Journal of Economic Perspectives—Volume 18, Number 1—Winter 2004 —Pages 3–26
Japan’s Financial Crisis and Economic
Takeo Hoshi and Anil K Kashyap
he recent Japanese economic experience has been dismal. Growth has collapsed, deﬂation has taken hold and the ﬁnancial system is in shambles. We begin our story by documenting the macroeconomic troubles that appear to have triggered the collapse of Japan’s ﬁnancial sector. We argue, however, that the macroeconomic factors alone are not likely to explain the full extent of the problems in the Japanese ﬁnancial system. We then turn to the sector-speciﬁc factors that are facing the Japanese banks, insurance companies and government ﬁnancial institutions, which together constitute roughly three-quarters of the ﬁnancial system. Finally, we provide estimates of the size of the losses that have been accumulated and review the steps necessary to resolve the problems promptly so that the losses stop growing.
The estimated losses from Japan’s ﬁnancial system problems, which presumably will be borne by taxpayers eventually, are huge. Even our fairly conservative estimate suggests the full cost to the taxpayers is at least 20 percent of Japan’s GDP. The sheer size of the cost, along with the interaction among the related economic problems, has made a decisive resolution of the problems politically difﬁcult.
y Takeo Hoshi is Paciﬁc Economic Cooperation Professor of International Economic Relations, Graduate School of International Relations and Paciﬁc Studies, University of California at San Diego, San Diego, California, and Faculty Fellow, Research Institute of Economy, Trade, and Industry, Tokyo, Japan. Anil K Kashyap is the Edward Eagle Brown Professor of Economics and Finance, Graduate School of Business, University of Chicago, and Consultant, Federal Reserve Bank of Chicago, both in Chicago, Illinois. Both authors are Research Associates, National Bureau of Economic Research, Cambridge, Massachusetts.
Journal of Economic Perspectives
There is no doubt that the poor macroeconomic conditions have contributed to the deterioration in the condition of the Japanese ﬁnancial sector. The conventional wisdom, concisely stated in the annual report of the Bank for International Settlements (2002, p. 135), is this: “The Japanese situation highlights the powerful two-way links between the real economy and the ﬁnancial system: the depressed state of the economy is hurting the banking system, and the poor health of the banking system is impeding the economic recovery.” We agree with this assessment, and therefore to start our analysis, we review the macroeconomic conditions and explain how we see the two-way links operating. We then explain why the Japanese ﬁnancial sector problems seem too big to be explained by purely cyclical factors. Output and Price Developments
Over the last decade, the Japanese economy has underperformed dramatically. Figure 1 shows the evolution of real GDP from the ﬁrst quarter of 1980 to the second quarter of 2003. The apparent decline of trend growth rate around the early 1990s is clear. The dotted line shows the level that GDP would have attained if starting in 1990 the economy had subsequently grown by 2 percent a year. The line that mixes dashes and dots shows GDP under the assumption that starting in 1985 the economy had continued to grow at the average pace of 1980 –1985. Compared with either of these benchmarks, Japan’s actual GDP growth has been disappointing. If we use the 2 percent growth as the benchmark case, the economy started to underperform in 1992 and now stands 10 percent below trend.
Kuttner and Posen (2001) refer to this period as the Japanese “great recession.” This seems a fair description given the substantial gap between actual GDP and the trend, although Japan’s growth experience is more one of stagnation and slow growth rather than depression.1 For instance, the worst annual growth...
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