Japan, instituted polices that were stringent for the Japanese economy. However, by 1986, Naksone believed that these policies would require some adjustment in order to avert the looming crisis. A private advisory group headed by Bank of Japan Chairman Maekawa Haruo and commissioned by Nakisone submitted a report commonly referred to as the Maekawa Report which states that the Japanese economic policies and structures needed to be re-oriented to a more international approach. In addition, this report recommended changes in policy toward fiscal expansion in order to avoid economic indications of an impending troubled economy (Suzuki 2000, 145). Facing international calls for fiscal expansion, the Japanese government failed to recognize and act on the predictions of economic failure. By 1986, according to Suzuki (2000, 146), exports continued to drop in yen terms, but not in dollar terms. In regard to the American dollar, exports rose by over 20% while imports fell. The United States threatened to drive down the dollar against the yen in order to force for policies of fiscal expansion from the Japanese government. However, the value of the yen continued to soar, and when exports dropped, the lack of domestic demand created a threat of recession. According to the Brookings Institute (2004, 89), Japanese attempts to adopt policies of fiscal expansion have failed because they fell into the liquidity trap. Krugman (1998) simplifies the liquidity trap by saying that it exists in a situation where policies become ineffective because interest rates cannot be pushed below zero. Referencing the 1937 Hicksion model of the liquidity trap, Krugman goes on to show that the current (current to the time of his paper in 1998) Japanese economic state of affairs mirrors the structure that Hicks put forth in his model of theoretical liquidity trap indicators. Money had become irrelevant and the interest rate had fallen to .37%, which is very close to zero. Yen Depreciation According to Dyrsdale and Gower (1998, 238), there is a conventional belief that the policies of Takahashi in the early 1930’s were intended to specifically depreciate the value of the yen in order to increase exports. The yen depreciated by about 30% in 1930, creating an upsurge in export demand in 1932. While there is some diverse speculation as to whether this was done purposely, this creates a model for indicating that a purposeful depreciation of the yen might create a positive back flush in the economy. As the economic global depression of the 1930’s acts as a “what to and not to do” model, the depreciation of the yen was a viable economic strategy to fight deflation and encourage demand. In 1996, Fred Bergstein reported that the Japanese policy of depreciating the yen was effective in creating higher demands for exports, although was not making near enough advances towards creating a positive advance against the stagnation of the previous five years. Bergstein (1996) reported that virtually all models indicated that a 1% devaluation of the yen to the dollar would result in an increase of Japan’s global current-account surplus to about $3 billion. The declines in 1995-96 would create an approximate $60 billion. Figure 2 and figure 3 reveal the sharp decline in the yen over the course of the later half of the 1980’s and the first half of the 1990’s. Fig. 2 Fig. 3 2010 Yen to Dollar valuation chart In McKinnen (2005, 53) it is reported that in 2002 there appeared to be a policy of attempts to create a devaluation of the yen through the discussion of overvaluation. Financial Services Minister Takenaka blatantly expressed his administrations hopes for a weaker yen while Finance Minister Shiokawa suggested that the yen was overvalued which was reported in 9 December 2002 issue of Financial Times. However, McKinnen (2005, 53) goes on to say that Okina of the Bank of Japan was against the devaluation of the yen stating that policies of large scale purchases of the foreign currencies with the intent of devaluing the yen could provoke issues in trade relations. However, others in the global community believed that a stronger Japan could do nothing but increase the overall global economy and did not have issue with attempts to devalue the yen. Hutchinson and Westermann (2006) reveal, however, that policies of devaluation of the yen in order to affect exports has not been the answer to a continued stagnation and marginal but steady increase in the deflation of the Japanese economy. They say that “Specifically, it is presupposed that foreign producers will stabilize the prices of their exports to Japan in their own currency terms, and hence pass the effects of the yen’s depreciation substantially, if not fully, to the Japanese importers and consumers”. This circumstance, while somewhat relevant in the past, has ceased to be a given. Therefore, the devaluation of the yen has been only marginally successful in creating impact on the economy and overall is not a success in stopping deflation. Bail Out It is necessary at this time to mention that a continuing practice of bailing out the national banks was prevalent in the 1990’s within the Japanese governmental practices. As of 2002, a sixteen year low was indicated through two decades of government bail-outs of the banking systems (Sabri 2002, 174). The unfortunate truth of the bail-out scenario is that it generally does not work in trying to create stability within an economy. Structural reforms and an acceptance of the failure of a banking system create a more stabilized financial force than continuing the policies and structures that have proven inadequate and without sound foundations. This is echoed in the bailouts in recent history that were made by the United States government in trying to stabilize a failing economy. Quantitative Easing and Zero Interest Rate Policy The zero interest rate policy that went into effect in Japan was intended to stimulate inflation so that prices would rise, thus ending the period of stagnation and deflation of the 1990’s. The intent was to provide financial incentives to spend money. According to Dicks (2010), this was intended to lower expectations about future interest rates. Through the provision of a zero interest rate, the stimulus to borrow was intended to create an inflationary response. However, this did not occur and the country fell into the liquidity trap, thus having no where to go from zero. This lead to a policy of quantitative easing where money was made - literally printed for - which no real basis of existence could be measured. By releasing physical money into the system that was not founded on backing, inflationary results were expected. This money depreciated the value of the current currency and promoted increased prices for which an increase in spending would result. This effort to create a positive result was not successful, creating more issues as the economy continued to wane. Some Success In 2002 the economic struggles of the Japanese economy found a turning point through which some relief to the events of the 90’s was experienced. According to the International Monetary Fund (2009), “the rescue and nationalization of two major banks and the resolution of of small regional institutions and credit unions - helped to reduce systemic stress.”. The report goes on to say that “A virtuous cycle began to take hold as the health of the banking system improved and corporates made progress in redressing the underlying imbalances of the bubble period by shedding the triple excess of debt, capacity and labor.” The problems of the system were being addressed, although without the aggression that some economists promoted. Resolutions of some of their economic problems led to increases and stabilization that resulted in uninterrupted expansion between 2002 and 2007. Price pressures began to move toward inflation in 2006, creating the first period of success in a two decade period of attempting to avert and then manage the crisis. A period of growth that was at 2% revealed a burgeoning health within the economy (International Monetary Fund 2009). The basic failures of the fiscal stimulus packages of the 1990’s were that they were not implemented with medium term strategy. Although in 1997 a fiscal stimulus project was designated with medium term strategy in mind, it was terminated that same year. The stagnation that was a result meant that there was an average growth of only about 1% per year with flattened tax revenue and a general government deficit of 5% of GDP. As a result, net debt increased to 60% which was a remarkable difference to the 15% of the previous decade (International Monetary Fund 2009). Banking Crisis Timeline: The following timeline shows the progression of the deflationary period that was provoked through a failure in the banking system within Japan: Key Events in Japan’s Banking Crisis 1989: Stock Market Peaked Crisis Phase1: Slowdown 1990 Land Prices Peaked 1994 Hyogo Bank Failed 1996 Series of housing loan companies failed Crisis Phase 2: Escalation and Fledgling Recovery 1997 Yamachi Securities Co. Ltd. and Hokkaido Tackusticku Bank Failed 1998 First injection of pubic funds into bank Long-Term Credit Bank of Japan and Nippon Credit Bank nationalized Resolution and Collection Corporation (RCC) starts purchase of NPL’s from healthy financial institutions Series of mergers among major banks 2000 Bank of Japan lifts zero interest rate policy Crisis Phase 3: Renewed Systemic Stress 2001 Bank of Japan lowers interest rates and implements quantitative easing policy 2002 Full deposit protection terminated Financial Revitalization program instituted Bank of Japan starts stock purchases from banks 2003 Resona Bank nationalized Industrial Revitalization Corporation of Japan (RCJ) established Ashikaga Bank nationalized Sustained Recovery 2004 Full protection of deposits payable on demand terminated 2005 Outstanding balance of banks’ lending trends upwards 2006 Bank of Japan lifts quantitative easing and zero interest rate policy (International Monetary Fund 2009) Conclusion Despite failing policies, the economy of Japan has seen a margin of success in rehabilitation. According to Krugman (2009, 76), the foundation of the recovery was based in exports by way of the enormity of the export business that was occurring in China who used a great deal of parts made in Japan. However, the recovery is limited in its nature because the interest rate in 2009 still remains at about .5%, leaving little room for error before diving back to zero percent and entering once again the liquidity trap. This trap has the capacity to pull the entire economy back into a stagnated sense of existence where the growth is stifled and the economy suffers from a lack of movement. The problems in Japan stem from a type of economic status called balance sheet recession. This type of recession is one founded on a scramble to recover, thus creating more overall problems within the system. The creditors become conservative in attempting to regain their debts and by ceasing to continue lending while the debtors become panicked and begin to try to become liquid. Debtors attempt to repay their debts more quickly, thus breaking their relationship with the creditors, which might seem good for the individual, but is not good for the overall economy. Creditors become more conservative and also liquidate choosing to invest in high security, low return investments in order to stay strong through a crisis. The entire problem comes down to fear that promotes less risky behavior that then crashes the system. The way the world has evolved in concerns with financial considerations is to embrace the gambler within the business person, promoting them higher through investment into their unknown futures. The system is created on the premise that the future can be predicted, thus investing into it can provide an expected return. However, as the economy proves over and over throughout history, there is no real assured tomorrow and investing is just a gamble, no matter how safe the predictions seem. Japan has experienced deflationary economic stress due to a lack of foreword thinking political policies and over use of antiquated ideas that show no sense of innovation. When the economy grew stagnant, the government was reticent to change their policies until a crisis occurred pushing them forward into decisions that seemed designed to create more problems. While the theory of the liquidity trap had existed since the 1930’s, the signs that Japan was falling victim to its trappings were not heeded. The devaluation of the yen showed some marginal results in provoking growth, the true advantages of exports in solving the problems would be found through the success of another country, that of China, as they found a booming business in selling products with Japanese parts within them. The deflationary period in Japan seems to be somewhat abated, although the Japanese economy suffers from the ills of the global economy. Some of the remaining issues of the crisis are concerned with interest rates that are so low that they barely registered within the economic structure. Whether or not there is true recovery or just a momentary rise is not clear. As in any gambling scenario, the fate of the players is not yet written. As well, the lessons learned have been steep, but they too may be doomed to repetition as the learning of many economic lessons are so often set to repeat. The future of the world’s economy is yet unknown, although there is much speculation. Therefore, there never really is an end to an economic story. Just the turn into the next phase. References Bergstein, Fred. 1996. The competitive depreciation of the yen. Retrieved on 26 May 2010 from http://pages.stern.nyu.edu/~nroubini/articles/YEN$BERG.HTM Boeckh, J. Anthony. 2010. The great reflation: how investors can profit from the new world of money. Hoboken, N.J.: John Wiley & Sons. Brookings Institution. 2004. Brookings papers on economic activity. Washington: Brookings Institution. Dicks, James. 2010. Forex trading secrets: trading strategies for the forex market. New York: McGraw-Hill. Drysdale, Peter and Luke Gower. 1998. The Japanese economy. East Sussex: Taylor and Francis. Harrison, Edward. 16 June 2008. Credit deflation and the Japanese problem. Credit Writedowns. Retrieved 24 May 2010 from http://www.creditwritedowns.com/2008/06/credit-deflation- and- japanese-problem.html Hutchison, Michael M., and Frank Westermann. 2006. Japans great stagnation financial and monetary policy lessons for advanced economies. Cambridge, MA: MIT. Greenwood, John. 5 March 2010. Japan’s two decades of deflation: causes treatments and prospects. INVESCO. Ppt. International Monetary Fund. 28 July 2006. IMF Executive Board concludes 2006 Article IV consultation with Japan. International Monetary Fund. Retrieved 25 May from http://www.imf.org/external/np/sec/pn/2006/pn0681.htm International Monetary Fund. 2009. Regional economic outlook: Asia and Pacific : global crisis : the Asian context. Washington, D.C.: International Monetary Fund. International Monetary Fund. 2009. World Economic Outlook, April 2009 Crisis and Recovery. Intl Monetary Fund. Krugman, Paul 1998. Japan’s trap. Retrieved 25 May from http://web.mit.edu/krug man/www/japtrap.html Krugman, Paul. 2009. The return of depression economics and the crisis of 2008. New York: W. W. Norton and Co. McKinnon, Ronald I. 2005. Exchange rates under the East Asian dollar standard: living with conflicted virtue. Cambridge, MA [u.a.]: MIT Press. Nakisone, Yasuhiro and Leslie Conners. 1999. The making of the new Japan: Reclaiming the political mainstream. Surrey: Curzon Press. Sabri, Nidal Rashid. 2002. International financial systems and stock volatility: issues and remedies. International review of comparative public policy, 13. Amsterdam [u.a.]: JAI. Suzuki, Takaaki. 2000. Japans budget politics: balancing domestic and international interests. Study of the East Asian Institute, Columbia University. Boulder [u.a.]: Rienner. List of Illustrations Fig 1. Retrieved from http://rds.yahoo.com/_ylt=A0oGkwQSsP9L7w0BxBhXNyoA;_ylu=X3o DMTE1OWpybGVpBHNlYwNzcgRwb3MDMwRjb2xvA3NrMQR2dGlkA01BUDAwN V8xMDI-/SIG=1362r23ur/EXP=1275134354/**http%3a//www.creditwritedowns .com/2008/06/credit-deflation-and-japanese-problem.html Fig. 2 The effect of export price cuts on Japanese competitiveness. Retrieved from http://www.newyorkfed.org/research/current_issues/ci2-1.pdf Fig. 3 2010 Yen to Dollar valuation chart. Retrieved from http://www.yenchart.com/Chart- Dollar-Yen.htm Read More