Japan's Long Stagnation, Deflation, and Abenomics

KENJI ARAMAKI
Japan’s
Long Stagnation,
Deflation, and
Abenomics
Mechanisms and Lessons
Japan’s Long Stagnation, Deflation, and Abenomics
Kenji Aramaki
Japan’s Long
Stagnation, Deflation,
and Abenomics
Mechanisms and Lessons
Kenji Aramaki
Tokyo Woman’s Christian University
Tokyo, Japan
University of Tokyo
Tokyo, Japan
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Preface
The objective of this book, which covers the Japanese economy since the
1980s, is to identify the mechanism of formation and collapse of a huge
bubble and the subsequent long economic stagnation and deflation and to
discover challenges that the current Japanese economy faces.
I worked mainly in the field of international finance in the Ministry of
Finance of Japan for about 30 years and then moved to Tokyo University,
where I taught international economics for more than 10 years. The rea-
son why I have written a book on the Japanese economy, which is not
strictly my specialty, is that I have had a strong desire to find out an answer
to my long-held questions, that is, “Why did the Japanese economy fall to
its current situation?” and “Was it inevitable?”
It was 1976, when I started to work, more than 40 years ago. The
Japanese economy at that time was dynamic and filled with increasingly
strengthened confidence. At the height of the euphoria of the bubble of
the late 1980s, I was working as economist at the International Monetary
Fund. Personally, I did not like what was going on with the Japanese
economy at that time, but my confidence in the strength of the Japanese
economy did not change. Even after the collapse of the bubble in the
1990s, I felt that the Japanese economy would be able to return at any
moment to the previous conditions, which had been filled with vitality.
However, the reality did not turn out that way. The Japanese economy
experienced a serious financial crisis in the late 1990s, and deflation set in.
Even after entering the 2000s, low growth continued, and the Japanese
economy lagged behind the growth of the global economy for decades.
Japan held a share that was higher than 9% in the world exports of goods
v
vi PREFACE
and services in the first half of the 1990s, but at present it is less than half
that, at about 4%. China’s nominal GDP, which was 18% of Japan’s nomi-
nal GDP in 1996, is 2.3 times larger than that of Japan, as of 2017.1 No
one at that time expected to see the economy as it is in 2017, and I have
thought that it is the responsibility of our generation to answer “why?”
However, the work to find out an answers presented many difficulties,
as there were limited opportunities to exchange views outside the field of
my expertise, which is international finance. I chose, for the first time, to
examine the issues of the Japanese economy as a topic in a seminar class
that I taught at the Faculty of Arts and Sciences of Tokyo University in the
summer term of 2011, and I started to read extensively the relevant arti-
cles and materials. In 2014, I was awarded the opportunity to conduct
research as a visiting professor at the School of Oriental and African Studies
(SOAS) of London University. There, I gave lectures on the Japanese
economy as a guest lecturer, while conducting research on international
financial crises. Preparatory work for these guest lectures motivated me to
further analyze the Japanese economy. Since the summer of 2015, when I
left SOAS, I have given presentations on the Japanese economy in London,
Berlin, and Zurich at the conferences of the Japan Economy Network
(JEN), which is an international network of researchers on the Japanese
economy that my colleagues at the SOAS, including Dr. Ulrich Voltz,
Prof. Machiko Nissanke, and Dr. Sotoshi Miyamura, and myself organized
in 2015 at a conference, together with the economists in attendance. The
book gradually came into a concrete shape, and it has taken more than
seven years to complete.
The central argument of the book is that, at the center of the anomalies
and difficulties of the Japanese economy over an extended period of time
including formation and collapse of the bubble, the financial crisis, and
deflation, were corporate behaviors that have changed while showing sub-
stantial fluctuations. For example, the biggest negative legacy that the
bubble left with Japan was excess assets (those assets for which sufficient
demand is not expected and, therefore, are necessarily unprofitable) of the
corporate sector. The reason why the economy did not show a strong
growth for a long time after the collapse of the bubble is that, as sales by
companies stopped growing and economic growth decelerated following
1
IMF World Economic Outlook, April 2018. Nominal GDP in terms of home currency of
each country is converted to the dollar using market exchange rate.
PREFACE vii
the burst of the bubble, the excess assets (unprofitable assets) expanded.
Companies could not swiftly dispose of such excess assets, and investment
was depressed for an extended period of time. Furthermore, despite sales
not increasing, wages continued to increase in the early years after the col-
lapse of the bubble, and profits of companies were further depressed by
this factor. Companies’ responses at that time to the problems brought
about by the collapse of the bubble were “passive,” and this passivity led
to a lengthening of the economic stagnation. When the financial crisis
broke out in the late 1990s, under the deteriorating business conditions
and with a sharp aggravation of funding environments, which were
described as not only “new loan curbing” but also as “outstanding loan
withdrawing,” company response shifted at a stroke to a “crisis response.”
Companies forcefully proceeded with wage reduction, replacement of
regular workers with non-regular workers, further restraint of investment,
and strengthening of their net asset position. Around this period, deflation
started with the declining wage level. The Japanese economy slowed fur-
ther, and fundamental changes occurred with the financial crisis.2
Due to such responses by companies, excess assets together with excess
debts and excess employment were removed by the mid-2000s, and the
economy returned to the normal. However, a defensive attitude of compa-
nies that emerged after the financial crisis was maintained, such that restraint
on investment and wages continued (“continued defensiveness” emerged).
The biggest characteristics of the stagnation of the Japanese economy are,
first, that it took as long as 15 years from the collapse of the bubble in the
early 1990s to the elimination of the excesses and, second, that a defensive
attitude on the part of companies continued (it has not been eliminated
even now), even after the problems with the balance sheets of companies,
which lay at the heart of the difficulties, had been rectified.
This book argues that behind the defensive attitude of companies is the
low-growth expectations held by companies. Low-growth expectations
became firmly rooted and settled under the reality of low growth that
2
Companies changed their behavior significantly after the financial crisis. Many Japanese
companies, which once placed a high priority on employment, forcefully pressed ahead with
labor cost reduction through wage cuts and replacement of regular workers by non-regular
workers, while protecting the employment of existing workers (Wakita [2014] described this
as “fortified Japanese companies”). Under such developments, there has emerged serious
social costs, such as very low marriage rates of young non-regular workers (see Chap. 7).
Defensive behaviors of companies are producing negative externalities.
viii PREFACE
extended over a long period of time, from the 1990s (the average growth
rate in 22 years from 1991 to 2012 was 1.0%). The total amount of (nom-
inal) sales of all the profit-making companies in Japan increased by merely
1.9% from fiscal 1990, when the collapse of the bubble started, to fiscal
2016.3 Japanese companies have been living in a world where growth does
not exist for more than a quarter of a century.
Regarding the low-growth expectations formed under such reality, one
view argues that, as the problems with the balance sheets of companies
were resolved, the low-growth expectation has become not so much a
reflection of economic reality, but rather a result of a habitualized way of
thinking (i.e., a mindset), and therefore, it will change if the mindsets of
companies are changed. In contrast, there is another view that argues that
the low-growth expectations have a rational, most likely structural basis. A
representative point of the latter view stresses the expected shrinkage of
domestic markets due to population decline.
As I explain in the book, I do not think the latter view (one that con-
tends that long-term and structural factors brought about the defensive
attitudes of companies or low-growth performance) applies to the major
part of the two-decade stagnation from the collapse of the bubble to the
beginning of the 2010s (this is the period which we call “the long stagna-
tion period” in the book). More specifically, I do not think that the view
can explain the mechanism of stagnation during the period up to the mid-
2000s, when the corporate sector finally eliminated the aftereffects of the
collapse of the bubble. In particular, although it is highly possible that
expectation of population decline will restrict corporate behaviors in the
future, it is only since the second half of 2000s that the population decline
has become a reality,4 and it was not so long ago, probably only after the
beginning of the 2010s, when the population decline was widely recog-
nized as an important problem by the general public. In this book, it is
argued that the fundamental mechanisms for the major part of the long
stagnation was, one, the lengthening of the process of disposition of excess
assets and, two, the strengthened defensiveness of companies after the
financial crisis. Furthermore, while it is difficult to clearly distinguish the
degree of their influence, factors arising from the defensive mindset (the
3

Ministry of Finance of Japan “Financial Statements Statistics of Corporations by
Industry.”
4

Statistics Bureau, Ministry of Internal Affairs and Communications, “Population
Estimates.”
PREFACE ix
part of defensiveness that does not seem to have a rational basis) still
remain in the mechanism of low-growth expectations by companies and
low-growth performances since the mid-2000s to the present.5 Therefore,
attempts to change such mindsets (e.g., governance reform that encour-
ages companies to employ outside directors in their management, promo-
tion of wage increases, and facilitating realization of higher growth than
before through alteration of foreign demand to domestic demand by pro-
moting such activities as tourism and inward foreign investment) are
thought to be effective. However, the mindset of companies cannot
explain the whole process and, particularly for the future, there is no deny-
ing that substantive issues still exist.
The comprehensive policy package that has been implemented by the
Abe administration, known as Abenomics, aims at both encouraging
changes in the mindset and addressing the substantive issues for the future.
The package has brought about some positive outcomes. However, cor-
porate behaviors have not significantly changed in a positive direction, and
the process is only half accomplished. At the same time, concerns are ris-
ing about by-products, including the declining growth contribution of
consumption, accumulation of potential risk in the financial system, and
continued significant deterioration of the fiscal position. This describes the
present condition of the Japanese economy.6
In writing this book, many people have extended their help to me. I
would like to thank the undergraduate students who passionately partici-
pated in my seminar class in the summer of 2011, in which I first started
to examine the Japanese economy intensively, and the undergraduates,
graduates, and alumni of my seminar who participated in “the workshop
on the Japanese economy,” which I held in the Faculty of Arts and Sciences
of Tokyo University. I am also very grateful to Dr. Takashi Omori (ex-
director of the division in charge of writing the “Economic White Paper”
in the Economic Planning Agency of Japan) who read the manuscript and
gave very many fundamental as well as technical comments; Dr. Teru
5
See Supplement to Chap. 6, in which the mechanism of stagnation is shown, with a focus
on company behaviors, by flowcharts, respectively, for three periods: “Period of passive
response” immediately after the collapse of the bubble; “Period of crisis response” after the
financial crisis in the latter half of the 1990s; and “Period of continued defensiveness” from
the mid-2000s.
6
While the objective of the book is to identify the mechanism of anomalies and difficulties
of the Japanese economy over the past 30 years from the bubble formation to present, it
briefly touches on measures to deal with current challenges in the Chap. 7.
x PREFACE
Nishikawa (Associate Professor, Yokohama National University) who

offered many beneficial comments; Mr. Masaru Homma (The European
Bank for Reconstruction and Development (EBRD)), Dr. Kunio Mikuriya
(The World Customs Organization (WCO)); and Mr. Takao Tashiro
(Japan Weather News) who gave useful comments on part of the book,
Mr. Mahito Sugaya (Certified Accountant) who gave very insightful com-
ments based on real-world experience; and Dr. Hiroshi Shibuya (Emeritus
Professor, Tokyo University) who commented on the basic theme of the
book. I am also very thankful to Professors Martin Fransman and Matthias
Zachmann of The University of Edinburgh, who first encouraged me to
write a book, after I gave a seminar in Edinburgh in 2015, on the issue of
long stagnation.
I would like to extend my thanks to my colleagues and the administra-
tive staff of the Department of Advanced Social and International Studies,
School of Arts and Sciences, University of Tokyo, to which I belonged
until March 2017. They kindly allowed and supported my sabbatical leave.
As stated before, guest lectures that I gave during the sabbatical leave were
a drive for the analysis in this book. I would like to express my gratitude
to Dr. Machiko Nissanke, Professor Emeritus of SOAS, who accepted me
as a visiting professor at SOAS; to SOAS Senior Lecturer Dr. Ulrich Voltz,
who supported my research on the Japanese economy through formation
and management of JEN that I noted before, and to SOAS Senior Lecturer
Dr. Satoshi Miyamura, who gave advice on the lectures on the Japanese
economy at SOAS. In particular, I am very grateful to Professor Emeritus
Machiko Nissanke, who provided me with a comfortable research envi-
ronment at SOAS and took time to usher a manuscript of the earlier
version of the book, first drafted based on lecture notes, into publication.
I am also thankful to the Tokyo Woman’s Christian University for the cur-
rent working environment, which they have provided for my research.
I am also very grateful to Ms. Patricia K. Mason, who thoroughly
reviewed the manuscript and offered very insightful and superb editorial
comments that greatly improved the manuscript. While I have worked for
the Ministry of Finance of Japan for about 30 years, I did not become
directly engaged in the issues that were most relevant to the themes of this
book. I would like to make it clear that the entire contents of the book are
based on public information and incorporate my personal thoughts. They
do not represent views of any institution that I belonged to in the past.
Data and their interpretations are mine, and if there are any misunder-
standings or insufficiency, they are solely my responsibility.
Preface xi
Last but not least, I would like to thank Professor Frank Rövekamp of
the Ludwigschafen University of Applied Sciences for his detailed and
positive review of the book’s outline, and to Palgrave Macmillan for pub-
lishing the book.
I will be very happy if this book could make some contribution to
reconstruction of the Japanese society and economy and also could offer
any useful lessons to other countries.
Tokyo, Japan Kenji Aramaki

Contents
1 Introduction: Objectives and Main Arguments of the Book 1
2 Formation of a Bubble and Its Background 33
3 Collapse of the Bubble and the Start of the Long

Stagnation 83
4 The Financial Crisis and Its Impacts, Long Recovery, and

Afterward129
5 Deflation and Monetary Policy189
6 Deflation and the Mechanism of Corporate Behavior221
7 Abenomics and Challenges for the Japanese Economy285
Bibliography341
Index361
xiii
List of Figures
Fig. 1.1 Total credit to private nonfinancial sector (in percent of

nominal GDP) 6
Fig. 1.2 Total credit to nonfinancial corporations (in percent of
nominal GDP) 7
Fig. 1.3 Total credit to households (in percent of nominal GDP) 7
Fig. 1.4 Total credit to general government (in percent of GDP) 8
Fig. 2.1 Urban land price index: Six largest cities (end March 2000 =
100) October 1954–April 2012 34
Fig. 2.2 Nikkei 225 (monthly average) June 1949–February 2013 35
Fig. 2.3 Actual and theoretical land price (land for business use,
Central Tokyo.1983 = 1) 1971–1991 37
Fig. 2.4 Actual and projected land price (all uses) in Tokyo
metropolitan area 37
Fig. 2.5 Rate of land price increases by area and by type of use in the
Tokyo metropolitan area, 1983–1991 38
Fig. 2.6 Spillovers of land price increases from Tokyo to Osaka and
Nagoya metropolitan areas and to local areas 39
Fig. 2.7 Aggregate floor size of the buildings belonging to the Tokyo
Building Association and average vacancy rate 40
Fig. 2.8 Development in interest-rate-adjusted PER 41
Fig. 2.9 Current account balance: US 1965–1990 43
Fig. 2.10 Current account balance: Japan 1966–1990 44
Fig. 2.11 Real GDP growth contribution by private investment in plant
and equipment (Ip) and net exports (NE) in 1956–1973
(high-speed growth era), 1974–1984 (stable growth era),
and 1985–1990 (bubble era) 45
xv
xvi List of Figures
Fig. 2.12 General government fiscal balance (GDP ratio): Japan

1965–199047
Fig. 2.13 Yen–dollar exchange rate (monthly average) 1980–1989 52
Fig. 2.14 Official discount rate: Japan 1980–1990 54
Fig. 2.15 Land holdings by all industries (excluding financial and
insurance companies) and their breakdown between
manufacturing and non-manufacturing sectors 58
Fig. 2.16 Physical assets (excluding land) held by all industries
(excluding financial and insurance companies) and their
breakdown between manufacturing and non-manufacturing
sectors58
Fig. 2.17 Physical assets (excluding land) held by four major
non-manufacturing industries 59
Fig. 2.18 Savings/investment balance of the government sector and
current account balance (both in GDP ratio): US 62
Fig. 2.19 Consumer Price Index (year-on-year change): US and Japan 63
Fig. 2.20 Real effective exchange rate of the yen (2010 = 100),
1970–199063
Fig. 2.21 Real GDP growth rate: US and Japan, 1980–1985 64
Fig. 2.22 Crude oil prices (Dubai, in dollar per barrel), 1965–1999 65
Fig. 2.23 Real GDP growth rate and share of private investment in
plants and equipment in real GDP 68
Fig. 2.24 Share in real GDP of private investment in plants and
equipment, government expenditure, and net exports: Japan
1965–199068
Fig. 2.25 Share of loans to three real estate-related sectors in total
outstanding loans 70
Fig. 3.1 Real GDP growth rate: Japan 1956–2017 87
Fig. 3.2 Unemployment rate 89
Fig. 3.3 Amount of real GDP: Japan 1955–2015 91
Fig. 3.4 Nominal GDP 92
Fig. 3.5 Output gap (in GDP ratio) 93
Fig. 3.6 Money stock (M2 + CD) (year-on-year change): Japan,
1985–199894
Fig. 3.7 The lending stance of financial institutions (share of “Eased” –
share of “Tight”): Japan 1990–2000 95
Fig. 3.8 Real GDP growth rate and contribution by private
investment: Japan, 1991–2012 98
Fig. 3.9 Cumulated Diffusion Index 99
Fig. 3.10 Quarterly growth rate of real GDP (year-on-year): Japan,
1987Q1–2012Q4100
List of Figures xvii

1985Q1–2000Q4105
Fig. 3.14 Growth contribution of major demand components
(three-year moving average): Japan, 1985–2000 106
Fig. 3.15 Share in real GDP of private investment, housing investment,
and government investment 107
Fig. 3.16 Assets, liabilities, and net assets of companies (all industries
excluding financial and insurance companies): FY 1960–2013 108
Fig. 3.17 Total sales of companies (all industries excluding financial and
insurance companies) and their breakdown between
manufacturing and non-manufacturing sectors 108
Fig. 3.18 Real GDP growth rate and expected growth rate held by
companies for the next three years 110
Fig. 3.19 Growth rate of nominal sales and growth rate of nominal
investment (both in three-year moving average) 110
Fig. 3.20 The exchange rate of the yen to the dollar and real and
nominal effective exchange rate (2010 = 100) 111
Fig. 3.21 Capital gains and losses accruing to land and stocks (in GDP
ratio)113
Fig. 3.22 Outstanding balance of long-term debt of companies (all
industries excluding financial and insurance companies) 114
Fig. 3.23 Expected growth rate and land price 115
Fig. 3.24 Fiscal balance of general government (in GDP ratio) 117
Fig. 3.25 General government deficit (in GDP ratio): Japan, US, the
United Kingdom, Germany, and France 118
Fig. 3.26 Outstanding balance of general government debt (in GDP
ratio)118
Fig. 3.27 Official discount rate 119
Fig. 4.1 Number of failed deposit-taking financial institutions 131
Fig. 4.2 Return on Assets (ROA: operating profits/total assets) 132
Fig. 4.3 Earned profits 132
Fig. 4.4 Operating profits by companies’ capital size 144
Fig. 4.5 Real GDP growth rate and asset price (1980 = 100): Norway 150
Fig. 4.6 Real GDP growth rate and asset price (1980 = 100): Sweden 150
Fig. 4.7 Real GDP growth rate and asset price (1980 = 100): Finland 151
Fig. 4.8 GDP growth rate: Norway, Sweden, and Finland 152
Fig. 4.9 Number of corporate bankruptcies 154
Fig. 4.10 Economic conditions, as judged by companies 155
Fig. 4.11 Lending stance of financial institutions, as judged by
companies, Japan 1990–2000 156
xviii List of Figures
Fig. 4.13 Nominal wages (year-on-year change, three-year moving

average)157
Fig. 4.14 Share of non-regular employees in total number of
employees, excluding executives 158
Fig. 4.15 Number of regular workers 159
Fig. 4.16 Financial surplus/deficit by sector (in percent of GDP) 159
Fig. 4.17 Consumer Price Index (excluding fresh food) (year-on-year
change)160
Fig. 4.19 Production capacity (“excessive”–“insufficient”) 163
Fig. 4.20 Interest-bearing liabilities/cash flow 164
Fig. 4.21 Long-term debt of companies 164
Fig. 4.22 Employment conditions as judged by companies
(“excessive employment”—“insufficient employment”) 165
Fig. 4.23 Cash and deposit holdings by nonfinancial companies 165
Fig. 4.24 Real GDP growth rate of the world and Japan 166
Fig. 4.25 Investment/cash flow 167
Fig. 4.26 Private investment and Foreign Direct Investment 168
Fig. 4.27 Nominal investment by the electric machinery and appliances
sector and the automobiles and parts sector 168
Fig. 4.28 Labor cost/value added 170
Fig. 4.29 Share of public fixed capital formation in real GDP 170
Fig. 4.30 Real GDP growth rate and growth contribution of private
consumption171
Fig. 4.31 Real wage (2015 = 100) 172
Fig. 4.32 Household savings ratio 173
Fig. 4.33 Trade dependence, export, import, and net export (in GDP
ratio)173
Fig. 4.34 Nominal investment, nominal amount of depreciation, and
nominal net investment 174
Fig. 4.35 Current account and goods and services account 175
Fig. 4.36 Yen to dollar nominal exchange rate 176
Fig. 4.37 Overseas investment/domestic investment 177
Fig. 4.38 Total assets of corporations (excluding financial and insurance
companies) and their trend line 181
Fig. 4.39 Share of excess assets in total assets: FY1985~FY2010 181
Fig. 4.40 Additional number of people unemployed and the
unemployment rate resulting from prompt resolution
of excess assets 182
Fig. 4.41 Physical assets (excluding land) of corporations (excluding
financial and insurance companies), their trend lines, and the
ratio of physical assets to sales 183
List of Figures xix
Fig. 5.1 The Consumer Price Index (excluding fresh food): Changes
from the previous year 190
Fig. 5.2 The GDP deflator and Consumer Price Index (excluding
fresh food) (year-on-year change) 191
Fig. 5.3 Import penetration 193
Fig. 5.4 Price developments in imports and import-competing
products194
Fig. 5.5 Cumulated changes in GDP deflator from 1990 to 2009 by
sector (%) 194
Fig. 5.6 Price changes from 1990 to 2009 of deregulation-related
products195
Fig. 5.7 Interest rates 200
Fig. 5.8 Stock price: Japan in 1990s and US in the Great Depression 201
Fig. 5.9 Consumer Price Index: Japan in 1990s and US in the Great
Depression201
Fig. 5.10 Taylor rule analysis of US and Japanese interest rates 202
Fig. 5.11 M2 and Consumer Price Index (excluding fresh food)
(year-on-year change) 212
Fig. 5.12 Base money and M2 (year-on-year change) 213
Fig. 5.13 Loans and government bonds held by domestic banks 213
Fig. 6.1 Sales and wages (all industries excluding financial and
insurance companies) 222
Fig. 6.2 Ratio of wages to sales and operating profits 223
Fig. 6.3 Operating profits, non-operational profits, and current profits
(all industries excluding financial and insurance companies) 224
Fig. 6.4 Current profits and changes in wages from previous year 225
Fig. 6.5 Assets and liabilities of companies (all industries excluding
financial and insurance companies) 226
Fig. 6.6 Assets and their breakdown between fixed and liquid assets
Fig. 6.7 Liquid assets and their components (all industries excluding
Fig. 6.8 Fixed assets and their major components (all industries
excluding financial and insurance companies) 228
Fig. 6.9 Investment securities and Foreign Direct Investment 228
Fig. 6.10 Liabilities and their breakdown between liquid and fixed
liabilities (all industries excluding financial and insurance
companies)230
Fig. 6.11 Liquid liabilities and their major components (all industries
excluding financial and insurance companies) 230
Fig. 6.12 Fixed liabilities and their components (all industries excluding
xx List of Figures
Fig. 6.13 Net assets and their components (all industries excluding
Fig. 6.14 Earned surplus and its components 233
Fig. 6.15 Capital/assets ratio 233
Fig. 6.16 Number of manufacturing companies by capital size (all
industries excluding financial and insurance companies) 234
Fig. 6.17 Ratio of physical assets (excluding land) to sales 240
Fig. 6.18 Estimated excess physical assets, investment, and depreciation
Fig. 6.19 Real gross private investment 242
Fig. 6.20 Cash flow, private investment, and private investment/
cash flow 243
Fig. 6.21 Dividends received from abroad and their share in non-
operational revenue 245
Fig. 6.22 Expected growth rate held by companies 246
Fig. 6.23 Ratio of current profits to sales (%) 246
Fig. 6.24 Ratio of outstanding Foreign Direct Investment (all sectors)
to physical assets (excluding land) (all industries excluding
Fig. 6.25 Overseas production ratio (manufacturing) 248
Fig. 6.26 Private investment, outward Foreign Direct Investment,
and cash flow 248
Fig. 6.27 Monthly nominal cash earnings per worker (in establishments
with five employees or more, year-on-year change) 250
Fig. 6.28 Monthly real cash earnings per worker (in establishments
with five employees or more [2015 = 100]) 251
Fig. 6.29 Real wages and labor productivity (1990 = 100) 252
Fig. 6.30 Labor income share 253
Fig. 6.31 Monthly cash earnings per worker for normal workers
and for part-time workers (2015 = 100) 254
Fig. 6.32 Ratio of wages of non-regular workers to those of regular
workers255
Fig. 6.33 Compensation of employees/net national income
(at factor price) 256
Fig. 6.34 Labor cost/value added 256
Fig. 6.35 Value added and ratio of wage increase, dividends, and
increase in net assets to value added 258
Fig. 6.36 Annual average wage (1991 = 100) 259
Fig. 6.37 Hourly earnings (manufacturing) (1990 = 100) 259
Fig. 6.38 Annual rate of increase in CPI (excluding food, energy) 260
Fig. 6.39 Export price index (yen base) (2015 = 100) 260
Fig. 6.40 Developments in terms of trade (output deflator and input
deflator): manufacturing (2005 = 100) 262
List of Figures xxi
Fig. 6.41 Developments in terms of trade (output deflator and input

deflator): electric machinery (2005 = 100) 262
Fig. 6.42 Share of G5 and China in world exports 263
Fig. 6.43 Employment income 264
Fig. 6.44 Net interest received by households 264
Fig. 6.45 Employment income + net interest received by household 265
Fig. 6.46 Ratio of nominal household consumption to household
income (including personal business income) 266
Fig. 6.47 Export price, import price, and terms of trade (2015 = 100) 266
Fig. 6.48 GDP gap and changes of monthly cash earnings per worker
from previous year 275
Fig. 6.49 Nominal wage and Consumer Price Index (excluding fresh
food) (changes from previous year) 276
Fig. 6.50 Real GDP growth and population growth (Japan) 277
Fig. 6.51 Real GDP growth and population growth (France) 278
Fig. 6.52 Real GDP growth and population growth (US) 278
Fig. 6.53 Real GDP growth and population growth (United Kingdom) 279
Fig. 6.54 Real GDP growth and population growth (Germany) 279
Fig. 6.55 Nominal GDP and population 280
Fig. 7.1 Developments in the stock and foreign exchange market: Five
subperiods under Abenomics 295
Fig. 7.2 Trading amounts by investor type in Tokyo, 1st section 297
Fig. 7.3 Accumulated change of Nikkei 225 (October 31, 2012 = 100) 298
Fig. 7.4 Accumulated change of yen = dollar exchange rate
(October 31, 2012 = 0) 299
Fig. 7.5 Yen = dollar exchange rate and real GDP growth rate 299
Fig. 7.6 Nikkei 225 and real GDP growth rate 300
Fig. 7.7 Real growth rate and growth contribution by demand
components: Preceding period (2010Q1–2012Q4) and
Abenomics period (2013Q1–2018Q1) 301
Fig. 7.8 Interest rate on government bonds by maturity 302
Fig. 7.9 Interest rate on government bonds, lending rate, and
outstanding balance of bank lending 303
Fig. 7.10 Real private investment 304
Fig. 7.11 Real private consumption 305
Fig. 7.12 Real exports, real imports, and real net exports 305
Fig. 7.13 Real government expenditure 306
change)307
Fig. 7.15 Expected inflation rate held by private sector economists
(average)308
Fig. 7.16 Expected inflation rate held by companies (all industries) 308
xxii List of Figures

change, excluding effects of consumption tax increase),
yen–dollar rate, and crude oil price 309
Fig. 7.18 Consumer Price Index (excluding fresh food, oil products and
other special factors), yen–dollar exchange rate, and crude oil
price310
Fig. 7.19 Yen–dollar exchange rate, and current profits 311
Fig. 7.20 Nikkei 225 and current profits 312
Fig. 7.21 Current profits, investment, cash, and deposits 312
Fig. 7.22 Labor income share 313
Fig. 7.24 Ratio of jobs offers to job seekers 314
Fig. 7.25 Hourly wages for regular and non-regular workers (year-on-
year change) 315
Fig. 7.26 Real GDP growth rate and expected growth rate held by
companies317
Fig. 7.27 Population of Japan and its future estimates 319
Fig. 7.28 Five-year real GDP growth rate 321
Fig. 7.29 Five-year growth rate of real GDP per capita 321
Fig. 7.30 Five-year growth rate of real GDP per working-age
population (15–64) 322
Fig. 7.31 GDP gap 323
Fig. 7.32 Potential growth rate 324
Fig. 7.33 Growth contribution by demand components 325
Fig. 7.34 Annual issuance of government bonds: FY 1965–2017 327
Fig. 7.35 Share in outstanding government bonds and FILP bonds
held by major holders 328
Fig. 7.36 Share of respondents for each age group who listed
deterioration in fiscal, employment, or economic
conditions as the cause of their concern for the future 330
List of Tables
Table 2.1 Major economic and political developments in the 1970s and
1980s42
Table 2.2 Average growth contribution of private investment in plant
and equipment and net exports: 1956–1973 (high-speed
growth period), 1974–1984 (stable growth period), and
1985–1990 (bubble period) (%) 45
Table 2.3 Major trade disputes between Japan and US 45
Table 2.4 Major cases of export restraint 49
Table 2.5 BOJ’s explanation of monetary policy changes in the late 1980s 56
Table 2.6 Factor analysis of Japan’s current account surplus (estimate)
(in 100 million US dollars) 65
Table 2.7 GDP growth rate and private investment (year-on-year
change, period average): 1956–1973, 1974–1984,
1985–1990 (%) 66
Table 2.8 Developments in real estate-related loans by banks
(%, trillion yen) 70
Table 2.9 Dependence of manufacturing companies on borrowing
from financial institutions (%) 71
Table 3.1 Five periods of the Japanese economy since the high-speed
growth era 88
Table 3.2 Comparison of real GDP growth rate: Japan and other
advanced countries, 1980–2012 88
Table 3.3 Contribution to real GDP growth by major demand
components97
Table 3.4 Economic cycles during the long stagnation period 98
xxiii
xxiv List of Tables
Table 3.5 Contribution to GDP growth by major demand components

(bubble period and four subperiods in the long stagnation
periods)102
Table 3.6 Economic stimulus packages after the burst of the bubble
(trillions of yen) 116
Table 3.7 Chronology of relevant events 122
Table 4.1 Outstanding non-performing loans (NPLs) and NPL ratio 135
Table 7.1 Five periods in relation to developments in stock price and
the yen rate under Abenomics 296
CHAPTER 1
Introduction: Objectives and Main

Arguments of the Book
1 Objectives and Main Arguments of the Book

This book examines the experience of the Japanese economy over last
30 years, from the 1980s, a time filled with a series of difficulties not
observed in advanced countries in recent years, including the formation
and collapse of a huge bubble, a two-decade-long economic stagnation,
and chronic deflation, with an aim of identifying the mechanisms and
drawing lessons for future economic policy management.
The Japanese economy grew to be the second largest economy next to
the United States through the period of rapid growth from the 1950s to
the early 1970s, and its per capita income rose to among the highest levels
in the world. Even after the end of the era of rapid growth, the Japanese
economy overcame shocks arising from the collapse of the Bretton Woods
fixed exchange rate system and the shift to the floating exchange rate, as
well as two oil crises in the 1970s, and continued to be an object of envy
with its very low unemployment rate and solid economic growth. Its
financial presence grew larger still under continued high economic perfor-
mance, and it even began to be regarded as an economic threat to other
countries in the 1980s. However, the Japanese economy formed a huge
bubble in the latter half of the 1980s, and after the bubble’s collapse at the
beginning of the 1990s, it suffered from a long period of economic stag-
nation and deflation. Japan’s nominal GDP, after hitting a peak of 534.1
trillion yen in 1997, stopped growing altogether and was 545.1 trillion
© The Author(s) 2018 1

K. Aramaki, Japan’s Long Stagnation, Deflation, and Abenomics,
https://doi.org/10.1007/978-981-13-2176-4_1
2 K. ARAMAKI
yen in 2017, only greater by mere 11.0 trillion yen (2.1%) 20 years later,
after its peak in 1997.1
Why did such a long stagnation, which nobody could have imagined,
occur? Although there have been extensive arguments, there is no definite
consensus on the mechanism of the stagnation, and therefore, views still
diverge on the lessons to be drawn. As briefly described later in this chap-
ter, while the US economy recovered relatively speedily from the Global
Financial Crisis (GFC) that struck in 2008, the European economies con-
tinued to show weaknesses in their recovery, and worries about a fall into
deflation were not entirely dismissed until rather recently. Furthermore,
the Chinese economy, which had been growing rapidly for several decades,
started to decelerate and while the situation has stabilized, concerns over
the future course of its economy have not been eliminated entirely. Did
these economies face the risk of falling into long stagnation and deflation
(or low inflation) that the Japanese economy experienced? If there was
such a risk, at least at certain point in time after the crisis, what was the
mechanism of such a risk? Assuming that these economies have successfully
emerged from such a risk, what worked? If the economies did not success-
fully avoid the risk, what are the remaining problems? In order to answer
such questions, it helps to have an understanding of the mechanism of
long stagnation and deflation experienced by the Japanese economy.
While attempting to explore the mechanism of the bubble, stagnation,
and deflation in Japan from the 1980s throughout this book, we seek
answers to the following concrete key questions:
• Why was the bubble formed? What could have been done to prevent it?
• How did the bubble collapse? What impacts did the collapse of the
bubble have on the economy?
• Why did the financial crisis break out in the late 1990s, as much as
seven years after the collapse of the bubble? Why were the
non-performing loan (NPL) problems that underlay the crisis not
resolved sooner?
1
In real terms, the average real growth rate since the collapse of the bubble until today has
been 1.2%, which is about half of the average growth rate of the advanced countries (2.2%)
(or, just one-third of the average growth rate of the world economy [3.6%]) over the period.
If the Japanese economy had grown at the average rate of growth of advanced countries
(2.2%), then the real GDP would have been 1.3 times as big as the actual size (if it had grown
at the world average rate, it would have been 2 times as large). (Calculated using the IMF
“World Economic Outlook April 2108 database”).
INTRODUCTION: OBJECTIVES AND MAIN ARGUMENTS OF THE BOOK 3
• What impacts did the financial crisis have on the economy?

• Why did the vulnerability of the Japanese economy remain, even
after the negative legacy of the formation and collapse of the bubble2
and the shock of the financial crisis had been overcome by the mid-
2000s? What are the fundamental problems the Japanese economy
currently has?
• Will Abenomics be able to solve the fundamental problems of the
Japanese economy?
The ultimate objective is to understand the mechanism of long stagnation

and deflation and draw lessons for the future in Japan and for other econo-
mies through exploration of the answers to these questions.
The major characteristics of this book include the following:
• First, to capture the real cause of the anomalies and difficulties of the
Japanese economy, we have taken an approach, based mainly on a
thorough examination of data and facts. Since the early 2010s when we
started examining the long stagnation of the Japanese economy, we did
not espouse any theory or views in advance, but aimed to first study and
analyze extensive arguments, data, and facts. This book draws on such
work and tries to present a view that can most coherently explain what
the data and facts indicate. This book has tried to comprehensively
describe and understand the three-decade-long period of anomalies
and difficulties of the Japanese economy, thereby offering a new per-
spective on the problem and contributing to the economic literature.
• Second, we present a view that it is appropriate to analyze the Japanese
economy over 30 years by dividing the whole period into subperiods.
The basic divisions are three: the bubble period from the mid-1980s to
the beginning of the 1990s; the long stagnation period of more than
20 years from the beginning of the 1990s to the early 2010s; and the
period of Abenomics from 2013. However, what is unique to this
study is that the analysis of the long stagnation period is conducted by
further dividing this period of more than 20 years into four subperiods.
This view arose from the observation that the changes in the Japanese
economy emerged suddenly after the collapse of the bubble, and the
changes developed into a long-term phenomenon. In other words, the
mechanism of stagnation is thought to have changed from one of an
2
The negative legacy, as is explained in the book, refers mainly to the hangover of excessive
assets and debt in the corporate sector.
4 K. ARAMAKI
abrupt nature to the one with a perpetual or structural nature through

the long process of stagnation. The mechanism of stagnation must
have changed over time. As is explained in this book, the turning point
occurred with the financial crisis in the late 1990s. Specifically, the peri-
ods of study are divided as: Period I, from the period when the bubble
burst at the beginning of the 1990s to just before the financial crisis in
the latter half of 1990s; Period II, from the financial crisis to the early
2000s when the longest economic expansion since the Second World
War started; Period III, from the first half of the 2000s to just before
the GFC erupted in 2008; and Period IV, from the GFC to just before
the start of the Abenomics.
• Third, we place a significant focus on the analysis of company behav-
iors. This focus also emerged from the data-centered approach. The
Japanese economy underwent very substantial changes with the col-
lapse of the bubble and also with the financial crisis. These changes
include, for example, substantial restraint of private investment after
the collapse of the bubble and the decline of nominal wages and
consumer prices after the financial crisis. Most of these changes are
related to corporate behaviors, and therefore, the analysis of these
behaviors has become a very important element of this book. We
examine how corporate behaviors evolved over these respective sub-
periods, including in the bubble period, after the collapse of the
bubble, and after the financial crisis, based not only on macroeco-
nomic data but also on the combined balance sheet data of all the
profit-making companies in Japan.
The analyses of company behaviors are mainly conducted in Chap. 6,

and these analyses suggest that corporate behaviors greatly changed in the
process of long stagnation. Corporate behaviors during Period I after the
burst of the bubble and before the financial crisis may be described as a
“passive response,” in which expansion of excessive asset holding and
assumption of excessive debt, as well as a surge in labor costs developed.
In the period from the financial crisis to the first half of the 2000s (a
period broadly corresponding to Period II), companies tried to rapidly
remove excessive assets and debt and cut labor costs in response to the
financial crisis. Corporate behavior in this period is thus described as “cri-
sis response.” The elimination of excessive assets, debt, and employment
was completed by the mid-2000s, that is, 15 years after the collapse of the
bubble. However, restraints on private investment and on wages by
companies, which became conspicuous in the period of crisis response,

remained unchanged, continuing into Period III (the long recovery) and
Period IV (GFC and afterward), and even into the period of Abenomics.
Such corporate behaviors since the mid-2000s may be described as “sus-
tained defensiveness.” Why such defensive attitudes by companies con-
tinue is examined in detail in Chap. 6.
There are many inferences that can be drawn from the examination of
the Japanese economy in this book. The most important is the danger
involved in excessive asset holdings by economic agents. “Excessive”
means a situation in which the asset concerned does not have sufficient
demand (or revenue) for the goods and services that it produces.
Hangovers of such excessive assets (low-profitability assets) bring about
continuous pressures for the curtailment of asset holdings and restraint on
investment. Low-profitability assets also compress profits and produce a
pressure to cut costs such as wages and procurements. These pressures
tend to reduce domestic demand through restraint on investment and
consumption (through wage restraint), and may lead to a prolonged stag-
nation, possibly placing downward pressures on prices. Furthermore,
when such asset holdings are financed by debt, costs and risk arising from
excessive assets and debt may be shifted to the financial sector, raising the
risk of a financial crisis. If a crisis does break out, it will likely leave an
extensive scar on the economy. Furthermore, when an extended period of
time is taken to eliminate excesses and overcome a financial crisis, behavior
of economic agents can be substantially altered and the economy as a
whole may shift to a different equilibrium situation (e.g., from a high- to
a low-growth equilibrium).
Figure 1.1 shows development not in assets but in debt, in terms of
the total amount of credit (i.e., debt if viewed from the private nonfinan-
cial sector side) to private nonfinancial sector (corporate and household
sectors combined) (in GDP ratio) for Japan, the United States, the Euro
area, and China. The ratio for Japan rose from a level of 160% in the mid-
1980s to above 200% at the end 1980s and reached a peak of 219.5% at
the end of 1993. Thereafter, the ratio stayed above 200% until 2000,
when the ratio fell below 200%, and it was in the mid-2000s when the
ratio returned to the pre-bubble level of around 160%. During this
period, the Japanese economy experienced a continued weakness in its
economic recovery and the financial crisis due to NPL problems. In the
United States, the ratio started to rise from a level over 120% in the latter
half of 1990s to nearly 170% in mid-2008 just before the collapse of
6 K. ARAMAKI
(%)
250.0
200.0
150.0
Japan
100.0 US
Euro area
China
50.0
0.0
01.03.1970
01.01.1973
01.11.1975
01.09.1978
01.07.1981
01.05.1984
01.03.1987
01.01.1990
01.11.1992
01.09.1995
01.07.1998
01.05.2001
01.03.2004
01.01.2007
01.11.2009
01.09.2012
01.07.2015
Fig. 1.1 Total credit to private nonfinancial sector (in percent of nominal GDP).
Source: Bank for International Settlements (BIS)
Lehman Brothers. The US ratio declined after that and became stabilized
at a level near 150% since about 2012. The ratio for the Euro area rose
from a level over 120% in 1999, to over 160% in the latter half of 2008,
and has stayed at this level, showing no sign of decline. The ratio for China
had been around 120% after entering the 2000s before a rapid increase,
starting at the end of 2008. It rose over 200% in mid-2015 and has become
flat more recently. It was at an extremely high level of 210.2% at the end
June 2017.
Figures 1.2 and 1.3 show a breakdown of the ratio into that for corpo-
rate and household sectors. A rapid increase in debt in Japan took place in
the corporate sector while debts of the household sector did not show a
big increase. The problem of excessive debts (and accompanying excessive
assets) was a problem of the corporate sector in Japan. A sharp increase in
debts emerged in the household sector in the United States. As was indi-
cated by the fact that the subprime loan problem triggered the GFC, the
original problem in the United States was not with the corporate sector
but with the household sector, and the figure shows that reduction in the
debt level of the household sector progressed speedily. The relatively quick
recovery of the US economy seems to have been founded on progress
made in adjustments of debt level. By contrast, the problem in the Euro
area was with the corporate sector, and there has been no progress in the
(%)
180.0
160.0
140.0
120.0
100.0
Japan
80.0 US
60.0 Euro area
40.0 China
20.0
0.0
01.07.1998
01.05.2001
01.03.2004
01.01.2007
01.11.2009
01.09.2012
01.07.2015
01.03.1970
01.01.1973
01.11.1975
01.09.1978
01.07.1981
01.05.1984
01.03.1987
01.01.1990
01.11.1992
01.09.1995
Fig. 1.2 Total credit to nonfinancial corporations (in percent of nominal GDP).
Source: BIS
(%)
120.0
100.0
80.0
60.0 Japan
US
40.0 Euro area
China
20.0
0.0
01.03.1970
01.01.1973
01.11.1975
01.09.1978
01.07.1981
01.05.1984
01.03.1987
01.01.1990
01.11.1992
01.09.1995
01.07.1998
01.05.2001
01.03.2004
01.01.2007
01.11.2009
01.09.2012
01.07.2015
Fig. 1.3 Total credit to households (in percent of nominal GDP). Source: BIS
8 K. ARAMAKI
adjustments of debt level, which seems to be the reason behind the weak
recovery in that region. In China, while the debt level of the household
sector is increasing, the corporate sector seems to have a more serious
problem. The rapid increase in debt level was triggered by the economic
stimulus package amounting to 4 trillion RMB announced at the end of
2008. There should have been an expansion of assets behind the increas-
ing debt. If these assets are not accompanied by sufficient demand, then it
is possible that the excessive assets could become a burden similar to those
excessive assets formed in the bubble era in Japan and could depress eco-
nomic activities in the future for a long period of time in China. The cor-
porate debt level hit a peak at the end of 2016 after the rapid increase and
declined slightly in most recent period. However, it is still at a level of
160%, which is higher than the level in the bubble period in Japan, and is
a matter of great concern.
Figure 1.4 shows total credit to the government sector. Together with
Fig. 1.1 that shows total credit (in GDP ratio) to the private nonfinancial
sector (corporate and household), these figures show that Japan’s govern-
ment debt increased by 121.8%, from 91.7% at the end of 1997 to 213.5%
at the end of June 2017, while the private nonfinancial sector’s debt
(%)
250
200
150
Japan
100 US
Euro area
China
50
0
01.03.1970
01.11.1972
01.07.1975
01.03.1978
01.11.1980
01.07.1983
01.03.1986
01.11.1988
01.07.1991
01.03.1994
01.11.1996
01.07.1999
01.03.2002
01.11.2004
01.07.2007
01.03.2010
01.11.2012
01.07.2015
Fig. 1.4 Total credit to general government (in percent of GDP). Source: BIS
declined by just 50.3%, from 209.8% to 159.5% over the same period.
Although the rise in government debt level was due mainly to growing
social security expenditures arising from the aging of the population, falls
in tax revenue due to stagnation, and repeated expenditure of fiscal stim-
uli, particularly in the 1990s, it may be said that the government bore
much of the direct costs (such as the use of public funds to resolve NPL
problems) and indirect costs (such as a rise in government expenditure in
the form of unemployment allowances and economic stimulus, as well as
revenue losses due to stagnation), which arose in the process of removing
excessive debt (or excessive assets) from the economy. The US
Government’s debt increased by 30.0%, from 68.0% at the end of June
2008 (before the Lehman collapse) to 98.0% at the end of June 2017,
while the private nonfinancial sector’s debt declined by 16.9%, from
168.4% to 151.5% over the same period. The increase in government debt
is about twice as big as the decline in the private nonfinancial sector’s debt.
By contrast, while the Euro area’s government debt increased by 22.2%,
from 66.9% at the end of June 2008 to 89.1% at the end of June 2017, the
private nonfinancial sector’s debt also increased by 4.3% from 157.3% to
161.6% over the same period. Debt levels of both private and government
sectors have been rising. As there is no progress in reducing the private
sector’s debt, we need to determine if it is at a sustainable level or if adjust-
ments are needed. In the case of China, the government debt increased by
17.9%, from 27.8% at the end of June 2008 to 45.7% at the end of June
2017, while the private nonfinancial sector’s debt increased by 94.9%,
from 115.3% to 210.2% over the same period. We should expect that the
government debt level will significantly rise if the private nonfinancial sec-
tor’s excessive debts (and excessive assets) are to be reduced.3
The aforementioned is the most important inference, that is, the d anger
of holding excessive assets or assumption of excessive debt. Japan is a case
3
The magnitude of increase in government debt depends on various factors including the
pace and the magnitude of adjustments and whether the economy experiences a financial
crisis or not. However, considering that even in the United States, where relatively quick
adjustments were conducted, the increase in government debt is nearly twice as big as the
decline in the private sector’s debt, then the possible increase in government debts in China
could be rather large, particularly if a financial crisis is experienced. If a reduction by 50% of
the private sector’s debt, say, to 160% (current level of Japan) (that is, a reduction by 50
percentage points) was conducted, it could be possible for government debt in China to go
beyond 100% of GDP, which still seems to be a manageable level.
10 K. ARAMAKI
in which the risk involved was manifest in the worst possible way. It
emerged through two channels. First was the extensive and deeply nega-
tive impacts on the economy, arising from the collapse of the bubble and
the breakout of the financial crisis. As will be explained in the book, a
financial crisis broke out in the latter half of the 1990s, that is, seven years
after the collapse of the bubble, and the crisis greatly and deeply altered
corporate behaviors. The biggest change was a drastic alteration of the
employment policies of companies. Companies regarded the provision of
employment as their social responsibility until the early 1990s, but they
drastically changed their policies in the face of the crisis. Specifically, com-
panies not only reduced the nominal wages but also cut down on regular
employment and replaced their regular employees with non-regular
employees such as fixed-term or part-time workers. Companies also started
to rapidly remove excessive assets and debt, and the absolute size of physi-
cal assets started to decline. Under these circumstances, deflation emerged.
The Japanese economy, having essentially returned to a normal position,
does not seem to have fully rid itself of the aftereffects of the collapse of
the bubble and shocks of the financial crisis. Overcoming this legacy con-
tinues to be an important challenge for Japan. A crisis can alter even basic
behavioral principles of economic agents.
The second channel relates to expectation formation. If time necessary
to remove excesses is lengthy after the collapse of a bubble, as well as to
overcome impacts of a financial crisis, expectations held by companies and
household may change, raising a risk of shifting the whole economy to a
different equilibrium. Of particular importance is the effect of the length-
ening of stagnation on the growth expectation of companies. A high-
growth expectation may raise investment and accordingly, raise growth
performance in a self-fulfilling way. By contrast, a low-growth expectation
can discourage investment and tends to bring about low-growth perfor-
mance. Therefore, in order to achieve high growth, it is important to
maintain a high-growth expectation. However, if the actual growth per-
formance continues to be low, then the growth expectation will be adjusted
downward. As is discussed in this book, in Japan, elimination of excessive
assets did not speedily progress after the collapse of the bubble; or rather,
the total asset size increased until the mid-1990s, and it took around
15 years after the collapse of the bubble to eliminate excessive assets by the
mid-2000s. Therefore, a significant restraint on investment continued for
a long period of time, producing prolonged low growth. As a result, the
growth expectation was adjusted downward, and the resultant low-growth
expectation seems to have become firmly rooted. Once the growth expec-
tation has been lowered, it is not easy to raise it. The difficulty in raising
growth expectations is shown in the responses of companies (in their con-
tinuation of restraints on wages and investment) to the comprehensive
economic policy package called “Abenomics,” which includes large-scale
monetary policy easing since 2013.
This book is structured as follows: Chap. 2 covers the formation of the
bubble. Chapter 3 briefly describes the collapse of the bubble and subse-
quent economic developments, and proposes to divide some 20 years of
stagnation from the collapse of the bubble to just preceding the Abenomics
period into four subperiods. This chapter also examines Period I, which is
the initial adjustment period after the collapse of the bubble until just
before the financial crisis. Chapter 4 covers the financial crisis in the late
1990s and its impacts (Period II), the subsequent long recovery (Period
III), and the turbulent era initiated by the GFC (Period IV). Chapter 5
examines the issue of deflation and monetary policy. Chapter 6 analyzes
corporate behaviors in order to identify the real mechanism of stagnation
and deflation. Chapter 7 covers Abenomics and challenges for the Japanese
economy. The main points of each chapter are summarized below.
2 Chapter 2: Formation of a Bubble and Its

Background
Chapter 2 analyzes causes of the huge bubble in the 1980s. The Japanese
economy experienced a large-scale asset inflation (bubble) in the 1980s.
Prices of both land and stocks increased nearly fivefold above the level in
the first half of the 1980s, when a sharp price increase started, in some
seven years to the peak at the end of the 1980s or the beginning of the
1990s. The real growth rate also rose from an average of over 3% during
around ten years from the early 1970s when the high-speed growth ended
until and including the first half of the 1980s to an average of higher than
5% in the second half of the 1980s. However, the bubble started to col-
lapse at the beginning of the 1990s, which became a prelude to the subse-
quent long economic stagnation.
This chapter examines the process of asset inflation, particularly the
land price surge, and shows that the price increase in commercial land in
the very center of Tokyo in the first half of the 1980s, which was started
probably by some real demand factor, changed into a bubble in the pro-
cess of its spillovers to other areas and also to residential land prices.
12 K. ARAMAKI
Then, the chapter identifies two factors as causes of the bubble formation:
one, problems with economic policy management in this period; and two,
behaviors of financial institutions under financial liberalization. With
respect to policy management, we note that the economic policies in this
period were operating under two constraints, which altered policies and
promoted the formation of the bubble. The first and biggest constraint on
the economic policy management at that time was a fierce trade dispute
with the United States. The market-oriented economic policies, including
large-scale tax cuts adopted by the Reagan administration in the United
States starting at the beginning of the 1980s (“Reaganomics”) led to
“twin deficits,” that is, huge fiscal deficits and trade deficits in the United
States. In contrast, against such factors as the surging dollar, Japan’s cur-
rent account surplus expanded, leading to fierce trade disputes with the
United States. Solving the disputes became a serious challenge for Japan,
which is dependent on the United States for its national security.
The second constraint on the policy management was a deterioration of
the fiscal position, which proceeded rapidly due to economic stagnation
after the two oil crises and the strengthening of social security since the
first half of the 1970s. The administration at that time, which had aban-
doned the introduction of a consumption tax (the general consumption
tax proposed under the Ohira administration), maintained a policy of fiscal
consolidation without tax increase, that is, a policy of containing fiscal
expansion during the major part of the 1980s. So, the principal policy
agenda in the 1980s was focused on how to address the external friction
without imposing a policy burden on the fiscal side.
Under these two constraints, the Nakasone administration, which started
in the first half of the 1980s, pushed forward with deregulation, particularly
urban redevelopment through deregulation on land use, as an important
tool to expand domestic demand, but this policy provided a first drive for a
rapid land price increase. As the external imbalances continued and protec-
tionist movements mounted in the United States, Japan’s administration
took the position of accepting coordinated depreciation of the US dollar
(or, yen appreciation), and moved forward with the United States to the
adoption of the Plaza Accord by G-5 in 1985. However, once the apprecia-
tion of the yen gained a momentum in the market, it went far beyond the
expectations of the related countries, doubling its value in about two years’
time. Halting a further yen appreciation became an important policy agenda
for the administration. Despite such yen appreciation, the external imbal-
ances did not diminish soon and therefore, the United States did not soften
its demand of Japan for domestic demand expansion. Under the circum-
stances, monetary easing was maintained for a prolonged period of time in
order to solve the external disputes and also to prevent further appreciation
of the yen. When the monetary policy stance switched to the tightening
stance at the end of the 1980s, more than nine years had passed since any
previous tightening. Furthermore, since about the mid-1980s, the admin-
istration started to emphasize the importance of transforming the Japanese
economy into one that would not produce internationally incompatible
external imbalances, by structurally reforming the economy (Maekawa
Report 1986). In this way, the focus of the economic policies shifted from
domestic economic objectives to external objectives to correct external
imbalances. Deregulation, continued monetary policy easing, and the pol-
icy stance to give precedence to external objectives over domestic objectives
all seem to have substantially contributed to the formation and expansion of
the internal bubble, through implementation of such measures as enact-
ment of laws promoting real estate-related development projects including
resort facilities across Japan. These problems with economic policy manage-
ment are the main factors that contributed to the formation of a bubble.
In addition to the problems with policy management, there was a sec-
ond factor that worked toward the formation of the bubble—bank behav-
iors under financial liberalization. Financial liberalization started in the
latter half of the 1970s. Due to such factors as reduced demand for funds
after the end of the high-growth era and increased availability of diversi-
fied funding channels under the financial liberalization, large companies,
which were once the important clients of financial institutions, reduced
their dependence on borrowing from financial institutions. Against the
background of such erosion of the traditional client base and declining
profit margin under the financial liberalization, financial institutions
expanded activities in new markets, particularly in real estate-related loans,
substantially contributing to the formation of the bubble. It should be
noted that financial liberalization was not accompanied by sufficient
strengthening of regulation and supervision of risk management by finan-
cial institutions. In addition to these factors, active financial activities by
companies, called “Zaiteku” (financing technology) and “Tochi Shinwa”
(mythical trust in landholding) are also seen as causes of the bubble.
Due to the formation of the bubble, the private nonfinancial corporate
sector, particularly the non-manufacturing sector, came to hold huge assets
(typically, physical assets such as buildings and facilities) that were far greater
than the size implied by the trend before the bubble period, and this
imposed a very heavy burden on the Japanese economy in subsequent years.
14 K. ARAMAKI
3 Chapter 3: Collapse of the Bubble and the Start

of the Long Stagnation
Chapter 3 first provides an overview of the collapse of the bubble and

subsequent economic stagnation over two decades, then divides the whole
stagnation period into four subperiods, and examines Period I, that is, the
period of initial adjustment after the burst of the bubble and before the
breakout of the financial crisis.
The bubble started to collapse at the beginning of the 1990s under the
sharp tightening of monetary policy from the end of the 1980s and the
introduction of the quantitative restrictions on real estate-related loans by
banks. Behind these policies were concerns over widening social inequality
between holders and non-holders of assets during the land price surge,
and at that time little attention was paid for controlling the risk to the
economy and financial system that would arise from the sharp asset price
inflation and its collapse. Such policy orientation, in hindsight, resulted in
inappropriate policymaking of crashing the bubble by aggressively coun-
tervailing policies.
Next, the chapter presents an overview of the economy in around
20 years after the collapse of the bubble, reiterating that the period is
identified as a long stagnation period, with the average growth rate over
the 20 years or so declining to a level less than one-fifth of the level during
the bubble era and with a sharply rising unemployment rate. In terms of
growth rate of per capita GDP, Japan’s performance was also stagnant as
compared with other advanced countries. Notably, there are three groups
of arguments on the cause of the stagnation; the supply-side factor views,
the demand-side factor views, and the financial sector-problem views. The
supply-side factor views contend that such supply-side factors as the delay
in enhancing production efficiency or demographic changes are behind
the long stagnation. However, we note that the Japanese economy, par-
ticularly the nominal GDP, suddenly stopped growing at the beginning of
the 1990s and that such a sudden change cannot be explained by struc-
tural factors, which usually change only gradually and, therefore, affect
the economy in a gradual manner. Further, the Japanese economy gener-
ally had a deflationary gap, that is, supply capacity was in excess of demand
during the long stagnation, and therefore, it is difficult to explain stagna-
tion by limitations on supply capacity. Under the demand-side factor
views, the handling of fiscal policy was criticized in that fiscal tightening in
the late 1990s hindered economic recovery. Also, insufficient monetary
policy easing was criticized for bringing about the long stagnation and
deflation. As for fiscal policy, it is important to point out that fiscal policy
substantially contributed to economic growth after the collapse of the
bubble through a series of stimulus packages that were compiled almost
yearly. Thus, it is argued, although there might have been a problem of
timing in the adoption of fiscal tightening, the fundamental cause of the
long stagnation from the beginning of the 1990s should be found in other
factors. While monetary policy management is examined in detail in Chap.
5 (Deflation and monetary policy), it is suggested that the problem with
the handling of monetary policy may have been more serious in crushing
the bubble, through aggressive monetary tightening and quantitative
restriction on real estate-related loans, rather than in the period after the
collapse of the bubble. This point is exemplified by the fact that the rate
of growth of money stock, which was over 10% per annum during the
preceding years, collapsed into negative territory at the beginning of the
1990s. The financial sector-problem views contend, for example, that
credit crunch, which reflected problems with financial sector soundness
due to the NPLs, led to the stagnation. However, the lending attitudes of
financial institutions were generally eased in the 1990s, excepting periods
immediately after the collapse of the bubble and during the financial crisis
in the latter half of 1990s. Therefore, credit tightening by financial institu-
tions could not have been the cause of the stagnation, at least not during
the early period of the stagnation after the collapse of the bubble and
before the financial crisis (this initial period is considered to be the most
critically important in the long stagnation).
After the overview, the chapter argues, as evidenced by the sudden halt
of nominal GDP growth, the long stagnation was started by a discontinu-
ous and abrupt factor (non-structural factor). At the same time, consider-
ing that the stagnation continued for more than 20 years, it seems that the
changes that were started by an abrupt factor were structuralized in the
process of stagnation, suggesting that the mechanism of the long stagna-
tion seems to have changed in the process. Drawing on this argument and
with a view to identifying the nature and change of the mechanism of
stagnation (disease) from the examination of characteristics of the econ-
omy (symptoms), it is proposed that we adopt an approach of dividing
these 20 years after the collapse of the bubble and until the start of the
Abenomics, that is, from 1991 to 2012 inclusive, into four subperiods
with different economic characteristics, so as to analyze the mechanism of
stagnation in each subperiod. In light of developments in such factors as
16 K. ARAMAKI
economic cycles, growth rate, private investment, and unemployment

rate, these four subperiods have been determined to be as follows:
Period I (1991–1997): “Initial adjustment” period, starting from the col-

lapse of the bubble to just before the start of the financial crisis
Period II (1998–2002): “Financial crisis and its impacts” period, covering
those years from the breakout of the financial crisis to the beginning of
the 2000s
Period III (2003–2007): “Long recovery” period, covering the long
recovery started in the early 2000s to just before the GFC.
Period IV (2008–2012): “Global Financial Crisis and after” period that
covers the period from the outbreak of the GFC to just before the start
of the Abenomics.
Chapter 3 examines Period I (initial adjustment). The growth rate

declined in Period I to a level lower than one-third of that in the bubble
era, and the biggest drag came from the stagnation of investment. The
investment stagnation is considered as to have arisen from stock adjust-
ment, that is, downward adjustment of excessive capital stock brought
about by excessive investment in the bubble era. Stock adjustment, in this
period, became a prolonged process. The reason for such a lengthened
process was due to the absolute size of the excessive assets but also to the
fact that sales of companies suddenly stopped growing and even declined
after the burst of the bubble. With the sales stagnation and the decline in
actual growth rate, expected growth rate held by companies gradually
declined, resulting in further lowering the level of required capital stock.
So, throughout the initial adjustment period, the size of excessive capital
stock did not decrease, instead increasing despite restraint on investment,
thus placing more depressing pressures on investment for a prolonged
period. In addition, the historic high value of the yen during the US–
Japan trade disputes, which were intensified during the first term of the
Clinton administration in the United States, hurt exports and placed addi-
tional negative impacts on investment. Furthermore, damages made to
the balance sheet of companies and financial institutions due to the asset
price deflation led to more cautious and contained investment. The declin-
ing growth rate lowered expected profitability of land and resulted in
declines in land prices (land prices continued to decline for the next
14 years), producing additional damage to balance sheets.
What should be noted is the fact that the size of assets (and also liabili-
ties) of the corporate sector continued to increase, even after the burst of
the bubble and until the mid-1990s. This is particularly true with the non-
manufacturing sector. This is probably because many of the excessive assets
formed during the bubble era were the types of assets that needed substan-
tial lead time before completion, such as real estate-related development
projects. Due to such a time lag and because companies did not choose to
quickly remove such low-profitability assets, stagnation of profits of com-
panies continued for a long time, damaging their financial position and
lowering their ability to repay their debts. This made the problems with the
NPLs increasingly more serious and finally led to a crisis of the financial
sector. An implication is that fiscal stimulus and monetary easing may have
succeeded in buying time by creating additional demand (the government
came to have huge debt as a result, though), but these macroeconomic
policies did not (could not) contribute to the speedy disposition of the
companies’ excessive assets (or supply capacity) formed during the bubble
era—a capacity that could not expect sustainable demand—and thus, were
unable to prevent the crisis.
4 Chapter 4: The Financial Crisis and Its Impacts,

Long Recovery, and Afterward
This chapter mainly examines the financial crisis and its impacts on the
Japanese economy (i.e., Period II: 1998–2002), but also covers periods
subsequent to the crisis until the Abenomics (i.e., Period III: 2003–2007
and Period IV: 2008–2012).
A financial crisis broke out in the autumn of 1997, seven years after the
collapse of the bubble. Profits of companies declined significantly after the
burst of the bubble, and NPLs increased year by year. With the decline in
the value of collateralized real estate, failures of small- and medium-sized
financial institutions started to surface in the first half of the 1990s.
Traditionally, a troubled financial institution was acquired by a healthy
financial institution, and all the business, such as deposits and loans, was
assumed by the acquiring institution. However, as it gradually became dif-
ficult to find an assuming institution, an assuming bank was established, to
which businesses of failed institutions were transferred and the Deposit
Insurance Corporation (DIC) provided financial assistance (grants). Then,
in the process of resolving housing loan companies that had large amounts
of troubled real estate-related loans, tax money was used in order to main-
tain the financial soundness of creditor financial institutions. This use of
tax money evoked very strong resentment among the public, and further
18 K. ARAMAKI
use of tax money for the financial sector became almost taboo. However,
in November 1997, after the failure of medium-sized securities companies
led to a default in the interbank market for the first time since the Second
World War, it became difficult for some financial institutions to obtain
funding in the interbank market. Soon after, in the same month of
November 1997, Hokkaido Takushoku Bank, one of the largest banks in
Japan, and then Yamaichi Securities, one of the big four securities compa-
nies, failed one after the other. Long lines to withdraw funds formed in
front of local banks, and the situation came close to a crisis. Against this
background, a law that made possible capital injection into banks was
enacted, and public money was used to strengthen the capital base of
major banks in March 1998. While the situation was stabilized temporar-
ily, troubles with the Long-Term Credit Bank of Japan (LTCB) surfaced
in the summer of 1998, and new laws were enacted so as to introduce a
strengthened capital injection scheme, tied with early correction measures
based on the capital asset ratio and also to introduce a comprehensive
resolution system for failed banks, including nationalization. Under the
new laws, injection of capital four times as great as the funds injected in
March 1998 was implemented in 15 banks in March 1999, and the LTCB
and the Nippon Credit Bank, another LTCB, were nationalized in late
1998. Making use of this comprehensive safety net framework, the gov-
ernment strongly promoted disposition of NPLs. The goal of halving the
NPL ratio, set by the government in 2002, was achieved in 2005, and
the NPL problems (or, excess asset hangovers in the corporate sector)
that had long been a burden on the Japanese economy were finally
resolved.
Why were the NPL problems, which stayed with the economy for some
15 years, not resolved sooner? Companies did not promptly dispose of
excessive assets that lay behind the NPL problems, and banks did not
swiftly dispose of NPLs. Behind these developments, there were optimistic
expectations for the future course of the economy in the initial stage: the
magnitude of expected negative impacts that could result from prompt
resolution of excessive assets or NPLs; managerial judgments to avoid real-
ization of losses, increase in bankruptcies and unemployment, and aggra-
vation of the economy; and the governance system that made such
judgments possible. In the same vein, the government, charged with the
responsibility of maintaining soundness of the economy and financial sys-
tem, also took a long time to resolve the NPL problems. The reasons for
this may include optimistic expectations for the future in the initial stage
again, but also nonavailability of such a comprehensive safety net frame-
work as had been introduced in 1997–1998 (in the absence of a compre-

hensive framework that included nationalization and capital injection,
pushing a speedy resolution of NPL problems beyond the banks’ capacity
could create a situation beyond control).
Examination of what is said to be a successful case of coping with the
collapse of the bubble and financial crisis in Scandinavian countries, reveals
that existence of political will to use public money to save the financial
system in the face of a financial crisis contributed to the early resolution of
the crisis and a relatively prompt recovery of the economy. In Japan, the
relevant authorities realized that the problems were more serious than
expected in the early 1990s. If such information had been widely shared,
it may have been possible to introduce a comprehensive framework that
included capital injection and to solve the NPL problems much sooner.
However, if such information had been extensively shared, it would have
been highly likely that bank runs would have occurred, and a crisis would
have emerged at the early stage of stagnation. Still, if the Japanese econ-
omy had a crisis at the beginning of 1990s, the subsequent developments
might have been very different. The Japanese economy might have been
able to go back, after the crisis, to a growth path similar to the one in the
preceding periods. Although it is entirely with a hindsight, the very efforts
to avoid a crisis in the early stage after the collapse of the bubble ultimately
delayed the crisis and led to the alteration of the Japanese economy.
After the breakout of the crisis, significant and fundamental changes
developed in the Japanese economy. In addition to the deterioration of
the economy, first, the unemployment rate increased sharply from an aver-
age of 2.8% in Period I (1991–1997) to an average of 4.7% in Period II–
IV (1998–2012). Second, the nominal wages started to fall, recording an
accumulated fall of nearly 13% by 2012. Third, the number of regular
employees peaked in 1997 and fell sharply after the crisis. Nearly 5 million
regular employment positions (about 13% of the peak level) were lost by
2005, and the share of non-regular employment continued to increase.
Fourth, the corporate sector changed from an excess investment to an
excess savings sector. Fifth, the Consumer Price Index (CPI) (excluding
fresh food) started to record a decline from mid-1998 and a mild deflation
started. In this way, the corporate behaviors were greatly altered by the
crisis, and the Japanese economy slowed further and entered the second
stage of stagnation.
This chapter also briefly discusses Periods III and IV. The Japanese
economy started the longest expansion beginning in the early 2000s, since
20 K. ARAMAKI
following the Second World War. Although the two economic recoveries
in the 1990s were both short-lived, the recovery in the 2000s continued
for a long period of time extending longer than six years and was relatively
strong in that investment made a positive contribution to growth. This was
due to two factors: (1) The so-called three excesses, that is, excessive capi-
tal stock, excessive debt, and excessive employment, which the corporate
sector assumed due to the formation and collapse of the bubble, had been
eliminated and their levels returned to the pre-bubble levels by around
mid-2000s. Thus, the negative legacy of the bubble was finally eliminated
(this corresponds to the resolution of the NPL problems for the financial
sector side). The second factor was favorable external environments of
high growth with low inflation in the world economy, which was later
termed “the great moderation.” However, even during the long recovery,
fundamental changes that had emerged in the Japanese economy (an ele-
vated unemployment rate, the decline in nominal wages, the shift from
regular to non-regular employment, companies’ shift to net saver posi-
tions, and deflation) continued, and restraints on investment and on labor
costs were maintained. In this period, in addition to these changes, other
developments became more apparent, such as a decline in growth contri-
bution of consumption under real wage reduction and increasing depen-
dence on foreign trade, characteristics which are observed in the current
Japanese economy.
Period IV (2008–2012) was a period when the Japanese economy expe-
rienced a series of external shocks, including the GFC, the European debt
crisis, and the Great East Japan Earthquake. The Japanese economy
recorded one of the deepest negative growth (annualized rates of 8.8% in
Q4 2008 and 18.2% in Q1 2009) among the major advanced economies
after the GFC, and its trade balance fell into deficit after the earthquake due
to the increase in energy-related imports. Despite these developments, the
yen-dollar exchange rate recorded a historic high. All these developments
showed increasing external vulnerability of the Japanese economy.
Despite the economy having eliminated the negative legacy of the bub-
ble and overcome shocks of the financial crisis in 15 years by the mid-
2000s, the solid economic growth did not come back. The average growth
rate over Periods III and IV (i.e., 2003–2012) was just 0.9%. Some factors
may have been depressing the growth potential of the Japanese economy.
Viewed in this way, the Japanese economy seems have assumed two
problems, even after having overcome the negative legacy of the bubble.
The first is the lasting shortage of domestic demand and the growing
dependence on foreign demand, coupled with the increased external

vulnerability. The second is a possible decline in growth potential resulting
from prolonged investment restraint. The key question is what has caused
these problems. This point is examined further in Chaps. 5 and 6.
5 Chapter 5: Deflation and Monetary Policy

In Chaps. 2, 3, and 4, we examined what happened to the Japanese econ-
omy in the last 30 years, in a sequential manner, and also have attempted
to understand the mechanism of the difficulties. However, our examina-
tion left us with an unanswered question: why did solid growth not return
even after negative legacies of the bubble had been eliminated? In Chaps.
5 and 6, we try to address the issue of long stagnation and deflation, so as
to capture the mechanism of the whole process including the problems
with the current economy. To this end, this chapter focuses on the issues
of deflation and monetary policy, and the next chapter examines corporate
behaviors that, in the author’s view, lie at the heart of the problem.
Chapter 5 first looks at evolution of deflation from the latter half of the
1990s, and presents an overview of the major arguments about its causes.
Then, monetary policy management is assessed from the viewpoint of its
effectiveness in the prevention of and for exiting from deflation.
The CPI (excluding fresh food) has been declining slightly for almost
15 years from mid-1998 to the first half of 2013, excepting brief periods
of price increase. The average annual decline was −0.3% and the accumu-
lated decline was −3.6%. Decline in the GDP deflator started in the first
half of 1990s, earlier than the timing of the decline in CPI, and the degree
of decline in the GDP deflator was greater than that of the CPI. As for the
causes of deflation, there are three major arguments; (1) the supply-side
argument identifies, as a cause of deflation, supply factors, such as penetra-
tion of cheap imports, technological p rogress including IT, and deregula-
tion; (2) the demand factor argument regards weakness of the economy
due to demand shortage as arising from such factors as insufficient mone-
tary easing as a cause of deflation; and, (3) the financial sector-problem
argument regards deficiency of the financial sector occurring due to NPLs
as a cause of deflation. As for the supply-side argument, considering that
the rate of import penetration became twofold in less than 20 years by the
latter half of 2000, that price fall was greater for imported and import-
competing goods than for other goods, and that the price of goods and
services in the deregulated areas fell more than other goods, certainly sup-
22 K. ARAMAKI
ply-side factors contributed to the price decline. However, considering

that such price declines that come from supply-side factors are generally
beneficial and expected to contribute to an expansion of the economy, the
arguments do not sufficiently explain the Japanese economy that had both
stagnation and deflation at the same time. As for the demand factor argu-
ment, the existence of a deflationary gap (excess of supply over demand)
that the Japanese economy has long suffered seems to support this view,
and the arguments that criticize insufficiency of monetary policy have been
mostly raised in this context. However, it is suggested here that the defla-
tionary gap may be interpreted as showing that supply was in excess of a
sustainable demand level rather than that actual demand is short of sustain-
able demand level, and thus, we must examine which interpretation is
more relevant before conducting an assessment of monetary policy. As for
the financial sector problem argument, as stated before, lending attitudes
of financial institutions in the 1990s were eased, excepting periods just
after the burst of the bubble and at the time of financial crisis, and, there-
fore, for Period I (initial adjustment period) the financial sector-problem
view cannot explain stagnation and deflation (problems at the time of
financial crisis are examined in Chap. 6 that analyzes company behaviors).
Then, the chapter examines the monetary policy. On monetary policy
management before Governor Kuroda’s easing under Abenomics (mon-
etary policy under Abenomics is examined in Chap. 7), assessments were
made separately for the period until the adoption of the zero interest rate
policy (ZIRP) in 1999 (basically corresponding to the period before the
Japanese economy started to have deflation and had been placed under
the zero lower bound constraint on interest rate) and, then, for the period
of subsequent quantitative easing in the 2000s (the period under defla-
tion and with the zero lower bound constraint). As for the period up to
the adoption of ZIRP, it is argued that monetary policy management
could have been improved in three respects, as pointed out in an Federal
Reserve Board (FRB) working paper (Ahearne et al. 2002). First, despite
the Bank of Japan (BOJ) significantly easing monetary policy nine times
from 1991 to 1995, and reducing the policy interest rate (official dis-
count rate) to 0.5%, i.e., very close to zero, as the inflation rate deceler-
ated more than expected, the real interest rate was kept high in the first
half of the 1990s. Second, the BOJ interpreted price stability as zero infla-
tion, admitting intermittent deflationary periods, which could be—and
actually were—difficult to exit. Third, the BOJ sent messages to the
markets that the increase in the interest rate was desirable by referring to
the zero interest rate as an abnormal interest rate, and deterring decline in
the long-term interest rate. Regarding the monetary policy management
after entering the 2000s, that is, after the Japanese economy had fallen
into deflation and had been placed under the zero lower bound con-
straint, the BOJ introduced the quantitative easing policy, targeting at the
outstanding balance of the current accounts with the BOJ, which contrib-
uted to the fall in short- and medium-term interest rates. However, the
rate of money stock increase did not change, bank loans continued to
decline until mid-2000s, and deflation continued, showing a limitation of
the policy effects.
We conclude that monetary policy, if managed differently, might have
had greater stimulating effects on the economy in the period immedi-
ately after the collapse of the bubble. However, one can argue if the
fundamental problem of the Japanese economy in that period was not
demand shortage as is typically presumed, but rather excessive produc-
tion capacity (excess assets), as previously suggested, then the most
important action was not to stimulate demand but to reduce excessive
capacity (excessive assets). For the latter (i.e., removal of excessive
assets), what macroeconomic policies, including monetary policy, could
do was limited.
6 Chapter 6: Deflation and the Mechanism of

Corporate Behavior
In order to capture the fundamental mechanism of stagnation and defla-
tion, we examine in Chap. 6 the behaviors of companies based on the
combined statistics of financial statements of companies. The analysis is
based on the Financial Statements Statistics of Corporations by Industry
compiled by the Ministry of Finance, which covers all the profit-making
corporations of 2.7 million that exist in Japan.
From the analysis of profit and loss, the following observations are
made. The total amount of sales of companies, which had been increasing
at an average rate of more than 6% in the 1980s, suddenly stopped grow-
ing soon after entering the 1990s and then started falling. The total
amount of wages continued to increase for a while after entering the 1990s
and became flat thereafter. The ratio of wages to sales, therefore, contin-
ued to increase, with a result that operating profits sharply declined after
entering the 1990s and stagnated throughout the 1990s. By contrast, cur-
24 K. ARAMAKI
rent profits started to recover in a rising trend in the 1990s due to improve-
ments in the non-operational balance, which includes such items as interest
payments, but unlike the 1980s, improvements in current profits did not
lead to wage increases in and after the 1990s.
From the analysis of assets and liabilities, it is observed that both started
to expand from the mid-1980s to a level greater than that implied by the
then trend, continuing to grow, albeit at a slower pace in the first half of
the 1990s. Subsequently, assets and liabilities started to shrink from the
mid-1990s, returning to a level close to that implied by the pre-bubble
trend by around mid-2000s. This means that it took about 15 years after
the burst of the bubble for the corporate sector to complete its downward
adjustments of the excessive assets and liabilities. A look at the composi-
tion of assets shows that physical assets, such as buildings and machineries
(excluding land), started to decline from around the time of the financial
crisis in the latter half of the 1990s. The total asset size started to expand
again in the first half of 2000s, but physical assets (excluding land) contin-
ued to shrink until 2012. By contrast, securities held for investment pur-
poses significantly increased.4,5,6 The composition of assets has been
altered. Parallel to the curtailment of domestic physical assets, the size of
liabilities started to significantly decline after the mid-1990s, and then
became flat as of the early 2000s.
4
Most of the securities held for investment purpose are stocks, but their breakdown to
domestic and foreign stocks is not available. If we convert the outstanding balance of Japan’s
foreign direct investment (FDI) vis-à-vis the rest of the world (year-end, denominated in US
dollars) into yen using year-end exchange rates, we can see that the FDI balance accounts for
30–50% of the amount of securities held for investment purposes. In other words, half of the
securities held for investment purposes may be stocks of domestic companies. They are can-
celed out in a consolidated basis and do not contribute to strengthening of the net asset
position.
5
Since the mid-2000s, outward FDI started to significantly increase and, particularly after
the Lehman shock, the pace of outward FDI was accelerated.
6
The combined amount of physical assets (excluding land) and the outstanding balance of
FDI vis-à-vis the rest of the world (year-end, converted to yen) had been almost flat (or
marginally decreased until 2012) after the financial crisis in the late 1990s, and only recently
has started to show a rising trend. After the financial crisis, companies have proceeded with
the reduction of domestic physical assets and the expansion of overseas production bases,
gradually shifting production capacity from inside to outside the country.
A very significant change is observed with regard to net assets. While

the rate of increase in net assets slowed down from the end of the 1980s,
net assets started to increase sharply after the financial crisis, mainly
through accumulated profits. Such development is more clearly observed
in relation to the capital asset ratio. The capital asset ratio started to rise
very sharply at the outbreak of the financial crisis and reached a historic
high in recent years.
How should we interpret these developments in financial statements of
companies? This chapter puts forward the following interpretation, draw-
ing on the developments in financial statements and also on observations
that have been made in the preceding chapters.
The problem started with the rapid expansion of asset size of the cor-
porate sector (particularly the non-manufacturing sector) from the mid-
1980s and the sudden stop and subsequent fall of sales growth after the
burst of the bubble at the beginning of the 1990s. These developments
indicate that the corporate sector came to have huge assets for which they
could not expect sufficient sales, that is, excessive assets (low-profitability
assets). This lay at the heart of the difficulties of the Japanese economy
after the collapse of the bubble.
Under the circumstances, the corporate sector initially took the follow-
ing responses. First, they restrained investment (investment stagnated) but
did not swiftly remove excessive assets (the total assets hit a peak in the
mid-1990s). Second, they basically maintained existing employment (reg-
ular employment showed a moderate increase until the second half of the
1990s). Third, they tried to restrain wage increases, but the combined
amount of wages paid by the corporate sector continued to increase for
some time. Fourth, as a result, operating profits stagnated, and companies
tried to secure current profits by improving non-operational balances
(through cutting down of interest payments, etc.). However, unlike the
pattern seen until the 1980s, the improvements in current profits did not
lead to increases in wages—that is, performance of companies and wage
increases were delinked.
After the collapse of the bubble, the corporate sector initially pursued
what may be called a traditional approach that placed importance on
securing employment and took their time to dispose of excessive assets
(this corresponds to the period preceding the financial crisis, and in
Chap. 6, this period is called the “Passive response” period in light of
the underlying corporate behavior). Under such response, costs and the
risks of holding excessive (low-profitability) assets started to be shifted
26 K. ARAMAKI
to the financial sector in the form of increasing NPLs, and then a finan-
cial crisis broke out in late 1990s. Faced with the crisis, the way the
corporate sector addressed the problem of excessive assets dramatically
changed, and with this change, the stagnation entered the second stage,
as stated before. Specifically, with the breakout of the financial crisis, in
addition to the deterioration of economic conditions, the lending atti-
tude of financial institutions was suddenly tightened, including for
small- and medium-sized borrowers for which the tightening, of lending
attitudes after the burst of the bubble had been relatively moderate. In
the face of such adverse changes in funding environments, the corporate
sector seems to have started to forcefully strengthen its capital base. The
net asset position and the capital asset ratio started to rise sharply.
Strengthening of the net asset position was achieved mainly through the
accumulation of profits. Under the prolonged sales stagnation, the only
options open to companies to secure profits were reduction of labor
costs, reduction of interest payments through repayment of debts, and
sales of assets. Therefore, the companies embarked on full-fledged labor
cost reduction through nominal wage reduction and curtailment of reg-
ular workers, replacing them with non-regular workers. They also started
substantial repayments of debts and disposition of assets. Furthermore,
companies strengthened their stance toward restraining investment,
with a result that the size of physical assets, such as buildings and machin-
eries, started to decline. Companies’ responses in the second stage of
stagnation suggest that the previous corporate behavioral pattern under
which priority was given to securing employment and investment had
been significantly altered. Companies now gave the first priority to
strengthening their net asset position and placed importance on labor
cost reduction, restraining investment, and accepting reduction in physi-
cal assets. In Chap. 6, in light of changes of company behaviors, the
period from the financial crisis up to the first half of the 2000s is called
“Crisis Response” period.
By the mid-2000s, shocks of the financial crisis were overcome, and
removal of excessive assets and debt as well as excessive employment had
been completed (it took about 15 years to remove excesses after the burst
of the bubble). However, such defensive behaviors of companies to
restrain labor costs and investment continued. Thus, in Chap. 6, the
period from the mid-2000s to present is called the “Sustained
Defensiveness” period. Such defensiveness of companies placed
ownward pressures on consumption (through wage restraint) and

d
investment, bringing about structuralized demand shortage and
depressed price levels. Restraint on wages also depressed price levels
through production cost channels. In this way, what paved the way for
the emergence of deflation is very likely to have been behavioral changes
of companies triggered by the financial crisis.7 This implies that deflation
is not the cause of stagnation but the outcome of the fact that companies
changed their behaviors after it became impossible to continue to hold
excesses following the financial crisis. This interpretation does not deny a
possibility that deflation itself may have added an extra burden on the
economy, through its own mechanism to discourage employment and
borrowings, and had made an exit from the low-growth cycle more dif-
ficult. However, still, the central problem of the Japanese economy is not
deflation, but companies’ defensive behaviors (structuralized defensive-
ness of companies) that had been drastically strengthened by the financial
crisis, and it is important to overcome this mechanism.
The chapter, however, contends that we need to have a cautious look at
whether defensiveness of companies, observed even today, should be
regarded as wholly irrational. We need to understand why companies’
defensiveness continued even after excesses had been eliminated by the
mid-2000s.
As for restraint on domestic investment, we note that behind such
behaviors are a depressed growth expectation for the domestic econ-
omy and relative high profitability of overseas operations, and restraint
of domestic investment could have been the outcome of rational choice
by companies.8 The decline in expected growth rate proceeded year by
year after the collapse of the bubble, hit bottom after the financial crisis,
and became flat thereafter. In other words, the low-growth expectation
became firmly rooted in the companies with the onset of the financial
crisis. There are two types of interpretation on the long held low-
growth expectation of companies. One interpretation attributes it to
7
In addition to such behavioral changes of companies, however, it is possible that external
factors such as international competition through cost reduction under the yen appreciation
and a rapid catching-up of emerging market economies contributed to the nominal wage
decline and the emergence of deflation. See Chap. 6 on this point.
8
Under the continued restraint of investment, return on asset (ROA), which had been
declining since the 1960s, hit a bottom in the latter half of 1990s and showed a slight
increase in the 2000s.
28 K. ARAMAKI
the defensive mindset (a way of thinking that has become a common

practice or a habit), and the other interpretation regards it as rational
and founded on substantive factors, such as the shrinking and aging of
the population.
As for wage restraint, if we compare developments of real income and
labor productivity from the 1990s, we can see that the rise in real income
exceeded that of labor productivity throughout the 1990s, and as a result,
labor income share substantially increased in the 1990s. In the light of this
development, the labor cost reduction that was started with the breakout
of the financial crisis may be understood as an unavoidable process that
aimed at correcting unsustainably high labor costs brought about by com-
pany response during a time of declining profits in the 1990s (i.e., the
passive response to maintain employment and insufficiently restrain
wages). In other words, the response can be considered rational. This
interpretation does not explain whether the wage restraint, still present
now, is rational. Chapter 6 argues that, under the long-held pricing behav-
iors of companies to maintain international competitiveness through
restraint on export prices, labor cost reduction through the replacement
of regular workers with non-regular workers backed by the existence of
duality in the labor markets was effectively utilized as a tool to maintain
competitiveness.
Although it is difficult to assess with certainty whether the current
restraint on wages and investment is excessive or rational, it is clear that
the negative consequences on the domestic economy caused by such
restraint are surfacing. Growth contribution of consumption has
declined. Prolonged investment restraint may have lowered export
competitiveness and growth potential. Japan’s share in world exports
has been halved in the last two decades, and growth rate continues to
be low.
To repeat, restraint on wages and investment by companies produced
everlasting domestic demand shortages and vulnerable growth, and the
long lasting investment restraint may have eroded export competitiveness
and the growth potential of the Japanese economy. This is the problem
that the current Japanese economy faces.
7 Chapter 7: Abenomics and Challenges for the

Japanese Economy
Chapter 7 examines architecture and effects of “Abenomics,” that is, a
comprehensive package of economic policies that the Abe administration,
starting in end-2012 has been implementing, and shows challenges for the
Japanese economy.
Abenomics is composed of “three arrows”: bold monetary policy to
overcome deflation (first arrow), flexible fiscal policy to create demand
and simulate dampened economy (second arrow), and growth strategy to
restore confidence of corporations and households and to promote invest-
ment (third arrow).
The basic logic underlying Abenomics is that, as the Japanese economy
is trapped in a vicious cycle of low growth and deflation, it is necessary to
overcome deflation through monetary policy, to stimulate stagnant private
economic activities through fiscal injection, and to realize the mid- and
long-term growth led by the private sector through growth-oriented poli-
cies. In light of the interpretations discussed in Chap. 6, Abenomics is
understood as a policy attempt to correct structuralized defensive behav-
iors of companies.
The first arrow, bold monetary easing, shot by Governor Kuroda, who
succeeded Shirakawa in March 2013, took the form of the Quantitative
and Qualitative Monetary Easing (QQE) announced in April 2013. QQE
included the setting of the price stability target of a 2% CPI (excluding
fresh food) annual increase to be achieved within about two years and the
targeted increase in monetary base at an annual pace of about 60–70 tril-
lion yen (raised to about 80 trillion yen in October 2014, and set as a
benchmark not a target in September 2016) through purchase of assets,
including long-term Japanese Government Bonds (JGBs). In February
2016, the BOJ introduced an additional measure of imposing a negative
interest rate of −0.1% on part of the outstanding balance of currents
accounts held by financial institutions at the BOJ (implemented from
mid-February). Furthermore, in September 2016, the BOJ moved away
from base money targeting, and instead adopted a policy focused on
short-term and long-term interest rate control (“yield curve control”). As
the second arrow, that is, on the fiscal policy front, economic stimulus
packages were compiled four times—in January 2013, December 2013,
December 2014, and August 2016. In April 2014, the consumption tax
rate was increased for the first time in 17 years, from 5% to 8%. For the
30 K. ARAMAKI
third arrow, that is, for the growth strategy, the administration adopted
the “Japan Revitalization Strategy” in June 2013. The strategy set a goal
of achieving around 3% nominal and 2% real GDP growth on average over
the coming 10 years. The revised revitalization strategy, adopted in June
2014, included such items as reducing the effective rate of corporate tax
to below 30% and deregulation in hard core areas, such as agriculture,
health care, and energy (the revitalization strategy was further revised in
June 2015, and June 2016).
The initial impacts of Abenomics, particularly those of the introduction
of QQE, were dramatic. Stock price (Nikkei 225) rose by 88% in just over
a one-year period to the end of 2013, and the yen depreciated against the
US dollar until May 2013, by more than 20%, from the high of below 80
yen to over 100 yen to the dollar in a half year. However, subsequent
developments are not as one-sided or dramatic as in the initial period, with
positive movements and stagnation intermingled.
Chapter 7 assesses five years under the Abenomics as follows. First, the
Abenomics, particularly in its initial phase, produced substantial deprecia-
tion of the yen and sharp rise of stock prices. This is most likely due to the
change of expectation held by the foreign investors regarding Japanese
economy, stock prices, and yen rate, which were triggered by bold mone-
tary easing. Second, depreciation of the yen rate and the rise of stock
prices have not changed the trend of real GDP growth by much so far.
However, since Abenomics started, the interest rate has declined across
the maturity from short term to long term, and bank lending has been
maintaining the growth trend since the recovery period after the Lehman
shock. The recovery momentum has been maintained. Third, a break-
down of the economic growth structure under Abenomics by demand
components indicates, as compared with the period preceding Abenomics,
the growth contribution of net exports has significantly increased, and the
growth contribution of government expenditure has nearly doubled; in
contrast, the contribution of consumption halved, and the growth contri-
bution of private investment more or less remained unchanged. Fourth,
price levels showed positive increase for more than two years from May
2013. This increase, however, is affected to a substantial degree by exter-
nal developments, including yen depreciation (rather than improvements
in domestic demand/supply conditions). Fifth, while company profits
have been registering record highs, private investment, while increasing,
has not shown significant increase; restraint on wages continues and cash
and deposit holdings by companies have also been recording historic

highs. Sixth, while the labor market shows the lowest unemployment rate
since mid-1990s, tightening of demand and supply conditions is greater
for non-regular workers compared to regular workers. The rate of wage
increase is higher for non-regular workers. Companies have not changed
their stance on restraining labor costs.
Therefore, under favorable policy environments where very coherent
policies have been pursued with political stability, economic recovery has
been continuing, and yet, companies have not perfectly exited from
defensive behaviors of restraining investment and wages, and there has
not been a significant change in growth trend. The structure of growth is
problematic in that the growth contribution of consumption has been
declining, and dependence of growth on government expenditure is
increasing.
The biggest factor that has brought about the continuation of defensive
behavior by companies seems to be the low-growth expectation of
companies.9
It is difficult to assess whether the low growth expectation itself is due
to the defensive way of thinking (mindset) that has been brought about by
reality of low growth over a quarter of a century, or it is founded on ratio-
nal factors such as population shrinkage. Judging from the accumulation
of cash and deposit holdings by companies (implying an attitude of risk
avoidance), the former factor seems to be working to a certain extent.
Furthermore, against the background of such factors as stagnation in
wage increases and the increasing use of non-regular workers by compa-
nies, concern for the future is strong among households. After the anom-
aly and difficulties over more than 30 years, the Japanese economy has
become an economy governed by low-growth expectation by companies
and concerns for the future of Japanese households.
In order to exit from the current situation, companies need an expecta-
tion that their sales will grow, and households need an expectation that their
9
The expected real growth rate of the Japanese growth rate held by companies (Cabinet
Office, “Survey on Company Behavior”) slightly rose after Abenomics started, but it then
declined and has stayed at a level of just over 1% for the last few years.
32 K. ARAMAKI
incomes will steadily grow.10 To realize such expectations, it is necessary to

overcome negative influences of the defensive mindset, if any. But, at the
same time, it is indispensable to tackle such substantive issues as population
decline and measures to increase productivity.
Bibliography
English Reference
Kosai, Yutaka (1986) The Era of High-Speed Growth – Notes on the Postwar
Japanese Economy. Tokyo: University of Tokyo Press.
10
Kosai (1986) wrote, in the famous paragraph from the 1956 Economic White Paper,
which announced the end of the postwar recovery, “there was … a concealed but profound
fear that a slackening of the growth rate would accompany the end of postwar reconstruc-
tion” (Kosai 1986, 106). “Since high growth was not expected to continue beyond the
recovery period, it was not generally thought that plant and equipment investment was
undertaken in earnest on an all-out scale.” “If growth were to continue beyond the recovery
period, the capital stock would have to be expanded …. Firms that had begun to be confi-
dent that growth would continue set about as though with one accord to renovate their plant
and equipment” (Kosai 1986, 108–9). This episode implies that the reality of high growth
drove the companies toward investment, which led to the continuation of high growth.
CHAPTER 2
Formation of a Bubble and Its Background
Japan experienced a formation of a huge bubble in the 1980s, which

turned out to be a prelude to the subsequent two-decade-long economic
stagnation. In this chapter, we will look at what happened to the asset price
(land and stocks) in Japan in the 1980s (Sect. 1), and why it happened and,
what could (should) have been done to contain the bubble (Sect. 2). In
examining causes of the bubble, we will look at two factors: economic
policy management in the 1980s and bank behaviors under financial liber-
alization from the latter half of the 1970s.
1 Formation of a Bubble in the 1980s
Asset Price Inflation and Subsequent Fall

Figure 2.1 shows evolution of the urban land price index (commercial use,
end March 2000 = 100) for the six largest cities in Japan from October
1954 to April 2012. Urban land price (commercial use) rose approxi-
mately 4.9 times in seven years from 107.8 in April 1983 to the peak of
525.4 in April 1990.1
1
The rate of change in the urban commercial land price index (six largest cities) from six
months before started to rise at a significantly higher pace than before, as early as in 1983,
with the rate of increase nearly doubling from 3.1% in March 1983 (which was about the
average rate of increase in the preceding two to three years) to 5.7% in October 1983, and it

34 K. ARAMAKI
600
500
400
Commercial use
300
Residential use
200
100
0
10/1/1954
4/1/1957
10/1/1959
4/1/1962
10/1/1964
4/1/1967
10/1/1969
4/1/1972
10/1/1974
4/1/1977
10/1/1979
4/1/1982
10/1/1984
4/1/1987
10/1/1989
4/1/1992
10/1/1994
4/1/1997
10/1/1999
4/1/2002
10/1/2004
4/1/2007
10/1/2009
4/1/2012
Fig. 2.1 Urban land price index: Six largest cities (end March 2000 = 100)
October 1954–April 2012. Source: Japan Real Estate Institute
Urban land prices started to decline from October 1990 and continued
to fall for 14 years to 67.2 in April 2004 (a decline of 87.0% from the peak
in April 1990), which was the level in 1972–73, before it showed a mini-
mal increase of 0.2% in October 2004.
For residential land, the urban land price index (residential use, end
March 2000 = 100) for the six largest cities increased by about three times
from 77.5 in April 1983 to the peak of 231.5 in April 1990. Then, it
declined to 76.9 (the bottom at the time) in October 2004, losing 66.8%
from the value at the peak.
Figure 2.2 shows that stock prices (Nikkei 225 [monthly average])
increased 5.4 times in a period slightly longer than seven years from
7,042 in August 1982 to 38,130 in December 1989.2 The Nikkei 225
continued to rise to hit a peak of 27.2% in April 1987. Although it is not easy to determine
the exact timing when the bubble started, it does not seem to be as late as the late 1980s
(that is when the rate of increase started to fall) as sometimes argued (e.g., Okina et al.
(2001) treats the four years from 1987 to 1990 “bubble period,” partly due to difference in
the definition of a bubble).
2
From September 1982, the Nikkei monthly average almost continuously recorded posi-
tive growth from the previous month with occasional brief falls until December 1989, before
it started to collapse in January 1990.
FORMATION OF A BUBBLE AND ITS BACKGROUND 35
(yen)
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
6/1/1949
7/1/1952
8/1/1955
9/1/1958
10/1/1961
11/1/1964
12/1/1967
1/1/1971
2/1/1974
3/1/1977
4/1/1980
5/1/1983
6/1/1986
7/1/1989
8/1/1992
9/1/1995
10/1/1998
11/1/2001
12/1/2004
1/1/2008
2/1/2011
Fig. 2.2 Nikkei 225 (monthly average) June 1949–February 2013. Source:
NIKKEI NEEDS
started to fall in January 1990, hit the bottom at 15,790 (−58.6% from
the peak) in August 1992, that is, in less than three years, and then became
fairly stabilized in the range of 16,000–21,000, before it resumed a fall in
late 1997.
Transformation of the Asset Price Inflation to a Bubble

We saw a sharp rise and fall of asset prices from the 1980s. We now know
what we were seeing was a bubble, but, as we see later, the asset price
increase in the early stage of the process appears to have been based on real
factors, that is, the increase may not have been a bubble initially. So, in this
section, we will look at when and how the asset price increase turned into
a bubble with reference to some existing research and reports.
efinition of an Asset Price Bubble

D
An asset price bubble may be defined as a phenomenon in which the price
of asset rises beyond the level that is based on fundamentals. The price
based on fundamentals (that is, the theoretical price) corresponds to the
36 K. ARAMAKI
discounted p resent value of future returns to the asset and is expressed as

follows, if the asset has no risk and if the return is fixed:3
P = R / i, (2.1)
where R = return (office or housing rent, interest, etc.) to an asset, P =

price of asset, i = long-term risk-free interest rate (typically, long-term
government bond yield in the secondary market).
If the asset has a risk and the return to the asset grows each period at a
fixed rate, g, the theoretical price will be written as:
P = R / (i + a - g), (2.2)

where α is the risk premium (an additional return on top of the return to
a risk-free asset that is required for a risk asset to be held), and g is the
growth rate of the return (R).
heoretical and Actual Price of Land

T
Figure 2.3 shows the development in both the actual price and the theo-
retical price of land for commercial use in central Tokyo, as calculated by
the Economic Planning Agency (EPA). Setting the level in 1983 as a base,
the increase in the actual price started to exceed that of the theoretical
price from around the mid-1980s and stayed above the theoretical price
throughout the rest of 1980s.4
Figure 2.4 shows a different estimation. It shows that, from 1987 in
Tokyo, the actual land price far exceeded the projected land price, which
was calculated based on a regression analysis.
These two analyses suggest that there was a land price bubble at least in
the latter half of the 1980s.
S pillovers of Land Price Increase

The foregoing suggests there was a land price bubble in Tokyo from
around the mid-1980s. Let us see in more detail how the bubble was
See the supplement to this chapter for the derivation of theoretical price (i.e., price based
3
on fundamentals).
4
In calculating the theoretical price, the prevailing levels of return and the interest rate
were assumed to be unchanged for the future. See Nenji Keizai Hokoku (Annual Economic
Report) 1991 (Economic Planning Agency).
Fig. 2.3 Actual and theoretical land price (land for business use, Central
Tokyo.1983 = 1) 1971–1991. Note: In calculating the theoretical price, the pre-
vailing levels of return and the interest rate are assumed to be unchanged for the
future. Source: Economic Planning Agency, “Nenji Keizai Hokoku (Annual
Economic Report) 1991”
800.0
700.0
600.0 Actual land price
500.0
400.0
300.0
200.0 Projected land price
100.0
70 72 B 74 76 78 80 82 84 86 88 90
71 73 75 77 79 81 83 85 87 89 91
Fig. 2.4 Actual and projected land price (all uses) in Tokyo metropolitan area.
Note: Land price is regressed on GDP of Tokyo and the long-term interest rate for
1970–1986. Source: Fiscal and Monetary Research Institute, Ministry of Finance,
Japan, “Shisan kakaku hendo no mekanizumu to sono keizai koka” (The
Mechanism of Asset Price Movements and its Economic Impacts), November
1993 Finansharu Rebyu
38 K. ARAMAKI
formed. Figure 2.5 shows land price developments by area and by type of

use in Tokyo from the early 1980s to the beginning of the 1990s. We can
see that the substantial land price increase started with commercial land in
the center of Tokyo, as early as 1983, a few years earlier than the mid-
1980s, which was suggested as the starting point of the bubble in the
preceding analyses. Figure 2.5 also shows that there were spillovers of land
price increases from the very center to the suburbs of Tokyo, and also,
from commercial to residential use.
Figure 2.6 shows that spillovers of land price increases spread from
Tokyo to two other metropolitan areas, namely, Osaka and Nagoya, and
then to local areas.
Figures 2.5 and 2.6 indicate that the significant land price increase
started in the very center of Tokyo for land for commercial use as early as
in 1983,5 and this development spread from land for commercial use to
land for residential use and also, from the very center of Tokyo to other
areas in Tokyo, then to other regions in Japan later in the 1980s. Next, we
need to know why the commercial land price started to rise sharply in the
center of Tokyo in the first place.
Fig. 2.5 Rate of land price increases by area and by type of use in the Tokyo
metropolitan area, 1983–1991. Source: Economic Planning Agency, Nenji Keizai
Hokoku (Annual Economic Report) 1991
5
This is when the rate of commercial land price increase nearly doubled (see Endnote 1 in
this chapter).
Fig. 2.6 Spillovers of land price increases from Tokyo to Osaka and Nagoya
metropolitan areas and to local areas. Source: Economic Planning Agency, Nenji
Keizai Hokoku (Annual Economic Report) 1991
There are factors that might have triggered the initial rise in commer-
cial land prices in central Tokyo, such as increasing attention from
abroad in financial markets in Tokyo and the expectation that a growing
number of offices of foreign financial institutions would be established
in Tokyo. Figure 2.7 shows that the vacancy rate of office space in Tokyo
was rapidly falling and reached almost 0% in the mid-1980s. This implies
that there was a real factor, that is, a tightening of demand/supply con-
ditions for office space to explain the rise in the price of commercial land
in Tokyo in the early 1980s. So, the significant rise in land prices may
well have started by a fundamental factor at the beginning. Through the
process of subsequent spillovers of price increase, however, to other land
uses and to other areas, an element of bubble may have begun at that
point, leading to a huge asset price bubble in extensive areas and sectors
in Japan.
heoretical and Actual Price of Stocks

T
Let us briefly look at the stock price increase. Here, a comparison between
the theoretical and the actual stock prices also suggests that there might
have been an element of a bubble in the latter half of 1980s. The interest
rate-adjusted price/earning ratio (PER, i.e., stock price divided by profit
per one unit of stock), that is, the interest rate multiplied by the PER, can
40 K. ARAMAKI
(ha) (%)
Average vacancy rate (RHS)
1750 2.5
Aggregate floor size (LHS)
1500 2.0
1250 1.5
1000 1.0
750 0.5
Office vacancy rate (RHS)
500 0
75 80 85 89
Fig. 2.7 Aggregate floor size of the buildings belonging to the Tokyo Building
Association and average vacancy rate. Source: Bank of Japan, “Chosa Geppo”
(Monthly Research Report) April 1990
be shown to correspond to the ratio of actual to theoretical stock prices.6

Figure 2.8 shows that the interest rate-adjusted PER (= actual stock price/
theoretical price) grew more than fourfold in the late 1980s, exceeding
previous peaks of 2.4 to 2.5 times at the end of 1970s and in the first half
of 1980s. This development may be explained by either an increase in the
expected growth rate of return or a decline in risk premium, or both.7
Both factors symbolize strong confidence held by companies and individ-
uals in the future course of the Japanese economy, which later turned out
to be unrealistic.
Summary
From the foregoing, the following observations may be made:
6
See 2.3 (Stock price) of Supplement to this chapter.
7
The theoretical price rises if the risk premium (α) decreases, and/or the expected growth
rate (g) of return increases in Eq. (2.2) on page 36.
Fig. 2.8 Development in interest-rate-adjusted PER. Note: PER = price/earn-

ing ratio, i.e., stock price divided by profit per one unit of stock. Source: Nenji
Keizai Hokoku (Annual Economic Report) 1993 (Economic Planning Agency)
First, the initial commercial land price rise in the central Tokyo may have
been based on fundamental factors.
Second, the subsequent price surge in commercial land from around the mid-
1980s in Tokyo, the spillovers to residential land prices in Tokyo and also
to other areas in Japan, however, seem to have been a bubble.
Third, the stock price rise in the late 1980s may have reflected an increase
in expected profit growth (GDP growth rate may have acted as its
proxy) and a fall in risk premium under strong confidence in the econ-
omy (which seems to have led to positive risk taking by companies and
individuals). However, both the high-growth expectation and low-risk
premium were not realistic.
2 Why Did the Asset Price Bubble Develop?

Could It Have Been Avoided?
So far, we have seen how the asset price bubble was formed. In this sec-
tion, we look at why such a bubble emerged. Two major factors often
mentioned as causes of the bubble are (1) economic policy management
42 K. ARAMAKI
in the 1980s, particularly a large-scale monetary easing over an extended

period of time; and (2) bank behaviors under financial liberalization initi-
ated in the latter half of the 1970s. In what follows, we look at these fac-
tors one by one, and also examine what could (should) have been done to
prevent the formation of a bubble.
Economic Policy Management
Chronology
A brief chronology of the important developments that happened in the
two decades over the 1970s and 1980s is shown in Table 2.1.
We can see from this brief chronology that these two decades were full
of many external turbulent incidents. The 1970s saw, first, the demise
of the stable exchange rate regime (Nixon shock). The peg system was
abandoned, and under the float system, the yen basically continuously
appreciated for subsequent decades, bringing the Japanese economy from
time to time to the state of “high yen driven stagnation.” The 1970s also
saw two oil crises, which drove the crude oil price (in terms of Arabian
light) to nearly 20 times higher than its 2 US dollars per barrel in the
early 1970s to around 40 US dollars per barrel in 1979,8 and the world
economy fell into a severe stagnation coupled with high inflation (stagfla-
tion). For Japan, both these developments (i.e., the collapse of the peg
system and the yen appreciation, and the worldwide stagflation), together
with the end of high-speed growth of the early 1970s, imposed a heavy
burden on the fiscal policy management, bringing about a sharp aggrava-
Table 2.1 Major economic and political developments in the 1970s and 1980s
August 1971 Nixon shock

December 1971 Smithonian Accord
October 1973– 1st oil crisis
December 1978– 2nd oil crisis
January 1981– 1st Reagan administration
May 1984 Yen–Dollar Committee report
September 1985 Plaza Accord
April 1986 Maekawa report
February 1987 Louvre Accord
October 1987 Black Monday
June 1990 Final Report of Structural Impediments Initiative (SII)
8
See Komine, Takao (2011a).
tion of the government fiscal position. Then, the 1980s saw a growing
friction between Japan and the United States against the background of a
worsening external trade balance of the United States during the first
Reagan administration and expanding external surpluses of Japan.
These two factors, that is, deterioration of fiscal position and intensifying
external disputes with the United States, provided the basic constraints on
the Japan’s economic policy management in this period. This is the first factor
affecting the bubble formation. The deterioration of the fiscal position also
acted as a push factor for financial liberalization to be explained later, which
is the second factor affecting the bubble formation. We will first look at how
Japan’s economic policy management was conducted under these constraints,
that is, trade disputes with the United States and deterioration of the fiscal
position, and find out what such policy management has brought about.
Japan’s Economic Policy Management in the 1980s Under

the Two Major Constraints
Let us examine the economic policy management in the 1980s and its
relationship with the bubble formation.
Fierce External Friction with US

Trade disputes with US presented a really difficult challenge for Japan’s
policy formulation. Figures 2.9 and 2.10 show developments in the
external positions of US and Japan, respectively. The US current
(millions of US dollar)
40000
20000
0
-20000
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
-40000
-60000
-80000
-100000
-120000
-140000
-160000
-180000
Fig. 2.9 Current account balance: US 1965–1990. Source: Bureau of Economic

Analysis (BEA), US government
44 K. ARAMAKI
(100 millions of yen)

160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
-20,000
-40,000
Fig. 2.10 Current account balance: Japan 1966–1990. Source: Cabinet Office,
“Choki Keizai Tokei Heisei 24” (Long-term economic statistics FY 2012)
account balance deteriorated sharply in the first half of 1980s. By con-

trast, Japan’s current account surplus significantly increased after enter-
ing the 1980s.
One of the backgrounds for these developments is found in the evolu-
tion of the Japanese economy at that time. In the stable growth era of
1974–1984, that is, an intermittent period between the high-speed
growth era and the bubble period, the growth contribution of private
investment in plant and equipment (Ip) sharply fell as compared with the
preceding high-growth era, from 1.6% to 0.3% on average. By contrast,
net exports (NE) became the major engine of growth, with the average
growth contribution rising from −0.3% to 0.6% (Table 2.2 and Fig. 2.11).
Although we will look at the factors behind these developments later,
such growing dependence of the Japanese economy on exports, particu-
larly exports to the United States, led to fierce trade disputes with the
United States.
While Japan had trade disputes with the United States almost inces-
santly after the Second World War, as is indicated in the major cases of
disputes listed in Table 2.3, the severity of disputes sharply increased as
Japan’s economy grew and its impacts became greater.
Table 2.2 Average growth contribution of private investment in plant and

equipment and net exports: 1956–1973 (high-speed growth period), 1974–1984
(stable growth period), and 1985–1990 (bubble period) (%)
1956–1973 1974–1984 1985–1990
Real GDP growth rate 9.3 3.3 4.6

Private investment in plant 1.6 0.3 1.7
and equipment
Net exports −0.3 0.6 −0.4
Source: Cabinet Office, GDP statistics
(%)
4.0
3.0
Ip
2.0 56-73 Ave

74-84 Ave
85-90 Ave
1.0
NE
56-73 Ave
0.0 74-84 Ave
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
85-90 Ave
-1.0
-2.0
Fig. 2.11 Real GDP growth contribution by private investment in plant and
equipment (Ip) and net exports (NE) in 1956–1973 (high-speed growth era),
1974–1984 (stable growth era), and 1985–1990 (bubble era). Source: Cabinet
Office, GDP statistics
Table 2.3 Major trade disputes between Japan and US
1950s– Textiles
1960s– Steel, color TVs
1970s– Beef and oranges, NTT (Nippon Telegraph and Telephone Corporation)
procurement, automobiles
1980s– Semi-conductors, mobile phones, etc.
46 K. ARAMAKI
Through the history of disputes, the focus of the negotiations shifted

from export restraint (textiles, steel, color TVs, automobiles), to market
access (NTT procurement, semi-conductors), and then to macro and
structural factors (Structural Impediments Initiatives (SII) [1989–1990]),
but the severity of disputes culminated with respect to automobiles, from
the latter half of 1970s to 1980s. The share of imported cars significantly
increased from over 10% at the end of 1950s to 18% in 1978, and then to
26% in 1980.9 The Big Three automakers in the United States laid off
workers, and one of the three, Chrysler came close to bankruptcy in 1980.
Workers demonstrated by destroying a Japanese car with hammers.10 In
1981, President Reagan publicized a rescue plan for the automobile indus-
try and requested a voluntary export restraint from Japan. In 1981, volun-
tary export restraint was placed into operation by Japan, limiting exports
to United States to 1.68 million units a year.
In March 1985, prior to the expiry of the voluntary export restraint,
Reagan stated that he would not request an extension of the voluntary export
restraint, based on the improvements in the performance of the US automo-
bile industry, but Japan voluntarily extended export restraint. In response to
the president’s decision, dissatisfaction with Japan spread rapidly. As many as
400 bills aiming to protect US products were submitted to the US Congress
a single year, 1985,11 and the atmosphere in Washington, DC, was described
by Japan’s ex-Foreign Minister, Ōkita, as “the night before the war.” In late
March 1985, the US Senate passed a resolution, by 92 to 0, asking the presi-
dent to retaliate against Japan, considered to be an unfair trade partner.
Under such circumstances, the policy agenda item in Japan with the
highest priority became the alleviation of the growing tension with the
United States. Before explaining policy responses by Japan, let us briefly
look at the second constraint on Japan’s policy management at that time
(i.e., deterioration of the fiscal position).
Deterioration of the Fiscal Position

The second constraint came from the inside. With the economic growth
rate significantly slowing down, Japan’s fiscal balance, which had been
basically in surplus until the early 1970s, dramatically changed, and the
nation started to record a large deficit from mid-1970s (Fig. 2.12).
9
See Komine (2011a).
10
In 1982, a tragic incident happened in which a young Chinese man, who was mistaken
for a Japanese man, was killed by laid-off automobile workers in Detroit.
11
See Volcker and Gyoten (1992).
(%)
3
0
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
-1
(FY)
-2
-3
-4
-5
Fig. 2.12 General government fiscal balance (GDP ratio): Japan 1965–1990.
Source: Cabinet Office
Causes of deficits can be found on both revenue and expenditure sides,

and fiscal consolidation became a priority policy agenda in the 1980s. On the
revenue side, due to the downward shift of the growth rate, the rate of rev-
enue increase fell substantially. On the other hand, expenditures expanded,
especially reflecting the reform of the social security system in 1973 (called
“Social Security Year 1”). Also, due to the fiscal stimulus implemented as a
result of the yen appreciation, oil crises, and international calls for domestic
demand expansion (“Locomotive countries” arguments12), the dependence
ratio of revenue on government bond financing sharply increased in the
1970s, reaching 39.6% in the initial budget for fiscal year 1979.
Prime Minister (PM) Ohira’s administration, which started in 1978,
declared that the fiscal year 1980 would be “the 1st year for fiscal con-
solidation” and that a general consumption tax would be introduced in
fiscal year 1980. However, under strong opposition from members of his
own ruling party, Ohira took back the proposal but still lost the absolute
12
Ahead of the summit meeting in London in 1978, an argument gained a high profile
that Japan, West Germany, and the United States, with their relatively good performance,
should act as the locomotive countries to lead the recovery of the world economy.
48 K. ARAMAKI
majority in the lower (i.e., more powerful) house election in late 1979.
After a hard fought internal battle within the ruling party (the “40 day
battle”), Ohira was reelected as PM. The battle continued, however, and
finally, a non-confidence resolution was adopted in the lower house in the
absence from voting of a large number of ruling party members. Ohira
dissolved the lower house, but in the midst of the campaign, he passed
away. Although the ruling party won the election, the Suzuki administra-
tion, which succeeded Ohira’s, committed itself to the pursuit of fiscal
consolidation without tax increase, which constrained the scope of fiscal
measures to cope with the policy agenda, including with the growing
external frictions during most of the 1980s.
How Did the Government Respond?

We looked at how the government responded to these developments:
The basic observation was that, under mounting criticism from the
United States for the external trade imbalance, highest priority in the eco-
nomic policy formulation gradually shifted in the 1980s from domestic
economic matters to the resolution of external economic conflict. With
the government commitment to fiscal consolidation, maintained for the
substantive part of 1980s, the policy choice roughly followed the follow-
ing sequence from (a) to (c). In what follows, we will look at these
responses.
(a) Export restraint and the expansion of domestic demand through

deregulation, including urban redevelopment by “Minkatsu” (mobi-
lization of private sector vitality)
(b) Coordinated exchange rate adjustments (Plaza Accord)
(c) Emphasis on the need to transform the Japanese economy into a
domestic demand-driven one and on the expansion of domestic
demand through monetary easing and, in the later stage, fiscal
expansion (structural reform and expansionary macroeconomic
policy).
Export Restraints and Deregulation

Export Restraints Could Not Solve the Disputes
Export restraints by Japan were frequently placed into force, as shown in
Table 2.4. Although Japan first resorted to this measure to cope with the
automobile dispute, as explained earlier, the problem was not resolved.
Table 2.4 Major cases of export restraint

Period Industry Main outcomes
Mid-1950s–early Textiles Voluntary export restraint (1955) and Japan–US

1970s cotton trade agreement (1957)
Japan–US textile agreement (1972)
Mid-1960s–1970s Steel Japan–Europe–US agreement on voluntary export
restraint (1969)
1960s–1970s Color TVs Japan–US orderly marketing agreement (1977)
1970s–1980s Automobiles Voluntary export restraint (1981)
Late 1970s–1980s Semi- Japan–US semi-conductor agreement (1986)
conductors
Source: Kanagawa (1987, 1989) and Matsuzaki (1988)
Deregulation and Urban Redevelopment Attracted a Policy Focus

Under the circumstances, from the first half of the 1980s, deregulation
and urban redevelopment started to be considered as an effective tool,
compatible with fiscal consolidation to stimulate domestic demand.
PM Nakasone, who took office in 1982, focused on deregulation and
mobilization of private sector vitality (“Minkatsu”), and particularly
emphasized urban redevelopment (“Urban Renaissance”). In February
1983, PM Nakasone instructed the Ministry of Construction to ease land
regulations, so as to make it possible for the private sector to build high rises
in the center of metropolitan areas.13 Also, in January 1983, the government
decided to make use of government-owned land for urban redevelopment
and housing supply, and subsequently sold a substantial amount of land in
central Tokyo for rather high prices (which was later criticized as spurring the
land prices hike and was suspended in 1987).14
Land-Related Projects Gained Attention Under the “Minkatsu” Policy

Under such policy developments, around 1983–1984, reporting began
to describe a fierce race for land acquisition, financed by financial institutions
and under way by small local real estate agents in the very center of Tokyo,
with the aim of reselling them at a higher prices.15
13
Komine (2011a, 112)
14
Komine (2011a, 115–17)
15
Komine (2011a, 123–4) quotes a writing by an ex-official of the Ministry of Construction,
50 K. ARAMAKI
In May 1985, the National Land Agency released “The Capital

Remodeling Plan,” which stated that demand for office space in central
Tokyo in 2000 was estimated to be 8,700 ha, a 5,000 ha increase (equiva-
lent to 250 high rises) over the 3,700 ha in 1985. This estimate was later
criticized as inflaming the land price hike.16
Adjustment of the Exchange Rates

Despite these policies, the US current account deficit continued to expand,
and Japan’s policy efforts gradually shifted toward acceptance of exchange
rate adjustments.
Behind this policy shift was a substantial appreciation of the US dollar
in the first half of the 1980s. In the early years of the first term of the
Reagan administration, the United States took a fundamentalist market
(no intervention) approach to the surging dollar. In 1983, a report
(referred to as the “Solomon Report,” after the name of one of its authors),
commissioned by the chairman of Caterpillar, Inc., was circulated in the
United States; and the report argued for the need for financial liberaliza-
tion in Japan and internationalization of the yen, with a view to correcting
the yen–dollar exchange rates. In May 1984, the Yen–Dollar Committee,
which was established by the Japanese Ministry of Finance and the US
Treasury in the previous year, released a report filled with many financial
deregulation commitments by Japan, as demanded by the Solomon
Report. However, such measures did not have immediate impacts on the
yen–dollar exchange rate, and therefore, did not contribute to a significant
correction of the trade imbalance between the two countries.
The United States and Japan moved forward to the Plaza Accord

From around the end of 1984 to 1985, under rising protectionist pressure,
the United States apparently sought a downward adjustment of the dollar
(or upward adjustment of non-US dollar currencies), although its official
stance was to regard the strong dollar as reflecting confidence in the US
economy and bringing about benefits that included price stability.
In January 1985, the G5 released a public statement for the first time
in which it considered the possibility of intervention in the foreign
who interviewed 20 local real estate agents that were actively buying land in the center of
Tokyo. He wrote that out of 20 agents, only one mentioned the intended use of the land that
it purchased, suggesting that they were buying land to resell at higher prices.
16
However, in 2000, the size of office space in the central Tokyo turned out to be 8000 ha,
not very far from the projection (Komine 2011a, 284).
exchange market to stabilize the exchange rate. In February 1985, coor-

dinated intervention by Japan and the United States was conducted to
contain further appreciation of the dollar.
In June 1985, in a meeting between Finance Minister Takeshita and US
Treasury Secretary Baker, Takeshita proposed coordinated intervention in
the foreign exchange markets, while Baker requested expansion of domes-
tic demand. Also in June 1985, PM Nakasone met with Secretary Baker
on the currency issue, and Nakasone is reported to have decided to accept
the appreciation yen at that time.17
The Plaza Accord Achieved and the Yen Started to Have a Dramatic

Appreciation
On September 22, 1985, at the G5 meeting, which took place in the Plaza
Hotel in New York, released an agreement (the Plaza Accord), which
stated, “some further orderly appreciation of the main non-dollar curren-
cies against the dollar is desirable” in conjunction with policy commit-
ments by each participating country. It has been reported that there was
an agreement among the G5 to aim for 10–12%18 depreciation of the
dollar in the near future, written in a “non-paper” that was submitted to a
preparatory meeting as a paper existing as non-existent.19 Once coordinated
intervention started, adjustment of exchange rates proceeded far beyond such
a target, and the yen appreciated from 240 yen to the dollar on September 20,
1985, to 200 yen by the end of 1985, and further to below 180 yen in March
1986. The yen continued to appreciate to a record 159 yen in December
1986, and to 124 yen in December 1987, almost doubling its value against
the US dollar in just a little more than two years (Fig. 2.13).
Structural Transformation of the Japanese Economy and Eased

Macroeconomic Policy
Structural Reform of Japan’s Economy—A Plan to Transform Japan’s
Economy to a Domestic Demand-led One Was Proposed and Restraint of
Further Yen Appreciation Sought.
While the exchange rate adjustments were under way, another strand of
thought was proposed that sought to transform the Japanese economy to
17
Komine (2011a, 148)
18
See Funabashi (1988) and Kondo (1999).
19
See Funabashi (1988, 28–9). It has not been made publicly available yet.
52 K. ARAMAKI
300
250
200
150
100
50
0
Jan-80
Jun-80
Nov-80
Apr-81
Sep-81
Feb-82
Jul-82
Dec-82
May-83
Oct-83
Mar-84
Aug-84
Jan-85
Jun-85
Nov-85
Apr-86
Sep-86
Feb-87
Jul-87
Dec-87
May-88
Oct-88
Mar-89
Aug-89
Fig. 2.13 Yen–dollar exchange rate (monthly average) 1980–1989. Source:
Bank of Japan
a domestic demand-led one. Also, the overshooting of the exchange rate

adjustments motivated Japan’s attempts to halt further yen appreciation,
which, under the efforts by Finance Minister Miyazawa, led to the Louvre
Accord for exchange rate stabilization.
As for the orientation toward transforming the economy to a domestic
demand-led one, in October 1985, PM Nakasone convened a private
study group headed by the previous Bank of Japan (BOJ) governor, Mr.
Maekawa, to examine structural problems in the area of international eco-
nomic relations and to formulate a medium- and long-term design of
Japan’s society and economy, which would be in harmony with interna-
tional economies. This action was apparently prompted by the concern
over the rising protectionist pressures in the United States.
In April 1986, the study group submitted a report (“Maekawa Report”),
which included the following contentions:
–– The large external imbalance has come to a critical phase, and we

have set a national goal to reduce it to an internationally compatible
level.
–– The large current account deficit has its root in our economic struc-
ture, including its export orientation.
–– In order to realize an internationally compatible economy, we have to
realize a domestic demand-led economic growth and fundamentally
change the structure of imports and exports and industries.
The essence of these contentions were included in subsequent reports

of formal governmental advisory committees.
In Parallel with a Reform Proposal of the Japanese Economy,

Attempts to Arrest Further Yen Appreciation Conducted
Finance Minister Miyazawa, who took over after Takeshita, who was
involved in the Plaza Accord, was critical of the Accord and endeavored to
establish an agreement for exchange rate stabilization among the G7, and
an agreement was released on February 22, 1987 (Louvre Accord). The
Accord stated as follows:
“The Ministers and Governors agreed that the substantial exchange rate
changes since the Plaza Agreement … have now brought their currencies
within ranges broadly consistent with underlying economic fundamentals ….
In current circumstances, therefore, they agreed to cooperate closely to fos-
ter stability of exchange rates around current levels.”
In the Accord, Japan promised to “follow monetary and fiscal policies

which will help to expand domestic demand and thereby contribute to
reducing the external surplus.”
Influence of These Efforts on Macroeconomic Policy

These two factors, that is, the idea to transform the economy to a domes-
tic demand-led economy and an attempt to halt further yen appreciation,
set a framework for policy formulation in the late 1980s. This was particu-
larly true in the area of monetary policy, as indicated by continuation of
substantial monetary easing. Let us look at developments in monetary
policy.
Interest Rate Reduced but Kept Relatively High in the First Half

of the 1980s
Monetary policy was tightened from the beginning of 1979 to control
inflationary pressure during the second oil crisis (discount rate was raised
54 K. ARAMAKI
five times, by a total of 5.5%, to reach 9.0% in March 1980). As the econ-
omy started to slow down from around the spring of 1980, monetary
policy was eased gradually from August 1980, and the discount rate came
down to 5.5% in December 1981. The economy started to recover, led by
export growth in the spring of 1983, and the monetary policy was broadly
unchanged. Although reduced to 5.0% in October 1983, interest rates
were kept high due to the high overseas interest rates (the US interest rate
was exceptionally high at around 10–14% throughout the first half of
1980s), and concerns for the further yen depreciation.
Monetary Policy Significantly Eased Further in the Latter Half of

the 1980s
With the slowing down of the economy due to the sharp yen appreciation
after the Plaza Accord, an economic policy package for domestic-demand
expansion through the maximum use of private sector vitality was adopted
in October 1985. Furthermore, the discount rate was reduced five times
from January 1986 to reach the historic low of 2.5% in February 1987,
where it stayed until May 1989, when it was raised for the first time in the
preceding nine years (Fig. 2.14). This most eased monetary environment
was maintained during the peak of the bubble.
(%)
10
9
8
7
6
5
4
3
2
1
0
Jan-80
Jul-80
Jan-81
Jul-81
Jan-82
Jul-82
Jan-83
Jul-83
Jan-84
Jul-84
Jan-85
Jul-85
Jan-86
Jul-86
Jan-87
Jul-87
Jan-88
Jul-88
Jan-89
Jul-89
Jan-90
Jul-90
Fig. 2.14 Official discount rate: Japan 1980–1990. Source: Bank of Japan
Background for the Eased Monetary Policy over an Extended Period

of Time
Why was the discount rate lowered to the historic low, and why did it stay
there for more than two years in the latter half of 1980s? Table 2.5 shows
how each instance of monetary easing was explained by the BOJ.
Distinct Characteristics Observed in BOJ’s Explanations

There are some very distinctive characteristics that are observed in the
explanations of the BOJ. First is that concerns over domestic economic
conditions are stated, but they do not to play a major role in explaining
BOJ’s monetary policy decisions. Second is that the following three fac-
tors (all external) seem to be given crucial consideration instead:20
① Correction of external imbalances through expansion of domestic demand,

② Intention to halt further appreciation of the yen, and
③ Efforts for international coordination of macroeconomic policy.
Fiscal Measures Implemented in the Latter Half of the 1980s

On the fiscal policy side, stimulus packages were compiled, and fiscal consoli-
dation efforts were finally halted in the late 1980s. In addition to the package
in October 1985, mentioned before, in April and September 1986, packages
of economic measures were compiled under the still growing current account
surplus, which was due possibly to the J-curve effects and slowing down of
the economy by yen appreciation (although it was later confirmed that the
economy had hit bottom in November 1986). However, still in April 1987,
President Reagan announced an imposition of a sanction tariff on certain
imports from Japan in the face of growing criticism in the United States
directed toward Japan, and in May 1987, a large economic measure with a
project size amounting to 6 trillion yen was announced by Japan.
Other Policy Measures

Other policy measures implemented in this period during the aforemen-
tioned policy orientation shift toward a domestic demand-led economy
included the enactment of laws to promote development of specific facili-
ties or resorts, particularly in local areas.
In 1986, a law (the so-called Minkatsu law) was enacted to promote devel-
opment of facilities and buildings, such as research centers, information facili-
For such observations, see Okina, Shirakawa, and Shiratsuka (2002).

20
56 K. ARAMAKI
Table 2.5 BOJ’s explanation of monetary policy changes in the late 1980s
Date of Contents of Explanation by the BOJ
policy the change
changes
January 5.0%→4.5% The measure is expected to promote expansion of domestic

30, 1986 demand and to contribute to correction of external imbalances
through lowering the interest rate. The BOJ will continue to
pay sufficient attention to the exchange rate developments.
(Statement by the chairman of policy committee)
March 10, 4.5%→4.0% This reduction was decided particularly with the stabilization of
1986 exchange rate in mind (BOJ Governor Sumita (Nihon Keizai
Shinbun, March 9, 1986))
(Note: This reduction was part of internationally coordinated
reduction of the interest rate with US and West Germany,
announced on the same day.)
April 21, 4.0%→3.5% BOJ hopes that this step will contribute to the further stabilization
1986 of the yen rate and the expansion of domestic demand and the
correction of external imbalances (BOJ press release, April 19, 1986)
(Note: The Federal Reserve Board (FRB) announced a
reduction of discount rate on April 18.)
November 3.5%→3.0% BOJ judged a further reduction in interest rate will be effective
1, 1986 in stimulating domestic demand. It strongly hopes that the
exchange rates will be stabilized
(BOJ press release, October 31, 1986)
(Note: Governor Sumita later acknowledged that he received a
telephone call from Finance Minister Miyazawa, who was in US
to meet with US Treasury Secretary Baker, and was informed of
US’ implicit request for a discount rate cut by BOJ. The joint
statement by Miyazawa and Baker was released on the day of
discount rate cut.)
February 3.0%→2.5% A further appreciation of the yen may strengthen deflationary
23, 1987 pressure on the economy and jeopardize achieving our
country’s fundamental policy of correcting external imbalances
through domestic demand expansion and structural adjustment
(BOJ press release, February 20, 1987)
Governor Sumita said that this cut was determined by placing
the most importance on the stabilization of the exchange rate
(Nihon Keizai Shinbun, February 21, 1987)
(Note: On the following day of the BOJ’s release, G7
announced an agreement (Louvre Accord) to stabilize the
exchange rates around the current levels.)
Source: Tabulated by the author, based on Komine (2011a, pp. 156–181)

ties, and international conference arenas by private sectors. One hundred

eighty-seven projects were approved, about 80% of which were undertaken
by entities funded by both private sector and local governments. Many of
these entities later met with difficulties or faced with bankruptcy.
Furthermore, in 1987, a law (the so-called Resort Law) was enacted to
promote development of resort facilities. Forty-two area projects submit-
ted by 41 prefectures (i.e., regional governments) out of a total of 47
prefectures were approved, most of which planned to build facilities for
skiing, golfing, and marine sports. Actual construction work for many of
them began in 1991, when the economy started to stagnate, and in more
than a few cases, projects were abandoned or went bankrupt.21
Rapid Expansion of Assets Held by Companies

Behaviors of economic agents significantly changed under these circum-
stances. This is particularly true with the corporate sector. Let us briefly
see how the corporate sector changed, as evidenced in their financial state-
ments compiled over the period.
Expansion of Physical Assets Held by Companies

Under such policy developments, there emerged a significant change in
the corporate sector. Figures 2.15 and 2.16, respectively, show land and
physical assets (excluding land) held by profit-making companies (exclud-
ing financial and insurance companies) that existed in Japan, with division
into manufacturing and non-manufacturing industries. Both figures indi-
cate that land and physical asset holdings were sharply expanded from the
mid-1980s, and the expansion was far more significant in non-
manufacturing industries than in manufacturing industries.
Figure 2.17 shows developments in the amount of physical assets
(excluding land) held by four non-manufacturing industries (construc-
tion, transportation and postal services, wholesale and retail, and real
estate), which were among major holders of such assets.22 Physical assets
include buildings, machinery, and equipment. From the figure, it is
21
Komine (2011a, 118, 213, 232).
22
The combined share in the total amount of physical assets of non-manufacturing indus-
tries held by these four industries accounted for 57% as of 1990, 6.1% for construction,
18.8% for transportation and postal services, 18.1% for wholesale and retail, and 14.1% for
real estate. Major holders of physical assets, other than these four sectors as of 1990, are
electricity (17.3%), entertainment (5.2%), and advertising (10.8%).
58 K. ARAMAKI
(t rillion yen)
250
All industries
200 (excluding
financial and
150 insurance
companies)
100 Manufacturing
Non-
50
manufacturing
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 2.15 Land holdings by all industries (excluding financial and insurance
companies) and their breakdown between manufacturing and non-manufacturing
sectors. Source: Ministry of Finance, “Financial Statements Statistics of
Corporations by Industry”
(t rillion yen)
400
350
All industries
300 excluding financial
and insurance
250 companies
200 Manufacturing
150 Non-manufacturing
100
50
0
FY1960
FY1964
FY1968
FY1972
FY1976
FY1980
FY1984
FY1988
FY1992
FY1996
FY2000
FY2004
FY2008
FY2012
FY2016
Fig. 2.16 Physical assets (excluding land) held by all industries (excluding
financial and insurance companies) and their breakdown between manufacturing
and non-manufacturing sectors. Source: Ministry of Finance “Financial Statements
Statistics of Corporations by Industry”
（trillion yen)
50
45
40
35 Construction
30 Transportation
25 and postal
20 service
15 Real estate
10 Wholesale
5 and retail
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 2.17 Physical assets (excluding land) held by four major non-manufacturing
industries. Source: Ministry of Finance, “Financial Statements Statistics of
implied that real estate-related projects were actively undertaken by non-

manufacturing industries from the mid-1980s. It should be noted that the
expansion of physical assets continued until the first half of the 1990s,
probably due to the time lag between planning and construction that was
inherent in development projects.
What we have seen thus far indicates that companies in Japan, particu-
larly those in the non-manufacturing sector, developed a gigantic stock of
physical assets, including real estate-related ones. The level of these stocks
turned out to be unsustainable and excessive, as was indicated by the fact
that the levels continued to decline subsequently for the long period of
time from the latter half of the 1990s. After the bubble period, the corpo-
rate sector was left with huge excessive assets.23
Economic Policy Management by the Government in the 1980s

The government’s response to the two constraints in macroeconomic pol-
icy management may be summarized as follows.
23
A detailed analysis of the balance sheets of the corporate sector is given in Chap. 6.
60 K. ARAMAKI
In the 1980s, policies were bound by two constraints, that is, external fric-
tion with the United States and fiscal deterioration, with the former
playing the dominant role. In early years, efforts to cope with these two
constraints through deregulation and “Minkatsu,” particularly in the
form of urban redevelopment promotion, apparently sowed a seed for
subsequent land price hikes.
Under the extreme intensification of friction with the United States in the
mid-1980s, Japan chose exchange rate adjustments, while the United States
preferred domestic demand expansion. Furthermore, the then administra-
tion of Japan set as a medium- to long-term goal the transformation of
Japan into an economy led by domestic demand to correct external imbal-
ances, thus gradually shifting the focus of economic policy from domestic
economic issues to solutions for external disputes. In the meantime, a seri-
ous domestic problem—the formation of a huge bubble—was in progress.
In parallel, Japan made efforts to halt further appreciation of the yen. Such
efforts and the policy orientation toward a domestic demand-led econ-
omy apparently constrained macroeconomic policy management, which
is responsible for the stabilization of the domestic economy, and led to
a series of instances of monetary policy easing and then fiscal expansions,
aggravating asset price inflation into the late 1980s. In this situation, the
corporate sector acquired hugely excessive assets.
What Was Wrong with Economic Policy Handling in the 1980s?

From the foregoing examination, it is apparent that the economic policy
management in the 1980s had unfavorable consequences, that is, contrib-
uting to the formation of a huge bubble. What was wrong then, and what
should have been done?
In order to see what was wrong with economic policy handling in the
1980s, we need answers to the following questions:
Q1 What caused US external deficits?
Q2 What caused Japan’s external surplus?
And after trying to answer these questions, we seek the answer to what
should (could) have been done by Japan under the circumstances.
What Caused the Dramatic Expansion of US External Deficits

in the 1980s?
With slogans such as “Strong America,” and “Small Government,” Reagan,
who was elected in the previous year, assumed the presidency in 1981.
Reagan submitted his “Economic Recovery Plan,” composed of (1)

large-scale tax cuts to promote investment and to promote savings by
medium- and high-income households that have high saving ratios; (2)
expenditure cuts to avoid absorption by the government of increased sav-
ings by households; (3) deregulation; and (4) stable monetary policy.
These policies were soon called Reaganomics.
The outcome of the Reaganomics was not quite what was initially
expected or hoped for. Investment surged, but the household savings ratio
followed a declining trend, due to falling inflation and unemployment
rates and active stock markets, all stimulating consumption. Revenue fell
short of projections due to lower than expected growth performance, and
expenditure cuts were not achieved as planned due to the expansion of
defense expenditure (“peace through strength”) and continued expansion
of social security expenditures, producing a deepening fiscal deficit.
An investment surge, coupled with a decreased savings ratio and deep-
ening fiscal deficits, brought about an increasing excess of investment over
savings (increased use of foreign savings to finance excess domestic invest-
ment), that is, expanding external deficits.24
At the same time, tight monetary policy from the end of 1970s to the
beginning of 1980s brought about high interest rates that attracted capital
inflows and a surging dollar.
These policies created huge external deficits on top of the fiscal deficit
(“twin deficits”).
24
The IS balance approach to current account determination may be helpful in capturing
this process.
We have a national account identity:
Y = Cp + Ip + Cg + Ig + X - M, (24.1)

Where Y = GDP, Cp = private consumption, Ip = private investment, Cg = government
consumption, Ig = government investment, X=export, M = import
Using T for Tax and rearranging the identity, we have:

{( Y - T - Cp ) - Ip} + ( T - Cg ) - Ig = X - M, (24.2)
i.e., (private savings − private investment) (= investment/savings balance of the private

sector) + (government savings-government Investment) (= investment/savings balance of
the government sector) = external balance. The combined savings/investment balance of
private and government sectors moved to excess investment in the United States under
Reaganomics, producing a huge external deficit.
62 K. ARAMAKI
Figure 2.18 shows developments in the savings/investment balance of

the government sector and the current account balance. We can see that
these two balances moved largely in a synchronized way during most of
the 1980s, indicating that the expanding current account deficits were
basically an internal US problem.
What Caused Japan’s Expanding External Surplus in the 1980s?

Next, let us look at what brought about Japan’s external surplus from the
beginning of the 1980s. Three factors seem to have been relevant.
Dollar Appreciation
The US dollar appreciated substantially under a policy combination of
stable monetary policy and expansionary fiscal policy. The nominal yen
rate against the dollar was kept fairly low for the first half of the 1980s (see
Fig. 2.13).
As the inflation rate was higher in the United States than in Japan in the
1980s (Fig. 2.19), the yen rate in real effective terms was fairly low, despite
expanding external surpluses throughout the first half of 1980s, contribut-
ing to the continuation of current account imbalances (Fig. 2.20).
(%)
1.0
0.0
-1.0 Savings/
investment
-2.0 balance of
government
-3.0 Current
account
-4.0 balance
-5.0
-6.0
-7.0
Fig. 2.18 Savings/investment balance of the government sector and current

account balance (both in GDP ratio): US. Source: BEA; US government; IMF,
“World Economic Outlook Database, October 2015”
(%)
16
US
14
Japan
12
10
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991
Fig. 2.19 Consumer Price Index (year-on-year change): US and Japan. Source:
IMF, World Economic Outlook database October 2015
(yen)
140
120
100
80
60
40
20
0
Apr-78
Mar-79
Feb-80
Jan-81
Dec-81
Nov-82
Oct-83
Sep-84
Aug-85
Jul-86
Jun-87
May-88
Apr-89
Mar-90
Jan-70
Dec-70
Nov-71
Oct-72
Sep-73
Aug-74
Jul-75
Jun-76
May-77
Fig. 2.20 Real effective exchange rate of the yen (2010 = 100), 1970–1990.
Source: Bank of Japan
64 K. ARAMAKI
Difference in the Economic Cycles

Another factor behind Japan’s current account surplus was a difference in
the economic cycles of the two countries. The real GDP growth rate of the
United States exceeded that of Japan in 1983 and 1984, as seen in
Fig. 2.21, contributing to the expansion of Japan’s exports.
Decline in Oil Prices

The third factor for Japan’s current account surplus was the decline in oil
prices. Oil prices started to fall at the beginning of the 1980s, significantly
reducing Japan’s import bills (Fig. 2.22).
The Nenji Keizai Hokoku (Annual Economic Report) FY 1984, pre-
pared by the Economic Planning Agency, estimated that most of the
increase in Japan’s current account surplus of 15.1 billion US dollars from
fiscal year 1982 to fiscal year 1983 could be explained by three factors: the
fall in oil prices, the difference in the cyclical phase between Japan and the
United States, and the exchange rate, as shown in Table 2.6.
If the deterioration in the US current account balance was basically a
problem that had been created internally and if Japan’s expanding current
(%)
8
U.S.
Japan
6
0
1980 1981 1982 1983 1984 1985
-2
-4
Fig. 2.21 Real GDP growth rate: US and Japan, 1980–1985. Source: IMF,
World Economic Outlook database October 2015
40
35
30
25
20
15
10
Fig. 2.22 Crude oil prices (Dubai, in dollar per barrel), 1965–1999. Source:
IMF, “International Financial Statistics” (“IFS”)
Table 2.6 Factor analysis of Japan’s current account surplus (estimate) (in 100
million US dollars)
FY 1982 FY 1983 Change
Current account surplus (actual) 91 242 +151

Special factor (oil price) 37 64 +27
Cyclical factor −72 45 +117
of which Domestic demand factor in Japan 40 55 +15
Domestic demand factor in US −173 −135 +38
Exchange rate 61 125 +64
(Residual) 126 133 +7
Source: Nenji Keizai Hokoku FY1984 (Annual Economic Report), Economic Planning Agency
account surplus was mainly due to external factors (expansion of the US

economy, appreciation of the US dollar, and the decline in oil prices), it
follows that what should have been corrected was not Japan’s policy but
the US policy. Therefore, in terms of economics, Japan should not have
responded to the US request to correct trade surplus.
Assuming that were the case, let us examine what Japan could have
done to reduce its external imbalances if it was still considered appropriate
(from a non-economic viewpoint) to respond to the US demand.
66 K. ARAMAKI
Table 2.7 GDP growth rate and private investment (year-on-year change, period
average): 1956–1973, 1974–1984, 1985–1990 (%)
1956–1973 1974–1984 1985–1990
Real GDP growth rate 9.3 3.3 4.6

Private investment in plants and equipment 17.3 3.0 10.4
First, let us see if Japan could have increased private investment in

plants and equipment (in this book, the words “private investment” and
“private investment in plants and equipment” are used interchangeably).
It is true that the rate of growth of private investment in plants and equip-
ment slowed down markedly in the 1980s, as compared with the 1970s,
as shown in Table 2.7.
Why did private investment in plants and equipment slow down? The
answer may be found in the reduction in GDP growth rate from the time
of the first oil crisis. If the GDP growth rate is expected to fall, then the
level of private investment in plants and equipment relative to GDP may
fall if companies invest in such a way as to maintain more or less a constant
capital/output ratio, thereby depressing investment growth.25
25
Assume that companies invest in plants and equipment so as to keep the capital–output
ratio (K/Y) constant (a) under the expected GDP growth rate (ge) and also assume for the
sake of simplicity there is no disposition of assets, then we have:
K / Y = DK / DY = I / DY = a, (25-1)
where K = capital stock, Y = GDP, I = private investment in plants and equipment
DY / Y = ge (25-2)

From Eqs. (25.1) and (25.2):
I / DY = I / ( Y ´ ge ) = a
(25-3)
So, we have:
I / Y = a ´ ge (25-4)

The decline of the share of private investment in plants and equipment

in GDP appears to reflect the reduction in expected growth rate, which
may well follow actual growth performance, after the end of high eco-
nomic growth, as shown in Fig. 2.23. If this is true, then Japan could not
realistically expect the growth rate of private investment in plants and
equipment to rise under the declining GDP growth rate.
Then, could we have increased government expenditure? In reality, the
substantial expansion of government expenditure offset the decline in pri-
vate investment from the latter half of the 1970s to the first half of the
1980s (Fig. 2.24). This action alone, however, could not have eliminated
the growing external imbalances, and instead brought about another
problem, that is, deterioration of the fiscal position.
Could we have increased consumption? In reality, as the economic
growth slowed down, the share of consumption in real GDP, which was
once over 60% in the mid-1970s, consistently declined on average to
59.7% in the second half of the 1970s, to 58.5% in the first half of the
1980s, and to 57.8% in the second half of the 1980s. If a shift to a domes-
tic demand-led economy, as was proposed by the Maekawa Report, was
to be materialized, increase in consumption level was needed. However,
in reality, consumption seems to have been a passive component of the
economy in Japan, and it is not clear if it can be an engine of economic
growth.26
That is, the share of private investment in plants and equipment in GDP has positive cor-
relation with the expected GDP growth rate, i.e., if the expected GDP growth rate falls, then
the share of private investment in GDP also falls.
Relaxing the unrealistic assumption of zero disposal of assets, let us assume that the
amount of disposed assets (D) is a fraction (b) of capital stock (D = bK). Then, ΔK = I−bK,
and therefore, Eq. (25.4) changes into
I / Y = a ( ge + b )
(25-5)
So, basically, the same argument applies even under this formulation.
26
As an argument for a need to enhance consumption in Japan, see Katz (1999).
Whether we can raise growth contribution of consumption in a sustainable manner is an
unanswered question even now, 30 years after the bubble period (see Chap. 7 for
this point).
68 K. ARAMAKI
(%)
25.0
20.0
15.0 Real GDP

growth rate
10.0 Share of
private
investment
5.0 in real GDP
0.0
-5.0
Fig. 2.23 Real GDP growth rate and share of private investment in plants and
equipment in real GDP. Source: Cabinet Office
(%)
30.0
25.0
20.0
Private
15.0 investment
Government
10.0 expenditure
Net exports
5.0
0.0
-5.0
Fig. 2.24 Share in real GDP of private investment in plants and equipment,
government expenditure, and net exports: Japan 1965–1990. Source: Cabinet
Office
The examination thus far of the situation that prevailed at that time
indicates, first, that it was becoming difficult to expect a rapid increase in
private investment in plants and equipment after the end of the high-
growth era with the slowing down of the growth rate, and, second, that,
in light of the deteriorating fiscal position, it also became difficult to fur-
ther expand government expenditures that had already been expanded to
make up for the decline in the growth contribution by private investment.
It is questionable whether private consumption, a major remaining com-
ponent of domestic demand, could have become a driver of growth when
the rate of economic growth was decelerating and the share of private
consumption in GDP was declining after the two oil crises and subsequent
recession.
If this were the case, it might have been difficult from the beginning to
drastically reduce external imbalances (current account surpluses) that
had been largely exogenously created, through expansion of domestic
demand on the side of Japan.27 It is possible that, in the process of politi-
cally pursuing goals difficult to achieve economically from the outset, seri-
ous problems emerged in the management of relevant economic
policies.28
Bank Behavior under Financial Liberalization

In this subsection, we will look at the second factor that may have been
responsible for the formation of the bubble, that is, the bank behavior
under financial liberalization. As shown in Table 2.8, real estate-related
loans by banks significantly increased from around the mid-1980s.
27
There may well be an argument that adjustments in the exchange rate or liberalization
of domestic markets will contribute to correcting external imbalances through changes in
exports and imports. However, effectiveness of the market opening depends largely on reac-
tions of companies and households and is therefore uncertain. Adjustments in foreign
exchange rates were actually implemented, and the external imbalance of both Japan and the
United States declined. As is shown in Fig. 2.18, however, the decline in current account
deficits of the United States took place in conjunction with the decline in the size of excess
investment in investment/savings balance, implying that the US external imbalance was a
domestically driven phenomenon after all.
28
It may be said that this is an outcome of external consideration taking precedence over
the stabilization of the domestic economy and society, given the circumstances that Japan
depends on a foreign country for its national security.
70 K. ARAMAKI
Table 2.8 Developments in real estate-related loans by banks (%, trillion yen)
Outstanding loan balance as of end fiscal year Average rate of
increase from FY
1984 1985 1986 1987 1988 1989 1985 to 1989
Total outstanding 229.3 249.6 273.3 297.6 322.3 356.8 9.2

amount of loans (100) (100) (100) (100) (100) (100)
Real estate 17.4 22.2 30.2 33.5 37.3 43.3 19.9
sector (7.6) (8.9) (11.1) (11.3) (11.7) (12.1)
Non-bank 23.2 29.6 36.9 45.1 50.9 59.6 20.7
financial (10.2) (11.9) (13.5) (15.2) (15.8) (16.7)
institutions
Source: Fiscal and Monetary Research Institute, Ministry of Finance, Japanese Government (1993)
(%)
35
30
25
20 Real estate
Non-bank
15 Construction
Total share
10 of three
sectors
5
Fig. 2.25 Share of loans to three real estate-related sectors in total outstanding
loans. Source: Tabulated based on Komine (2011a, 77)
Figure 2.25 shows that the shares held by three real estate-related sec-
tors (real estate, non-bank financial institutions, and construction) in total
loans significantly increased from the first half of 1980s.
We need to determine why banks increased real estate-related loans
in this period. Behind such behaviors, there were two pressures at
work. First was the erosion of the traditional client base of banks (par-
ticularly, big manufacturing companies). This was due to such factors
as the decline in investment needs of companies with the end of high-
speed growth era, accumulation of their own funds, and financial liber-
alization that had made financing through capital markets easier,
particularly for big companies. Second was the shrinking profit margin
of banks, also due to financial liberalization, which had made competi-
tion harder for banks in both funding and lending markets. These fac-
tors pushed banks to new profitable markets, including real estate-related
loans, longer term loans, and loans to medium- and small-sized com-
panies and individuals.
Let us look at these factors in some more detail.
eclining Dependence of Companies on Borrowing from Financial

D
Institutions
Dependence of manufacturing companies on borrowing from financial
institutions started to decline from the mid-1970s under “downsizing”
with the transition from high-speed growth to the stable growth after the
oil crises (Table 2.9). Financial institutions were faced with the erosion of
an important client base.
ecline of Profit Margins of Banks under Financial Liberalization

D
Japan’s financial system after the war was characterized by, one, control of
deposit interest rates and, two, the specialized financial institutions sys-
tem, under which securities and banking, and short-term and long-term
lending, were separately conducted by different groups of financial institu-
tions (by banks and securities companies and by commercial banks and
long-term credit banks, respectively).
Table 2.9 Dependence of manufacturing companies on borrowing from finan-

cial institutions (%)
End of FY 1975 1976 1977 1978 1979 1989
Dependence on borrowing 38.4 37.8 37.4 36.1 32.5 25.2

Dependence on long-term borrowing 21.4 21.4 20.6 19.2 15.8 11.7
Note: Dependence on borrowing = long-term and short-term borrowings/total financing

Source: Tabulated from data from the Fiscal and Monetary Research Institute, Ministry of Finance, Japan
(1993)
72 K. ARAMAKI
Control on deposit interest rates provided stability to the manage-

ment of banks, particularly small- and medium-sized banks, because as
long as these banks could collect deposits (at a low interest rate), they
could profitably provide those funds to big commercial banks, which in
turn lent the funds to big companies, short of funds under high-speed
growth. The branching regulation, under which the opening of new
branches were controlled by the authorities, also helped this mechanism
(the system was sometimes called the “Convoy system”). From around
the latter half of 1970s, liberalization progressed, however, and this sys-
tem started to change. Driving forces were, first, deterioration of the
fiscal position (again), and, second, liberalization of controls on interna-
tional capital flows.
Deterioration of the Fiscal Position

Deterioration of the Fiscal Position Forced Liberalization of Interest
Rates.
With the deterioration of the fiscal position, beginning around the mid-
1970s, the government started issuing a large amount of government
bonds Japanese Government Bonds (JGBs). Previously, all the JGBs were
held by financial institutions and resale was regulated (sold to BOJ), and
therefore, there was no secondary market. However, as banks could not
continue to hold large amounts of JGBs with low interest, resale regula-
tion was relaxed in 1977, and a secondary market was created, that is, a
product with a liberalized interest rate became available. As most of JGBs
that had been issued were 10-year bonds, banks worried that JGBs with
liberalized interest rates, maturing in two years, would come into the mar-
ket in 1983 (i.e., eight years after the start of large issuance), and that
regulated two-year time deposits would lose competitiveness in the mar-
kets and a large outflow of funds from these deposits could occur.
Given the banks’ worries, products with liberalized interest rates were
allowed, but these changes eventually squeezed the banks’ profit margins.
In 1979, Certificates of Deposit (CDs, i.e., transferrable deposits of large
amounts) with liberalized interest rates were allowed. In 1985, the interest
rate on large amount deposit was liberalized.
The share of deposits with liberalized interest rates in the amount of
banks’ total funding sharply increased from 7.5% at the end of FY1984 to
53.4% at the end of FY1989,29 squeezing the banks’ profit margins. Banks
29
Ministry of Finance (1993).
sought business providing high profits in new markets, such as small- and
medium-sized enterprises (SMEs), individuals, and real estate-related loans.
Liberalization of International Capital Flows

Another Driving Force Was the Relaxation of International Capital
Controls.
The 1980 reform of the Foreign Exchange Law, in principle, liberalized
cross-border capital transactions. The “real demand rule” for forward for-
eign exchange transactions, which had required underlying facts such as
trade contracts, was abolished in 1984, in the negotiations of the Yen–
Dollar Committee with the United States, making hedging of exchange
rate risks far easier. Companies raised funds overseas by issuing securities,
avoiding regulated domestic markets, and placing another competitive
pressure on interest rates of loans by banks.
“ Tochi Shinwa” (Mythical Trust in Landholding)

Under these circumstances, banks turned toward high-profit, and seem-
ingly, low-risk real estate-related loans. Entering the securities business was
not easy, given legal restrictions governing the separation of banks from
securities businesses (Article 65 of the Securities Law, in principle, prohib-
ited banks from engaging in the business of securities business, similar to
the US Glass–Steagall regulation). Therefore, banks sought profit oppor-
tunities in lending to SMEs, long-term loans that were more profitable
than short-term loans, and real estate-related loans. Banks had to rely on
real estate collateral in lending to SMEs or real estate sectors, as their abil-
ity to collect information for these new clients was limited. Real estate-
related loans were traditionally unfavored by banks, but “Tochi Shinwa”
(mythical trust in landholding)30 and strong profit orientation by some
30
“Tochi Shinwa,” which literally translated means “land myth,” is a perception that there
is no asset more profitable than land. This perception held well until 1980s. For example, an
estimate is made that, although investment of 3 million yen in deposits in 1955 would have
increased to 22.83 million yen in 1985, investment of the same amount in land in one of the
six largest cities would have increased to 402 million yen, 17.6 times more in 1985 (Ministry
of Finance 1993). Price of land continued to rise after the Second World War, with an excep-
tional fall in 1974, after the oil crisis. There had been land price surges twice (early 1960s and
around 1972–73) after the war, but neither of them were later found to be a bubble. In the
1980s, the asset price surge was generally not considered as a bubble at that time. Noguchi
(1992) counted the number of the articles that appeared in the media, such as Nihon Keizai
Shimbun, which have the word “bubble” for each year from 1985 to 1992. He found that
74 K. ARAMAKI
banks and the spillovers to other banks helped spur this transformation of
what had been a traditionally conservative business model for banks.31
“ Zai-Tech” (Financing Technology)

Also notable is that companies engaged in financial activities. Active
involvement in financial activities, called “Zai Teku” (financing technol-
ogy), spread among companies, partly due to positive reporting by media.
Companies raised more funds than necessary to invest in financial assets.
From 1985 to 1989, while the net shortage of funds of the corporate sec-
tor as a whole was about 62 trillion yen, the sector raised as much as about
233 trillion yen, nearly four times as much as the shortage. Typically, they
raised funds by Commercial Papers (CPs), or overseas issuance of equity-
linked securities at low cost, and invested these funds in “large amount
deposits”, offered by banks with higher interest rates, or stocks through
accounts managed by financial institutions.32
Summary
In this chapter, we have examined that the two factors that affected the
formation of the bubble—economic policy management and bank behav-
iors in the 1980s. The trade disputes with the United States and the dete-
rioration of the fiscal position imposed constraints on the management of
economic policies in the 1980s.
Under these constraints, the government tried to stimulate the economy
through deregulation, including urban redevelopment, which seems to
the number was 1–8 in each year from 1985 to 1988, 11 in 1989, the peak year of the
bubble, 194 in 1990, and then a dramatic increase to 2,546 in 1991, and 3,475 in 1992.
These numbers suggest the asset price developments started to be recognized as a bubble
only after those prices had started to fall.
31
In the 1980s, aggressive profit-seeking by banks was under way. One famous phrase that
was spoken by the chairman of one of the biggest city banks in the early 1980s conveys well
the thinking of the era; “Mukou Kizu ha Towanai” (literally, frontal scar will not bother).
“Mukou Kizu” is a scar that one receives from a frontal assault, when fighting an enemy,
while “Ushiro Kizu” (a scar on the back) is the kind one would suffer when trying to escape
from the enemy. Samurai regarded Ushiro Kizu as a shame. This phrase indicates that the
management of banks at the time accepted or even encouraged aggressive profit-seeking by
their staff (see Kusu [2005]). Presumably, raising objections to such profit-seeking activities
meant dropping out from internal competition in the institution.
32
Ministry of Finance (1993).
have planted seeds for the formation of a bubble in the early 1980s although
there was a real factor for asset price increases in the very initial stage. Under
continued disputes with the United States, the government accepted the
appreciation of the yen (Plaza Accord) and also tried to transform Japan’s
economy into a more domestic demand-led one. However, with the sharper-
than-expected appreciation of the yen, the BOJ was motivated to ease mon-
etary policy repeatedly to promote the expansion of the domestic economy
and to stabilize the yen rate in the late 1980s. Furthermore, in the process
of formulating international consensus for exchange rate stabilization, the
government committed to use fiscal policy to expand the domestic econ-
omy, which all created the conditions for the development of a bubble.
Furthermore, the policy idea to transform the Japanese economy to a
domestic demand-led one regrettably produced laws that promoted unsus-
tainable land-related development projects throughout the country.
Another factor that might have been responsible for the bubble was the
banks’ behaviors during the financial liberalization. With the erosion of
traditional client base and shrinking profit margins under liberalization,
banks tried to enter new markets and sharply increased their real estate-
related loans, which spurred the increase in land prices. Companies’
aggressive engagements in financial activities also contributed to the stock
market surge.33
These activities, taken together—heavy involvement by banks in real
estate-related loans and aggressive financial activities by companies—were
inevitably accompanied by high risk. With hindsight, strengthening of risk
management by banks and tightening of regulation and supervision to
that end was needed, but the issues were not sufficiently addressed at the
time. Why were these risky (in hindsight) activities left unchecked? Who
should be held responsible? Bank and company managers? Bank and com-
pany shareholders? Government? Mass media? We need to ask what could
have been done when all these agents had strong confidence in the
Japanese economy, and yet, were trapped by the “Tochi Shinwa” and
accordingly, could not see the risk of land price collapse?34
33
The number of individual shareholders increased by around 10% each year in this period,
from over 16 million in FY1985 to over 24 million in FY1989 (Ministry of Finance 1993).
Privatization of government-owned Japan Telegram and Telephone Corporation and sales of
its shares to the public in 1987 attracted nationwide attention.
34
See Kusu (2006).
76 K. ARAMAKI
However, we should note that all these actions occurred amid fierce
disputes with, and strong pressures from the United States, on which Japan
was (and still is) dependent for its national security. It is most regrettable
that, under the circumstances, policy focus shifted from domestic issues to
external problems, and the evolving problems, that is, the formation of a
huge bubble, went unchecked, and necessary actions (i.e., giving priority to
the consideration of domestic economy over external considerations, or at
least limiting external considerations within the range of what was compat-
ible with the stability of the domestic economy) were not taken.
3 Supplement
Theoretical Price of an Asset
efinition of an Asset Price Bubble

D
A asset price bubble is a phenomenon wherein the price of an asset rises to
a level that is not based on fundamentals.
Fundamental Price and Its Derivation
Fundamental Price
The price based on fundamentals (=theoretical price) is expressed as below:
If the asset has no risk and the return is fixed:
P = R / i, (2.1)
where R = return (office or housing rent, interest, etc.) to an asset, P =

price of asset, i = long-term, risk-free interest rate (typically, long-term
government bond yield in a secondary market).
If the asset has a risk and the return to the asset grows each period at a
fixed rate of g, the fundamental price is rewritten as follows:
P = R / (i + a - g), (2.2)

where α is the risk premium (an additional return that is required for a
risk asset to be held, on top of the return to a risk-free asset)
Derivation
Risk-free Case
Derivation of theoretical price (price based on fundamentals)
Assumption: There is no difference in risk profile across assets
Formulation: The rate of return will be equalized across different assets
via arbitrage, so that we have
R/P=i (2.3)
Note: Arbitrage may be defined as a simultaneous purchase and sale of

assets to make profits from price discrepancy.
Then, we have:
P=R/i (2.4)
Risk Asset Case

If the asset has a risk, then its rate of return has to be higher than that of
risk-free assets (this additional part is called the risk premium (α) as
explained before). Then, instead of (2.4), we have
P = R / (i + a ) (2.5)

The aforementioned assumes that the asset price is constant. If the asset
price changes, then, the formulation changes as follows.
The rate of return for buying the asset in period 1 for P1 and selling it
in period 2 for P2 is shown in the left-hand side of Equation (2.6). and it
will be equal to the rate of return of the risk-free asset on the right-hand
side of the equation.

(R + (P 2 - P1 ) ) / P1 = i
(2.6)
Or,
P1 = ( R + P2 ) / (1 + i ) (2.7)

In the same way, the asset price in period 2 (P2) may be expressed as
follows.
78 K. ARAMAKI
P2 = ( R + P3 ) / (1 + i ) (2.8)

By inserting (2.8) into (2.7), we have
P1 = ( R + ( R + P3 ) / (1 + i ) ) / (1 + i ) (2.9)

Or,
P1 = R / (1 + i ) + R / (1 + i ) + P3 / (1 + i )
2 3
(2.10)

By repeating this, we obtain;
P1 = R / (1 + i ) + R / (1 + i ) + R / (1 + i ) +  ,
2 3
(2.11)

which means that P1 is equal to the discounted present value of future

returns
Growth of Return
If we assume that the return (R) grows every period at a fixed rate of g,
then we have
P11 = R / (1 + i ) + R (1 + g ) / (1 + i ) + R (1 + g ) / (1 + i ) + 
2 2 3
(2.12)

As this is the sum of geometrical series, assuming g < i, it can be written

as:
P1 = R / ( i - g ) (2.13)

If the asset has a risk, then we use i+α instead of i:
P1 = R / ( i + a - g ) (2.14)

Note: The above explanation is from Chapter 2 of Nenji Keizai Hokoku

(Annual Economic Report) (1991).
Interest Rate-Adjusted PER and the Ratio of the Actual

to Theoretical Stock Price
The theoretical price of stock is expressed by Eq. (2.1) (i.e., P = R/(i + α
− g)).
If we assume no risk and no growth in return, the theoretical stock
price is expressed by Eq. (2.2) (i.e., P = R/i).
Assuming the return (R) in Eq. (2.2) can be replaced with profit per
one unit of stock (ρ), then the theoretical stock price (P) is expressed as
P= r /i (2.15)
The interest rate- adjusted PER (i × (Actual stock price/profit per one
unit of stock (ρ))) corresponds to the ratio of Actual stock price to
Theoretical stock price:
iPER = i ´ ( Actual stock price / r ) = Actual price /

( r / i ) = Actual stock price / Theoretical stock price (2.16)
The theoretical price rises if the risk premium decreases, and/or the
expected growth rate of return increases
Note: PER = price/earning ratio, that is, stock price divided by profit
per one unit of stock
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CHAPTER 3
Collapse of the Bubble and the Start

of the Long Stagnation
In this chapter, we will first provide an overview of how the bubble col-
lapsed at the beginning of the 1990s and what happened to the Japanese
economy during the subsequent decades after the collapse of the bubble.
Then, to identify the mechanism of the long stagnation, a division of the
stagnation period of about two decades until Abenomics (i.e., 1991–2012)
into four subperiods is proposed. After the division into subperiods, this
chapter focuses on the first subperiod, that is, around seven years from the
beginning of the 1990s to just before the financial crisis that broke out in
late 1997. This period can be characterized as the starting period of the long
stagnation and, therefore, is very important in that its examination should
be able to give clues for the fundamental mechanism of the stagnation.
1 Collapse of the Bubble
The Government’s Response to the Bubble

As we have seen in Chap. 2, the asset price inflation that occurred in the
latter half of the 1980s was generally not regarded as a bubble, even at the
end of the 1980s. The asset price inflation was considered as a problem
not because of its risk of collapse and consequent negative impacts on the
economy, but mainly from social and equity viewpoints.

84 K. ARAMAKI
ounting Nationwide Criticism, Particularly toward the Land Price Surge

M
As we saw in Chap. 2, asset prices started to rise rapidly from the first
half of the 1980s, and by the latter half of the 1980s, criticism of asset
price inflation became stronger, particularly, in relation to the land price
surge. The price rise was thought to have had a decisive impact on
inequality, between the “Haves” and “Have Nots,” and the price of a
house in big cities like Tokyo rose to a level equivalent to ten times as
high as the annual income of average income earners, making it impos-
sible for them to own a house throughout their lifetime.
Around that time, many nasty incidents were reported in relation to
such land-related activities as “Ji-age” (literally, land lifting), in which bul-
lying or even violent actions were taken to force residents from their land,
which potential buyers or their commissioned agents (sometimes, gang-
sters) targeted to purchase, and the government was strongly criticized for
letting the land prices surge.
overnment Responded by Various Measures

G
It was not true that the government did nothing to cope with the situa-
tion. For example, in July 1985, an administrative circular was issued from
the Ministry of Finance (MOF) to banks. The circular requested that
banks refrain from lending for speculative land transactions, and similar
circulars were issued in April and December 1986, October 1987, and
October 1989, to address the issue from the financing side. Notably, how-
ever, the objectives of these circulars were not to restrain land-related
lending itself, which was necessary from a risk control viewpoint, but to
contain lending to speculative land transactions (Kusu 2006).
easures Implemented in the Land Use Regulation and Taxation Areas

M
Under the continued rise in asset price, in October 1987, the Cabinet
decided on “Outline of Emergency Land Measures,” which included such
measures as flexible operation of monitoring zones under which certain
land transactions were placed under prior registration requirements to the
authorities, guidance on banks, suspension of sale of lands owned by the
ex-National Railway, and the review of relevant taxation issues.
In October 1989, the Basic Land Law was enacted, stipulating princi-
ples applied to land including priority of public welfare and restraint on
speculative transactions.
COLLAPSE OF THE BUBBLE AND THE START OF THE LONG STAGNATION 85
onetary Policy Stance Changed in 1989

M
As we have seen in Chap. 2, monetary policy management was bound by
considerations for external factors (i.e., correction of external imbalances
and arresting further yen appreciation). However, from around mid-1987,
as the wholesale prices started to show signs of increase, reflecting a recov-
ery of the economy, the Bank of Japan (BOJ) began to place a greater
emphasis on monitoring price developments. In August 1987, the BOJ let
the short-term interest rate rise, and a shift toward monetary policy tight-
ening came into sight. However, in October 1987, the world economy
experienced a sharp global fall of stock prices (“Black Monday”), and the
monetary policy shifted again toward easing. In January 1988, the joint
statement by Prime Minister Takeshita and President Reagan stated, “To
achieve sustained growth as well as to foster exchange rate stability, the
Bank of Japan agrees, under the present stable price conditions, to con-
tinue to pursue the current policy stance and to make efforts to accom-
modate declining short-term interest rates” (Okina et al. 2001). While the
Deutsche Bundesbank raised the discount rate in July 1988 and the
Federal Reserve Board (FRB) in the United States raised the discount rate
in August 1988, the BOJ’s policy change had to wait until 1989.
OJ Started to Sharply Raise the Discount Rate

B
In May 1989, the BOJ raised the discount rate by 0.75% from 2.5% to
3.25% for the first time in nine years. This was explained as a preemptive step
to stem inflation under yen depreciation, which had started around May
1989 (Komine 2011, 303). In October 1989, the BOJ raised the discount
rate by 0.5 to 3.75%. In December 1989, Mieno took the BOJ governor
position. He stated in a press interview after inauguration, “we cannot
ignore increase in land price in the sense that it can trigger an inflation
expectation .… If there were not for financing, land prices will not rise, so,
we cannot say it is unrelated .… We have not tightened monetary policy to
lower land prices, but it is included in there when we make an overall judg-
ments” (Komine 2011, 306–7. Author’s translation), making it clear that
land price developments were included in the overall judgment of the man-
agement of monetary policy. In December 1989, the BOJ raised the dis-
count rate by 0.5 to 4.25%. In March 1990, the BOJ raised the discount
rate by 1.0 to 5.25%. In August 1990, BOJ raised the discount rate by
0.75 to 6.0%. Thus, in around one year and three months, the BOJ rapidly
raised the discount rate five times by 3.5% points from 2.5% to 6.0%.
86 K. ARAMAKI
ggregate Lending Limit Imposed by the Ministry of Finance on Land-

A
Related Loans and Other Measures Enforced
In March 1990, the MOF issued a circular that asked banks to limit the
rate of increase in loans to real estate-related sectors,1 to a level equal or
less than the rate of increase in total loans (what is called “an aggregate
lending limit”). This stayed in effect until December 1991. In April 1991,
land price tax (tax on big landholdings) was introduced.2 In May 1991,
relevant laws were amended to strengthen regulations on land-related
loans by non-bank financial institutions. In this way, a range of policy mea-
sures was put into force to cope, directly or indirectly, with problems of
land price surge.
2 The Bubble Started to Collapse

As the discount rate was raised in May 1989, the transaction volume in the
stock market started to decline. The Nikkei Stock Average, which peaked
at 38,915 at the end-1989, started to weaken from the beginning of 1990
and had a collapse in February 1990, beginning a long decline. Land
prices in Tokyo had already peaked in 1987 and became fairly stabilized,
before starting to fall in 1990.
Long Stagnation
The asset price finally began declining at the beginning of the 1990s.
Nobody knew at that time that it was going to be the start of a two-
decade-long stagnation of the Japanese economy. In this section, we
briefly look first at what happened to the Japanese economy by comparing
economic performances before and after the burst of the bubble. Then,
we will list major arguments and counterarguments on the causes of the
long stagnation. Next, we will consider, in a more detailed manner, char-
acteristics of the stagnation, giving particular attention to their changes
1
Real estate-related loans to construction and non-bank sectors were excluded.
2
Yoshimasa Nishimura, who was director-general of the Banking Bureau, Ministry of
Finance, in 1994–1996, later stated that the Banking Bureau at the time was very reluctant
to intervene in the banks’ lending activities in such a direct way as to set an aggregate lending
limit when the Bureau was pushing forward with financial liberalization, but had to introduce
it under the mounting criticism from the ruling Liberal Democratic Party (LDP)’s commit-
tees and media on surging land prices (Matsushima and Takenaka 2011, pp. 308–314).
over the time span of about two decades, that is, from 1991 to 2012 (we
denote these two decades as the period of long stagnation). Based on this
examination, we will present our view that we need to divide the whole
period of two decades into four subperiods, in order to find out the real
mechanism of stagnation.
What Happened to the Japanese Economy after the Burst of the Bubble
GDP Growth: Comparison with the Past

Real GDP growth stagnated for more than two decades after high growth
in the bubble period. Figure 3.1 shows real GDP growth rate for the
period from 1956 to 2017. We divide the whole period of more than half
a century into the following five periods and show the average growth rate
for each of these periods (Table 3.1).3
(%)
15.0 1956–1973
9.3%
10.0 1985–1990
1974–1984 5.2%
3.6% 2013–2017
5.0
1991–2012 1.3％
1.0%
0.0
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
2016
-5.0
-10.0
Fig. 3.1 Real GDP growth rate: Japan 1956–2017. Note: Data for 1956–1980
are from GDP statistics with base year = 1990, data for 1981–1994 are from sta-
tistics with base year = 2000, data for 1995–2016 are from statistics with base
year = 2011, and data for 2017 are from the preliminary quarterly estimate basis.
3
The years from 2013 onward are examined as the Abenomics period in Chap. 7.
88 K. ARAMAKI
Table 3.1 Five periods of the Japanese economy since the high-speed growth era
High-speed growth period 1956–1973

Stable growth period 1974–1984
Bubble period 1985–1990
Long stagnation period 1991–2012
Abenomics period 2013–2017
Table 3.2 Comparison of real GDP growth rate: Japan and other advanced
countries, 1980–2012
1980–1989 1990–1999 2000–2012
(%) (%) (%)
Japan 4.4 1.5 0.8

Simple average of the US, UK, 2.5 2.4 1.6
Germany, and France
Source: International Monetary Fund (IMF), World Economic Outlook April 2018 database
Growth rate during the long stagnation is about one-tenth of that in the
high-speed growth era and less than one-fifth of that in the bubble period.
GDP Growth: Comparison with Other Countries

Table 3.2 shows a comparison of the growth performance with other
advanced countries. After the burst of the bubble, Japan consistently
underperformed in contrast to other major advanced countries, whereas
Japan had substantially outperformed them in the 1980s.4
Unemployment Rate
Japan’s unemployment rate was fairly low, staying in the range of 1–3% for
nearly four decades after the Second World War. After the collapse of the
bubble, it sharply increased, rising over 5%, and then remaining at an ele-
vated level that averaged 4% in the long stagnation period (Fig. 3.2).
4
In terms of growth rate of real GDP per capita, the Japanese economy also underper-
formed. A simple average of the rate of growth of GDP per capita in national currency (con-
stant price base) for Japan over 1991 to 2012 is 0.8%, while the simple average for the other
four advanced countries (the United States, Germany, France, and the United Kingdom) is
1.4%.
(%)
6 1991–2012
4.0%
2013–2017
5
3.4%
4
1985–1990
3 1974–1984 2.5%
2.1%
1956–1973
2
1.5%
Fig. 3.2 Unemployment rate. Source: Statistics Bureau, Ministry of Internal

Affairs and Communications
hy Did the Japanese Economy Stagnate So Long?: Major Arguments

W
As we have seen in the previous subsection, macroeconomic performance of
the Japanese economy significantly deteriorated after the burst of the bubble,
and the stagnation on average continued for two decades. Why did it happen?
This is the biggest question that we address in this book. In this subsection, we
briefly look at major arguments regarding the causes of the long stagnation.
Major arguments on the causes of the long stagnation can be classified
into three groups:
1. Supply-side views, which regard structural factors, including low

TFP growth, loss of competitiveness, and an aging and shrinking
population, as responsible for the long stagnation.
2. Demand-side views, which regard demand shortage as a cause; they
tend to focus on policy mistakes in fiscal and monetary areas that
failed to provide sufficient demand stimuli.
3. Financial sector-problem views, which regard deficiency of the

financial sector, ceasing to appropriately perform an intermediary
function due to non-performing loan problems, as responsible for
stagnation.
Let us briefly look at each of these views.

90 K. ARAMAKI
Supply-Side Views
There was always a certain number of people, if not many, who took the
supply-side view. To quote some examples of such arguments from their
books or articles:5
Demand shortage arguments are inappropriate in explaining the lost

1990s …. The Keynesian economics that emphasize aggregate demand …
may be effective in explaining short-term economic developments such as
business cycles, but cannot explain such a long stagnation as experienced by
Japan in the 1990s. (Hayashi 2003, 3)
The problem … is a low productivity growth rate. Growth theory … accounts
well for the Japanese lost decade of growth. (Hayashi and Prescott 2002, 206)
The fundamental cause of economic stagnation is in the enterprises …. Big
structural changes (major contents of which are said to be “industrialization
of China” and “progress of IT revolution”) occurred in the global economy
in the 1990s. Stagnation of the Japanese economy from the 1990s was due
to the fact that the Japanese corporations could not properly respond to
such changes. (Noguchi 2005, 7, 70) (Explanation in the parenthesis is
added by the author based on Noguchi 2005, 10)
As the working age population continues to decline, the domestic demand-
type industries, which account for a large part of employment, constantly
suffer from excess supply, and their business performance will never improve.
(Motani 2010, 140)
Let us briefly examine these supply-side arguments in light of relevant

data. It is true that the trend of real GDP growth changed after the burst
of the bubble, as we see in Fig. 3.3, indicating there may have been struc-
tural factors at work.
However, developments in the nominal GDP give an entirely different
impression. The nominal GDP experienced an abrupt change around the
burst of the bubble (Fig. 3.4).
In terms of the growth rate, Japan’s nominal GDP growth sharply
slowed down from the average of 7.3% during 1988–1991, to 1.6% over
5
For Hayashi (2003), Noguchi (2005), and Motani (2010), quoted sentences are transla-
tions, by the author of this book, of the Japanese original texts.
(trillion yen)
600.0
500.0
400.0
300.0
200.0
100.0
Base year = 1990
Base year = 2011
0.0
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
Fig. 3.3 Amount of real GDP: Japan 1955–2015. Source: Cabinet Office, GDP
statistics
1992–1997.6 In absolute amount terms, the nominal GDP peaked at 534

trillion yen in 1997, and it was 495 trillion yen in 2012, which is 7.3%
lower than the level in 1997.
From such developments in nominal GDP, two questions are posed:
First, can such an abrupt change be caused by structural factors that take
time to be formed and change only slowly and, therefore, make the
economy difficult to change in a short period of time? In other words,
was it something cyclical or something of abrupt nature that played a
crucial role in causing such an abrupt change in nominal GDP?
Second, however, why did such an abrupt change continue for the long
period of two decades? If caused by some abrupt factor, did it become
structuralized in the process? If yes, when and how?
6
The economy peaked in February 1991, but the real growth rate still recorded a relatively
high level of 3.3% in 1991, as compared with the below 1% growth in the subsequent three
years.
92 K. ARAMAKI
(trillion yen)
600.0
500.0
400.0
300.0
200.0
100.0
Base year = 1990
Base year = 2011
0.0
1955
1959
1963
1967
1971
1975
1979
1983
1987
1991
1995
1999
2003
2007
2015
2011
Fig. 3.4 Nominal GDP. Source: Cabinet Office, GDP statistics
Can the supply-side view give a satisfactory answer to the first question?
Such structural factors as productivity growth, erosion of competitiveness,
and demography all proceed only gradually and, therefore, are unlikely to
cause such an abrupt change as in the development of nominal GDP that
we saw.
Another point that should be explained by the supply-side view is that
the Japanese economy generally suffered from a deflationary gap (supply
> demand) during the long stagnation (Fig. 3.5); therefore, it is difficult
to consider that inefficiency on the supply side, such as low productivity
growth or shortage of supply capacity, was a problem. Supply capacity was
sufficient.
Demand-Side Views
Next, let us look at demand-side views. As the Japanese economy primarily
suffered from demand shortage during the long stagnation, as touched
upon in the preceding subsection, and also, because demand level can be
(%)
4
-2
-4
-6
-8
-10
Fig. 3.5 Output gap (in GDP ratio). Source: IMF World Economic Outlook
Database. October 2017
changed quickly by cyclical factors, there are many people who support
the demand-side view. With respect to the cause of demand shortage,
many arguments focus on the mistake or inappropriate handling of poli-
cies, in the fiscal or monetary areas.
Fiscal Policy Mistake

Some of the demand-side arguments focus on fiscal policy. For example,
the consumption tax hike from 3% to 5% in April 1997 and other fiscal
tightening measures, including the discontinuation of special income tax
cut implemented in 1994–1996 and decrease in public work expenditure
from the mid-1996 are blamed for interrupting the recovery and bringing
about the long stagnation. However, as will be explained later, fiscal stim-
ulus packages were repeatedly formulated to support the economy after
the collapse of the bubble, resulting in a huge government debt.
Considering that it is not possible to support the economy forever by fiscal
demand injection, although the appropriateness of the timing of fiscal
tightening in 1996–1997 may be questioned, the fiscal stance cannot be
considered as the fundamental cause of the long stagnation.
94 K. ARAMAKI
Inappropriate Monetary Policy

It was the monetary policy that was criticized most severely, by those who
saw problems in policies of the government. Many argued that inappropri-
ate management of monetary policy was responsible for the long stagna-
tion. We will examine this issue in Chap. 5 in more detail, but let us just
look now at Fig. 3.6. Money stock (M2 + CD) growth rate, which recorded
a level higher than 10% in the latter half of 1980s, took a nosedive around
the beginning of 1991, recording negative growth in September 1992 for
the first time since 1968, when the statistics were first published. The
response to the bubble by the BOJ and the government from the end of
the 1980s to the beginning of the 1990s, through the sharp and substan-
tial increase in the discount rate and the introduction of the aggregate
lending limit, may be described as “too much, too late” (rather than “too
little too late”). Overkilling the economy with policy measures in response
to strong social criticism on surging land prices and the inequality between
“Haves” and “Have Nots” apparently played an extremely important role
at the beginning of the two-decade-long stagnation.
(%)
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
Jan-85
Oct-85
Jul-86
Apr-87
Jan-88
Oct-88
Jul-89
Apr-90
Jan-91
Oct-91
Jul-92
Apr-93
Jan-94
Oct-94
Jul-95
Apr-96
Jan-97
Oct-97
Jul-98
-2.0
Fig. 3.6 Money stock (M2 + CD) (year-on-year change): Japan, 1985–1998.
Source: Bank of Japan
Financial Sector-Problem Views

The third argument, the financial sector-problem views, typically, contend
that the financial sector problem, or the deterioration of the financial sec-
tor soundness due to non-performing loans (NPLs), brought about the
credit crunch, which depressed the economy. However, the lending stance
of financial institutions was generally not tight in the major part of the
1990s, except for relatively limited periods right after the burst of the
bubble and in the height of the financial crisis in 1997–1998, as shown in
Fig. 3.7. This indicates that financial tightening does not seem to be a
cause of the stagnation, at least in the early stage of stagnant decades, that
is, from the beginning of the 1990s until the financial crisis in the late
1990s, which, as argued later in this subsection, seems to be the most
important period in the process of the long stagnation (Fig. 3.7).
he Need to Divide the Whole Period into Subperiods

T
When we looked at major arguments regarding the causes of stagnation in
the preceding subsection, we saw that the performance of nominal GDP
experienced an abrupt change at the beginning of the 1990s. We argued
that such an abrupt change could not have been caused by structural
(%)
40
30
20 Large
companies
10
Semi-large
companies
0
Small- and
Mar-90
Dec-90
Sep-91
Jun-92
Mar-93
Dec-93
Sep-94
Jun-95
Mar-96
Dec-96
Sep-97
Jun-98
Mar-99
Dec-99
Sep-00
-10 medium-
sized
companies
-20
-30
-40
Fig. 3.7 The lending stance of financial institutions (share of “Eased” – share of
“Tight”): Japan 1990–2000. Source: Bank of Japan, “Tankan Survey”
96 K. ARAMAKI
factors that normally change slowly and, therefore, affect the economy
only gradually. So, it may be that some cyclical or other discontinuous fac-
tors caused such an abrupt change. At the same time, we also noted that
such an abrupt change remained for many years and entirely altered the
trend of nominal GDP. In other words, the abrupt change was perpetual-
ized. So, the stagnation may have been caused by discontinuous elements
but seems to have been structuralized as years went by. This fact implies
that the mechanism of stagnation changed from the one that is of an
abrupt nature to the one that is of a sustainable nature. If this is the case,
we will not be able to see the real mechanism of stagnation if we lump the
two decades together and try to find a single stagnation mechanism.
Rather, we may be able to get closer to the real cause of the stagnation if
we seek to find what factors played an important role in causing stagnation
in what subperiod and examine whether and how such factors changed
over time in the whole process of stagnation.
Thus we need to divide the whole process into appropriate subperiods
in such a way that each subperiod is governed by its unique stagnation
mechanism, which may be different across subperiods. Then, the question
is how we can identify such subperiod, which was governed by a specific
stagnation mechanism. As we do not or rather cannot know the answer
beforehand, we take a two-staged approach; we first make a tentative divi-
sion of the whole period into subperiods by looking at changes in the
characteristics of economic performance during the two decade-long stag-
nation, and then try to identify the mechanism of stagnation in respective
subperiods, and, second, drawing on the findings of the first-stage analy-
sis, we try to capture the whole picture of the stagnation mechanism in the
second stage.7 Here, we will look at economic performance in the stagna-
tion period in light of various indicators, so as to make tentative subdivi-
sions of the entire stagnation period.
Characteristics of the Stagnation Period

First, let us look at the distinctive features of the long stagnation period
in contrast with other periods. Decomposition of real GDP growth into
contributions by major demand components shows that the contribution
7
Chapters 3 and 4 conduct mainly the first-stage analysis, based on four subdivisions of the
whole period that is introduced in this chapter. Drawing on the findings of these analyses,
Chap. 6 conducts the second-stage analysis to find the real mechanism of stagnation. As a
result, the four subperiod analyses will develop into the three-staged evolution of stagnation
mechanism that focuses on corporate behavior.
Table 3.3 Contribution to real GDP growth by major demand components

High growth Stable growth Bubble period Long stagnation
period 1956–73 period 1974–84 1985–90 1991–2012
(%) (%) (%) (%)
Real GDP growth 9.3 3.6 5.2 1.0

Private 5.5 1.9 2.5 0.6
consumption
Housing investment 0.8 −0.1 0.4 −0.1
Private investment 1.6 0.3 2.0 0.0
in plants and
equipment
Government 1.5 0.7 0.6 0.3
expenditure
Net exports −0.3 0.7 −0.3 0.2
by private investment8 to GDP growth is zero during the stagnation

period (Table 3.3). Such a null contribution of private investment is the
most distinctive feature in the stagnant period.
Growth Contribution of Private Investment Varied During

the Long Stagnation Period
In the two decades, performance of private investment was not unchanged.
After the burst of the bubble, private investment and also GDP growth
itself experienced four dips as shown in Fig. 3.8. Private investment
recorded a negative growth contribution in 1992–1993 after the bubble
burst, in 1998–1999 during the financial crisis, in 2001–2002 after the
collapse of the dot-com bubble, and in 2008–2009 when the Global
Financial Crisis (GFC) broke out. These changes in private investment
significantly affected GDP growth performance during the stagnation
period, and therefore, we should take note of the performance of private
investment when dividing the two decades into subperiods.
Developments in Diffusion Index

We also need to look at cyclical indicators. During the stagnant two decades,
the Japanese economy went through five economic cycles (Table 3.4).
Cumulated Diffusion Index (an indicator of economic cycles) shows
that after the bubble burst, there were two short recoveries interrupted,
8
The words “private investment” and “private investment in plants and equipment” are
used interchangeably in this book.
98 K. ARAMAKI
(%)
8.0
6.0
4.0
2.0 Real GDP

growth
0.0 rate
Growth
-2.0 contribution
by private
-4.0 investment
-6.0
-8.0
Fig. 3.8 Real GDP growth rate and contribution by private investment: Japan,
1991–2012. Note: Data for 1988–1994 are from GDP statistics, with 2000 as the
base year; and for 1995–2012 from statistics, with 2011 as the base year. Source:
Cabinet Office, GDP statistics
Table 3.4 Economic cycles during the long stagnation period

Cycle Trough Peak Trough
11th November 1986 February 1991 October 1993

12th October 1993 May 1997 January 1999
13th January 1999 November 2000 January 2002
14th January 2002 February 2008 March 2009
15th March 2009 March 2012 November 2012
Note: Cycles are counted after the Second World War.

respectively, by the financial crisis and by the dot-com bubble collapse, and
one long recovery interrupted by the GFC (Fig. 3.9).
The average growth rate in the expansion phase over 1994Q1–1997Q2
(2.1% on a year-on-year basis) was markedly weak, compared with the
preceding expansion in the bubble period (5.5% over 1987Q1–1991Q1).
The expansion phase after the financial crisis in the late 1990s was also
weak (1.5% over 1999Q2–2000Q4) and short (less than two years). In
this way, two expansions in the first 10 years after the burst of the bubble
3000
2500
2000
1500
1000
500
0
1997
1998
1999
2000
2000
2001
2002
2003
2004
2005
2005
2006
2007
2008
2009
2010
2010
2011
2012
1990
1990
1991
1992
1993
1994
1995
1995
1996
Fig. 3.9 Cumulated Diffusion Index. Source: Cabinet Office
were weak (and short in the case of the second expansion phase). By con-
trast, the recovery from the early 2000s was fairly long, extending over
more than six years (the longest after the war), while the average growth
rate over 2002Q2–2008Q1 was 1.5%, that is, the same as in the preceding
expansion phase (Fig. 3.10).9
Unemployment Rate
Figure 3.11 shows developments in the unemployment rate. A difference
from the previous chart (Fig. 3.2) is that the long stagnation period
(1991–2012) has been divided into two periods: the pre-financial crisis
period (1991–1997) and the post-financial crisis period (1998–2012).
The unemployment rate was not very high until 1997, that is, before the
financial crisis, averaging 2.8%, but it sharply increased after the financial
crisis to a level near 5%.
9
The expansion phase in this growth rate calculation is defined as starting from the first full
quarter after the quarter in which the preceding bottom was identified, and ending in the
quarter in which subsequent peak was identified.
100 K. ARAMAKI
(%)
15
10
0
1987/ 1- 3.
10-12.
7- 9.
4- 6.
1990/ 1- 3.
10-12.
7- 9.
4- 6.
1993/ 1- 3.
10-12.
7- 9.
4- 6.
1996/ 1- 3.
10-12.
7- 9.
4- 6.
1999/ 1- 3.
10-12.
7- 9.
4- 6.
2002/ 1- 3.
10-12.
7- 9.
4- 6.
2005/ 1- 3.
10-12.
7- 9.
4- 6.
2008/ 1- 3.
10-12.
7- 9.
4- 6.
2011/ 1- 3.
10-12.
-5
-10

1987Q1–2012Q4. Source: Cabinet Office
(%)
6 1998–2012
4.6% 2013–2017
5
3.4%
1991–1997
4
1985–1990 2.8%
3 1974–1984 2.5%
1956–1973 2.1%
2 1.5%
Fig. 3.11 Unemployment rate. Source: Statistics Bureau, Ministry of Internal

Affairs and Communications
Non-Uniformity of the Economic Performance during the Long

Stagnation and a Need to Divide the Whole Period into Four
Subperiods
The foregoing indicates that the two decades of the stagnation period
were not uniform, that is, economic characteristics (symptoms) were dif-
ferent across the years. Let us summarize what we have seen:
Behavior of private investment is significantly different on average in the

long stagnation period, as compared with that in other periods, record-
ing zero growth contribution on average during the stagnation.
Private investment dipped four times; that is, after each of the following
incidents—the burst of the bubble, the financial crisis, the collapse of
the dot-com bubble, and the GFC.
There were two weak recoveries in the first decade of stagnation and one
long recovery in the second decade of stagnation.
The unemployment rate was not significantly high before the financial
crisis, but it sharply increased thereafter.
These differences in characteristics of the economic developments or

the difference in the symptoms of the disease (stagnation) suggest that, in
our examination, it may be useful to divide the whole two decade-long
period in the following way:
The first dividing line may be the financial crisis. The unemployment rate
was moderate up to 1997, but it was elevated from 1998. The economy
apparently suffered serious impacts during the financial crisis and under-
went a substantial change.
Another dividing line may be the start of the long recovery in the early
2000s. There were two weak recoveries before the early 2000s and one
long recovery after that.
One more dividing line may be the outbreak of the GFC. The long recov-
ery was interrupted in 2008, and the economy was thrown into a turbu-
lent era due to a series of external shocks.
Based on these considerations, we may divide the stagnant period of

two decades into the following four subperiods:
Period I 1991–1997: After the burst of the bubble to just before the
financial crisis. This subperiod may be called “Initial adjustment period”
102 K. ARAMAKI
Period II 1998–2002: From the financial crisis and to just before the long
recovery. This subperiod is called “Financial Crisis and its impacts”
Period III 2003–2007: This period covers most of the long recovery and
is termed “Long recovery”
Period IV 2008–2012: This subperiod covers the turbulent era from the
GFC to just before the period of Abenomics that substantively started
in 2013 and is called “Global financial crisis and after.”
Table 3.5 shows growth contribution of major demand components in

the aforementioned four subperiods in the long stagnation period, sepa-
rated by aforementioned dividing lines. The bubble period is shown for
comparison purpose.
In these subperiods, major characteristics of the economy seem to be
distinctively different.
Period I 1991–1997: Initial adjustment period
Growth rate became less than one-third of the rate in the preceding bub-
ble period (from 5.2% to 1.7%).
Table 3.5 Contribution to GDP growth by major demand components (bubble

period and four subperiods in the long stagnation periods)
Bubble period Period I Initial Period II Period III Period IV
1985–1990 adjustment Financial Long recovery Global
(%) 1991–1997 crisis and its 2003–2007 financial
(%) impacts (%) crisis and
1998–2002 after 2008–12
(%) (%)
Real GDP 5.2 1.7 0.4 1.7 −0.2

growth
Private 2.5 1.0 0.6 0.6 0.3
consumption
Housing 0.4 −0.1 −0.2 −0.1 −0.1
investment
Private 2.0 −0.1 −0.2 0.5 −0.3
investment in
plants and
equipment
Government 0.6 0.8 0.2 −0.3 0.3
expenditure
Net exports −0.3 0.2 0.1 0.8 −0.2
Source: Calculated based on GDP statistics provided by Cabinet Office

The most important negative factor for growth was private investment in
plants and equipment (its growth contribution declined by 2.1% points,
from +2.0% points in the bubble period to −0.1% points in Period I).
Period II 1998–2002: Financial crisis and its impacts
The growth rate further fell to 0.4%. Private investment stagnation aggra-
vated (its growth contribution further declined to −0.2% points).
Period III 2003–2007: Long recovery
The growth rate recovered to 1.7%. Private investment recovered, with a

positive contribution to growth (0.5% points).
Period IV 2008–2012: GFC and after
The growth rate became negative, again (−0.2%). Private investment

recorded a negative contribution again (−0.3% points).
We would like to reiterate a need to divide the two decades into subpe-
riods with different characteristics. In many analyses of Japan’s stagnation,
more than 20 years, after the burst of bubble, are often lumped together
and called the “Lost Decades.” Arguments are presented to explain a sin-
gle “long stagnation.” However, problems with the economy seem to have
changed over the period of two decades. In this book, we divide the long
stagnation period into subperiods based on characteristics of the economy
and aim to identify the real mechanism of the Japan’s long stagnation.
3 Initial Adjustment after the Collapse

of the Bubble (Period I: 1991–1997)
In this section, we will look at Period I that spans from 1991 to 1997, that
is, a period from the collapse of the bubble up to just before the financial
crisis in the late 1997, which brought about far-reaching impacts on the
economy, as we see later. We start with fact findings, that is, we will see
what happened to the Japanese economy in this period and examine pos-
sible causes of the stagnation, with particular focus on the decline in pri-
vate investment (that played the most important role in the stagnation in
Period I). We also will see what the government did to find out what
104 K. ARAMAKI
should (could) have been done to prevent such a long stagnation, as the
economy actually experienced.
What Happened in Period I?

The economic expansion that started after November 1986 ended, hitting
a peak in February 1991, more than one year after the stock price began
its fall at the beginning of 1990, and the economy entered a contraction
phase, as shown in developments in Cumulated Diffusion Index (Fig. 3.12).
The most distinct feature of this contraction phase is the severity of the
contraction. In terms of quarterly growth rate (year-on-year basis), the
growth rate of real GDP sharply decelerated from the average of 6.0% in
the preceding three years over 1988Q1–1991Q1 to 1.0% over a contrac-
tion phase from 1991Q2–1993Q4 that followed. The growth rate in a
subsequent expansion phase was also low at 2.1% over 1994Q1–1997Q2
(Fig. 3.13). The length of the contraction phase (32 months, which is the
second longest contraction phase after the war) is another characteristic of
this contraction phase.10
The main cause of the contraction was private investment. Decomposition
of real GDP growth into contribution by major demand components
1800
1600
1400
1200
1000
800
600
400
200
0
1990
1990
1991
1992
1992
1993
1993
1994
1994
1995
1996
1996
1997
1997
1998
1999
1999
2000
2000
1985
1985
1986
1986
1987
1987
1988
1989
1989
10
The longest contraction phase is 36 months from February 1980 (peak) to February
1983 (trough) after the second oil crisis.
(%)
12
10
0
1985/ 1- 3.
1988/ 1- 3.
1991/ 1- 3.
1994/ 1- 3.
1997/ 1- 3.
2000/ 1- 3.
10-12.
10-12.
10-12.
10-12.
10-12.
10-12.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
-2
-4

1985Q1–2000Q4. Source: Cabinet Office
confirms that the most important negative factor was private (corporate)
investment in plants and equipment, recording negative growth contribu-
tion in many years in the first half of 1990s. By contrast, government
expenditure and private consumption supported the growth in the initial
adjustment period in 1991–1997 (Fig. 3.14).11
Why Was Private Investment Depressed So Severely and So Long?

We have seen that the biggest drag to growth in Period I was a decline in
private investment. We would like to know why private investment was
depressed so severely and so long. We will list three factors: (1) the
accumulation of excessive capital stocks in the bubble period and their
prolonged adjustment by corporations; (2) continuous decline in expected
growth rate; and (3) the balance sheet damage made to corporations by
11
Growth contributions by each of demand components tend to fluctuate, and therefore
in Fig. 3.14, the three-year moving average of growth contributions of each demand compo-
nent is shown, so as to see the basic trend.
106 K. ARAMAKI
(%)
7.0
6.0
5.0 GDP
growth rate
4.0
Private
consumption
3.0
Private
2.0 investment
Government
1.0 expenditure
Net export
0.0
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
-1.0
-2.0
Fig. 3.14 Growth contribution of major demand components (three-year mov-

ing average): Japan, 1985–2000. Source: Cabinet Office
asset deflation. The former two factors played a fundamental role, and the
third factor provided an extra burden.
Stock Adjustments
Stock Adjustments Conducted

We can see from Fig. 3.15 that private investment surged in the bubble
period. The average share of private investment in real GDP was really
high at 17.1% in 1988–1992, as compared with 12.5% in the stable
growth period (1974–1984).12 So, it is natural that excess assets created
by overinvestment in the bubble period were downward adjusted (stock
adjustment) as the economy slowed down after the burst of the bubble.
However, the stock adjustment continued for a very long period of time.
The share of private investment in real GDP stayed flat from mid-1990s
to the first half of 2000s, and private investment was unable to act as a
driving force for growth.
12
As implementation of investment tends to have a lag, the peak of investment comes later
than the peak of economic cycle.
(％)
20.0
18.0
Private
16.0 investment
14.0
12.0 Housing
investment
10.0
8.0 Government
6.0 investment
4.0
2.0
0.0
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
Fig. 3.15 Share in real GDP of private investment, housing investment, and
government investment. Source: Cabinet Office
Why Was the Stock Adjustment Not Completed Sooner

While stock adjustments were inevitable, we would like to know why
stagnation of private investment continued for such a long time and why
the subsequent recovery was also slow. In fact, although the economy
started to expand in late 1993 and private investment recovered a positive
contribution to growth, the recovery at that time was weak, and private
investment did not have its previous strength.
The background of this weakness can be found in Fig. 3.16. This figure
shows developments in total assets, liabilities, and net assets of all profit-
making companies (excluding financial and insurance companies) in Japan.
It clearly shows the bubble period left Japan with excess assets accompa-
nied by excess liabilities. The pace of increase in assets and liabilities in the
second half of the 1980s was far higher than that in the preceding period.
The existence of such excess assets seems to have placed a downward pres-
sure on private investment.
Furthermore, Fig. 3.17 shows developments in total sales of all compa-
nies (excluding financial and insurance companies) in Japan and their
breakdown into manufacturing and non-manufacturing sectors. The total
amount of sales suddenly stopped growing after the burst of the bubble at
the beginning of 1990s and started to absolutely decline in the 1990s.
This is particularly the case for non-manufacturing industries.
108 K. ARAMAKI
(trillion yen)
1800.0
1600.0
1400.0
1200.0 Assets
1000.0 Liabilities
800.0 Net
600.0 assets
400.0
200.0
0.0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
Fig. 3.16 Assets, liabilities, and net assets of companies (all industries excluding
financial and insurance companies): FY 1960–2013. Source: Ministry of Finance
“Financial Statements Statistics of Corporations by Industry”
(trillion yen)
1800
1600
All industries
1400
(excluding
1200 financial and
insurance
1000 companies)
800
Manufacturing
600
Non-manufacturing
400
200
0
FY1960
FY1964
FY1968
FY1972
FY1976
FY1980
FY1984
FY1988
FY1992
FY1996
FY2000
FY2004
FY2008
FY2012
Fig. 3.17 Total sales of companies (all industries excluding financial and insur-
ance companies) and their breakdown between manufacturing and non-
manufacturing sectors. Source: Ministry of Finance “Financial Statements Statistics
of Corporations by Industry”
Due to the sudden halt of sales growth, the size of physical assets, such
as buildings, machineries, and equipment, became excessive relative to the
sales volume.13 The fact that companies had such assets, for which the
companies could not expect sufficient sales, surely imposed another
depressing impact on investment.
Continuous Downward Adjustment of Growth Expectation
Expected Growth Rate Declined with Declines in Actual Growth

Rate
This mechanism may be looked at from a different angle in Fig. 3.18. The
growth rate expected by companies (listed manufacturing and non-
manufacturing companies) for the immediate three years into the future
fell from an average of 3.4% in the bubble period (1985–1990) to 2.2% in
the initial adjustment period (1991–1997), and then to 1.0% in the finan-
cial crisis and its impacts period (1998–2002), before rising to 1.8% in the
recovery period (2003–2007).
The downward adjustments of growth expectation until the beginning
of the 2000s seem to have reflected the continued decline in growth per-
formance, provided in Fig. 3.18, and this decline in expectation reduced
the required level of private investment by companies.14
What matters to companies may be expected sales growth rather than
expected growth of the economy, but the expected growth rate may well
act as a proxy for expected sales growth rates for companies. Figure 3.19
shows that the sales growth rate in the immediate past significantly affected
private investment. In particular, after the bubble burst, the decline in sales
growth negatively affected private investment.15
Why Did the Growth Rate or Sales Growth Continue to Decline?

From these observations, we can see that the formation of excess assets on
the one hand, and the halt of growth and subsequent decline in sales on
the other hand, significantly affected company behavior, and also, the
economy as a whole. Excess assets were the negative legacy of the bubble,
and therefore, their disposition was inevitable. Why then did sales con-
tinue to decline for long?
13
This point is examined in detail, based on combined financial statements of companies
in Chap. 6.
14
See Footnote 25 in Chap. 2.
15
Note that both sales and investment are in nominal terms in the figure.
110 K. ARAMAKI
(%)
8
6
Real GDP
4 growth
rate
2 Growth
rate in
coming
0 3-years
expected
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
by
-2 companies
-4
-6
Fig. 3.18 Real GDP growth rate and expected growth rate held by companies for
the next three years. Source: Cabinet Office “Survey on company behavior”
(%)
50
40
Rate of
30 nominal
investment
20 increase
(3-year moving
10 average)
0 Rate of
nominal sales
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
-10 increase
(3-year backward
-20 moving
average)
-30
-40
Fig. 3.19 Growth rate of nominal sales and growth rate of nominal investment
(both in three-year moving average). Source: Ministry of Finance “Financial
Statements Statistics of Corporations by Industry”
Prolonged Investment Restraint

One reason may be found in the prolonged stock adjustment. Due to the
hangover of excess assets, stock adjustment, and therefore, investment
restraint became a prolonged process, depressing the economy. It was in the
mid-2000s when excess assets were finally removed, and in the intervening
15 years from the burst of the bubble, investment could not become a driver
of economic growth.
Sharp Yen Appreciation

Another depressing factor on the growth was the rapid yen appreciation in
the mid-1990s.The yen appreciated from 125 yen to the dollar in January
1993, when the first term of the Clinton administration started, to 79.75
yen to the dollar on April 19, 1995, representing some 57% appreciation
of the yen vis-à-vis the US dollar in just little more than two years.16 Rapid
yen appreciation, together with the Great Hanshin-Awaji Earthquake in
January 1995, hurt exports and dampened business confidence (Fig. 3.20).
(yen)
160 350
140 300 Nominal
120 effective
250 exchange rate
100 of the yen
200 Real effective
80
exchange rate
150
60 of the yen
100 Nominal
40 yen = dollar
20 50 exchange rate
2010 = 100 (RHS)
0 0
Jan-73
Sep-75
May-78
Jan-81
Sep-83
May-86
Jan-89
Sep-91
May-94
Jan-97
Sep-99
May-02
Jan-05
Sep-07
May-10
Jan-13
Fig. 3.20 The exchange rate of the yen to the dollar and real and nominal effec-
tive exchange rate (2010 = 100). Source: Bank of Japan
16
A Ministry of Finance official in charge of international financial matters, including
exchange rates, later wrote as follows: “Bickering over trade between Japan and the United
States, which was intensively covered by the mass media, regrettably helped convince market
players that the yen’s surge would not be halted unless Japan’s current account surplus was
brought down” (Sakakibara 2000, 174).
112 K. ARAMAKI
In real effective terms, which is more relevant to the competitiveness of

Japanese exporters, the yen rate in the mid-1990s, when Japan was strug-
gling with the aftereffects of the bubble, was the highest in more than
40 years since the collapse of the fixed exchange rate system.
In this way, the economy was deprived of two important private demand
components, investment and exports, in the initial adjustment period. So,
as we have seen, in the initial adjustment period, major contributors to
growth were government expenditures (0.8% of 1.6% average growth) and
private consumption (1.0% of 1.6%). However, government expenditures
could not support the economy forever. Private consumption may be able
to support the economy for a short time under an economic contraction,
as it is a relatively stable component in the aggregate demand. However,
in the case where the economy stagnates for as long it actually did, the
growth contribution of consumption is most likely to decline proportion-
ately to the decline in the growth rate of the economy as a whole.
Therefore, it was difficult for consumption to continue to be a driver of
recovery under the prolonged stagnation.
alance Sheet Damage

B
In the initial adjustment period, one more factor depressing investment
and growth was at work. It is the damage to the balance sheets of compa-
nies, reducing the capacity for risk-taking.
Capital Losses Incurred by the Collapse of the Bubble

In Chap. 2, we saw the formation of a huge bubble in the 1980s. To repeat
the data, urban land price Index (commercial use in six largest cities) rose
4.9 times in seven and a half years from 107.8 in October 1982 to 525.4 in
April 1990. Thereafter, it declined continuously for 14 years from October
1990 to 67.2 (−87.0%) in April 2004, which was the level in 1972–1973,
before it showed a minimal increase of 0.2% in October 2004.
Stock prices (Nikkei 225 [monthly average]) also increased 5.4 times in
seven years and four months, from 7,042 in August 1982 to 38,130 in
December 1989. It started to fall in January 1990, hit the then bottom of
15,790 (−58.6%) in August 1992, that is, in less than three years, and
then became stabilized basically in the range of 16,000–21,000, before it
resumed a fall in late 1997.
GDP statistics provide estimates of capital gains and losses (both
realized and unrealized), arising from price developments in stocks and
land for each year (Fig. 3.21).
(%)
200.0
150.0
Capital
100.0 gains/losses
related to
stocks
50.0
Capital
gains/losses
0.0 related to
land
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
-50.0
-100.0
Fig. 3.21 Capital gains and losses accruing to land and stocks (in GDP ratio).
Note: Bars show the combined amount of realized and unrealized capital gains and
losses. Source: Cabinet Office, GDP statistics
According to these estimates, while the cumulative capital gains

accrued to the economy as a whole over 1986–1989 amounted to 4.7
times the average GDP in that period, the cumulative capital losses
accrued over 1990–2002 was 3.2 times the average GDP in the period,
with 69% of these losses accrued in 1990–1997, a period overlapping
Period I. As more than 90% of land and stocks were held by the private
sector,17 these capital losses were surely to damage balance sheets of com-
panies and also financial institutions, discouraging their positive risk-
taking behaviors, such as investment.
Some evidence of such intimidated behaviors are found in develop-
ments in companies’ borrowings (Fig. 3.22). The outstanding balance of
long-term debt of companies became almost flat after FY 1994, when the
balance was 384 trillion yen, likely reflecting companies’ efforts to repair
their balance sheets. The balance hit a slightly higher peak of 406 trillion
yen in 1998, after which the long-term debt fell sharply.
17
As of 1990, 91.4% of land and 93.6% of stocks were held by the private sector (FY 2009
GDP statistics, Cabinet Office).
114 K. ARAMAKI
(trillion yen)
450.0
400.0
350.0
300.0
250.0
200.0
150.0
100.0
50.0
0.0
FY1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
Fig. 3.22 Outstanding balance of long-term debt of companies (all industries
excluding financial and insurance companies). Source: Ministry of Finance
Continued Decline of Land Prices

Among these damages, it was capital losses accruing to landholdings that
continued to arise for a long period of time after the collapse of the bub-
ble. Annual rates of decline in land prices were in the range of 20% for
three years, from 1992 to the beginning of 1995, and then around 10%
for the subsequent seven years until 2003. These declines continued to
impose additional damages to the balance sheets of companies and
depressed positive economic activities.18
A question arises as to why the land price continued to decline for such
a long period of time, more than three times as long as the average correc-
tion period after a housing price boom (which usually includes land
prices), as found by the IMF.19 As shown in Fig. 3.23, it is possible that the
18
These price declines aggravated non-performing loan problems for banks, as examined
in Chap. 4.
19
IMF (2003) examined the historical experiences of booms and busts in equity and hous-
ing prices. The study covered equity prices in 19 industrial countries, for which equity price
indices were generally available from 1959, and housing prices for 12 countries, for which
housing price indices generally started in 1970. A bust was defined as a peak-to-trough
(%)
7.0 350
6.0 300
Expected real
5.0 250 growth rate
for coming
4.0 200 3-years
Commercial
3.0 150 land price (6
largest cities)
2.0 100 Mar 2000 = 100
(RHS)
1.0 50
0.0 0
FY1973
FY1976
FY1979
FY1982
FY1985
FY1988
FY1991
FY1994
FY1997
FY2000
FY2003
FY2006
FY2009
FY2012
Fig. 3.23 Expected growth rate and land price. Note: Urban land price is calcu-
lated as of April 1 of each respective year. Source: Japan Real Estate Institute,
Cabinet Office “Survey on company behavior”
continued decline in the expected real growth rate, which may well have
reflected continued stagnation, reduced the expected rate of return to
landholdings and thus depressed demand for land. This process continued
until the early 2000s and then was temporarily suspended as the expected
growth rate started to rise, most probably reflecting the long recovery.
Land prices started to rise in the latter half of the 2000s, but this positive
process did not continue for long with the impacts of GFC.
Thus, companies continued to incur realized/unrealized capital losses
due to the collapse of the bubble and subsequent asset deflation, con-
tinuing for more than a decade until the beginning of the 2000s. During
the excess capacity hangover, profits stagnated (as will be examined in
Chap. 6 in more detail), and the balance sheets of companies continued
decline where the price change fell into the top quartile in all declines during bear markets
(both indices were deflated by the Consumer Price Index (CPI). The study identified 52
equity price busts between 1959:Q1 and 2002:Q3 (one bust per country for every 13 years).
On average, busts involved a price decline of about 45% and unfolded over a period of 10
quarters. The study identified 20 housing price crashes between 1970:Q1 and 2002:Q3 (one
bust per country every 20 years). Price correction in the busts averaged 30% and lasted about
4 years, about a year and a half longer than equity price busts.
116 K. ARAMAKI
to deteriorate in the 1990s. Therefore, risk-taking behaviors of compa-

nies continued to be heavily discouraged, restraining investment for a
long time.
How Did the Government Respond?

Let us look at how the government responded. In the face of economic
contraction after the bubble burst, the government repeatedly imple-
mented extensive expansionary measures.
Fiscal Policy
The government implemented as many as 12 large economic stimulus pack-
ages in less than 10 years between August 1992 and December 2001, and
6 out of 12 packages were implemented in Period I (Table 3.6). A new pack-
age was announced every year after the contraction started, except in
1996–1997, when no package was compiled, reflecting a short recovery
and a fiscal consolidation policy that was pursued in that period but aborted
shortly thereafter. The scale of eight packages were over 2% of the GDP.20
Table 3.6 Economic stimulus packages after the burst of the bubble (trillions of
yen)
August April September February April September
1992 1993 1993 1994 1995 1995
Package volume 10.7 13.2 Approx. 6.0 15.3 Approx. 7.0 14.2
(percent of GDP) (2.2%) (2.7%) (1.2%) (3.1%) (1.4%) (2.8%)
Amount of public 8.6 10.6 5.2 7.2 11.4
investment in the
package
April November November October October December

1998 1998 1999 2000 2001 2001
Package volume Over 16.0 Over 20.0 Approx. Approx. Approx. Approx.
(percent of GDP) (3.2%) (4.7%) 18.0 11.0 5.9 (1.2%) 4.1 (0.8%)
(3.5%) (2.1%)
Amount of public 5.2 8.0 7.2 4.2 2.5
investment in the
package
Source: Summarized from Table 1 in Nakao (2002)
20
The largest stimulus package in 1998 was over 4.7% of GDP.
Reflecting fiscal stimulus efforts, government investment (in GDP

ratio) significantly increased over the 1990s, making up, in part, for the
decline in private investment (see previous Fig. 3.15).
As a result of fiscal stimulus, as well as revenue-reducing and expenditure-
increasing effects of economic stagnation and the impacts of the population
aging on welfare expenditure, the government deficit dramatically expanded
(Fig. 3.24), and government debt (in GDP ratio) sharply increased.
Deterioration in fiscal balance was very significant relative to other
advanced countries (Fig. 3.25).
Japan’s government debt sharply increased and reached a high level
that is far larger than other advanced countries (Fig. 3.26).
Monetary Policy
The discount rate, which was among the major tools of monetary policy
at the time, was raised five times from the level of 2.5% to 6.0% in a year
and three months from May 1989 to August 1990. Then, from July 1991,
only 10 months later, it was lowered seven more times to reach 1.75% in
September 1993. In 1995, the discount rate was further reduced twice to
reach 0.5%, a level close to zero (Fig. 3.27).
(%)
4
-2
-4
-6
-8
-10
-12
Fig. 3.24 Fiscal balance of general government (in GDP ratio). Source: IMF,
World Economic Outlook Database, October 2017
118 K. ARAMAKI
(%)
6
4
2
0 Japan
-2 US
-4 UK
-6 Germany
-8 France
-10
-12
-14
Fig. 3.25 General government deficit (in GDP ratio): Japan, US, the United
Kingdom, Germany, and France. Note: General government net lending/borrow-
ing (in percent of GDP). Source: IMF, World Economic Outlook October 2013
database
(%)
300
250
200 Japan
US
150 UK
Germany
100 France
50
Fig. 3.26 Outstanding balance of general government debt (in GDP ratio).
Source: IMF World Economic Outlook Database, October 2013
(%)
7
0
Jan-85
Oct-85
Jul-86
Jan-91
Oct-91
Jul-92
Apr-93
Jan-94
Oct-94
Jul-95
Apr-96
Jan-97
Oct-97
Jul-98
Apr-99
Apr-87
Jan-88
Oct-88
Jul-89
Apr-90
Fig. 3.27 Official discount rate. Source: Bank of Japan
Under these policy efforts, the economy started to recover in 1994–1996,

but as we have seen, the recovery was weak and the stagnation did not end.
On the contrary, the Japanese economy was eventually faced with an unprec-
edented financial crisis in the late 1990s, which we will look at in Chap. 4.
Summary of the Initial Adjustment Period

The trouble with the Japanese economy started with the collapse of the
bubble. The sudden brake on the bubble by aggressive monetary policy
tightening and the introduction of direct limits on real estate-related lend-
ing, as was evidenced by the nosedive in the growth rate of money stock,
ushered in the collapse of the bubble and led the economy into a reces-
sion. As the economy decelerated, excesses formed in the 1980s in both
assets and liabilities became a heavy burden for companies.
Fig. 3.16 clearly shows that the bubble era left Japan with excess assets,
coupled with excess liabilities. The pace of growth in both assets and liabili-
ties in the latter half of the 1980s was notably faster than in preceding
periods. The problem with these excesses was that these assets were not
accompanied by sustainable demand (sales), or in other words, they were
not profitable. So, what was needed most in the initial adjustment period
was the disposition of these excesses. However, the removal of these
120 K. ARAMAKI
excesses by the corporate sector took a long time. The reason for the long
time of disposition may be as follows. Initially, there was some delay in
recognizing that assets were in excess and had to be downward adjusted,
even after the collapse of the bubble and the halt of sales growth. Next, the
excess itself expanded as the actual growth rate, and therefore, the expected
economic growth rate (which leads to the expected sales growth rate) fell.
(This point will be examined in detail in Chap. 6). Lastly, after the problem
of excess assets came to the surface, the magnitude of the excess (to be
discussed in Chap. 4 and its Supplement 2), and therefore, the expected
negative impacts of their disposition when swiftly disposed of may have
lengthened the disposition.
Furthermore, the sharp appreciation of the yen rate around the mid-1990s
hurt exports and also imposed dampening effects on business confidence.
Worsening balance sheet conditions imposed an additional burden.
Substantial capital losses incurred by nonfinancial and financial corpora-
tions due to sharp asset deflation imposed damages to their balance
sheets, making these corporations cautious toward investment and debt
assumption.
Continued decline in growth rates also reduced expected return to
landholding and therefore reduced demand for land, depressing the land
prices and further creating capital losses each year.
In this way, in the initial adjustment period, the Japanese economy was
deprived of two major important drivers of economic recovery: private
investment and exports.
The government supported the economy, and private consumption
provided certain stabilizing effects to the economy, but sustainability of
their growth contribution could not be expected under the prolonged
stagnation.
With hindsight, Period I seems to be of critical importance. The prob-
lem of overinvestment in the bubble period and balance sheet damages by
the collapse of the bubble were addressed by companies through their
curtailing of investment and refraining from additional borrowing, so as to
adjust production capacity downward and repair their balance sheets.
Meanwhile, the government implemented very extensive stimulus and
macroeconomic policies to support the economy. However, external devel-
opments, particularly sharp appreciation of the yen during trade disputes
with the United States, limited the scope of more export-led recovery.
Under these circumstances, the weakness of economic performance con-
tinued for a long time, which in turn lowered growth expectation held by
companies for the future, leading to continued, self-fulfilling low growth.
Costs of lengthened adjustments of excess capacity of the corporate
sector were gradually shifted to the financial sector and surfaced as the
worsening of non-performing loan problems. This culminated in the late
1990s in the form of the first systemic financial crisis after the Second
World War. Despite huge (realized and unrealized) losses arising from
excess (unprofitable) assets formed during the bubble, Japan did not have
a social or political crisis per se during the two decade-long stagnation,
largely due to extensive government support. The lengthened adjustment
process left Japan with negative legacy, however, including sharply ele-
vated government debt and a downward shift of growth, trending to a
very low level.
If the disposition of excess assets had been swiftly completed in the first
half of 1990s, the economy would have been rapidly freed from the over-
hang of the adjustment burden and could have made a fresh start relatively
early, with such strength as in the past. The magnitude of necessary adjust-
ment, however, seems to have made this choice difficult. The fact that we
could not or did not solve the problem in Period I turned out to be most
crucial in the subsequent two-decade developments. After all, the Japanese
economy, while avoiding swift adjustment, could not avoid in-depth
adjustment (disposition of excesses), and in the end, there developed a
crisis. The topic of the financial crisis, including reasons for non-disposal
of excesses in a short period of time, is covered in the next chapter.
122 K. ARAMAKI
Supplement
Table 3.7 Chronology of relevant events
October 1987 Black Monday

May 1989 BOJ raised the discount rate for the first time in nine years
June 1989 Prime Minister Takeshita resigned amid a scandal (current Prime
Minister Abe is the 17th prime minister after Takeshita)
January 1990 Stock prices started to fall
March 1990 MOF imposed an aggregate lending limit on real estate-related loans
1990 Land prices started to fall
August 1990 Iraqi troops invaded Kuwait
January 1991 The Gulf War started
February 1991 The Japanese economy peaked and started to slow down
August 1993 Non-LDP administration formed (Prime Minister Hosokawa)
October 1993 The Japanese economy hit a bottom
February 1994 Japan–US dispute over the “numerical target” for market opening
demanded by the Clinton administration
April 1995 Yen recorded the then historic high at of 79.75 yen to the dollar
November 1996 Prime Minister Hashimoto instructed Finance Minister Mitsuzuka and
Minister of Justice Matsuura that a reform of Japan’s financial system
had to be examined
November 1996 Finance Minister Mitsuzuka requested the chairmen of five advisory
councils on securities transactions, accounting, the financial system,
insurance, and foreign exchange to prepare as soon as possible a plan to
complete a reform of Japan’s financial system by 2001, and
subsequently each of these councils started examination of the issues, so
as to prepare a reform plan by June 1997
December 1996 The Cabinet decided on the fiscal consolidation target of reducing the
fiscal deficit to equal or less than 3% of GDP at the earliest before fiscal
2005
January 1997 Prime Minister Hashimoto declared a start of drastic reforms in six
areas, including fiscal structure and the financial system
January 1997 A report on a reform bill of Foreign Exchange and Foreign Trade
Management Act was approved by the advisory council on foreign exchange
April 1997 Consumption tax rate was increased from 3% to 5%
June 1997 BOJ law amended (its independence strengthened)
June 1997 Comprehensive financial liberalization (Japan’s financial “Big Bang”)
authorized by four relevant advisory councils (securities transactions,
accounting, the financial system, and insurance) to MOF
July 1997 Thai baht recorded a sharp fall (start of the Asian currency crisis)
November 1997 Sanyo Securities filed an application for protection under the Corporate
Rehabilitation Law, causing a default in the interbank market
November 1997 Hokkaido Takushoku Bank announced its inability to continue
November 1997 Yamaichi Securities announced closure of business
November 1997 Fiscal Structure Reform Act enacted
(continued)
(continued)
April 1998 Comprehensive Economic Measures decided
May 1998 Fiscal Structure Reform Act amended (in December 1998, its
implementation was suspended)
October 1998 Government decided to nationalize the Long-term Credit Bank of
Japan (first nationalization of private bank after the war)
November 1998 Emergency economic measures decided (historically largest size)
December 1998 Nippon Credit Bank nationalized
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CHAPTER 4
The Financial Crisis and Its Impacts, Long

Recovery, and Afterward
In this chapter, we cover three periods that follow Period I (1991–1997):

Period II (1998–2002: financial crisis and its impacts), Period III (2003–2007:
long recovery), and Period IV (2008–2012: Global Financial Crisis (GFC)
and after). The focus is on the financial crisis that began in late 1997 and its
impacts on the Japanese economy. The subsequent two periods will be exam-
ined more briefly.
1 Period II (1998–2002) Financial Crisis and Its

Impacts
In this section,1 we will examine Period II that covers 1998–2002. First,
we look at how the financial crisis unfolded and was addressed; second,
why non-performing loan (NPL) problems, which were the fundamental
cause of the crisis, were not solved sooner; and third, the far-reaching
impacts of the crisis on the Japanese economy.
The Unfolding of the Financial Crisis and Its Resolution

Overview
Financial Crisis Breaks Out
Seven years after the collapse of the bubble, a financial crisis broke out. In
early November 1997, a medium-sized securities firm, called Sanyo Securities,
1
Description in this chapter owes much to Nakaso (2001).

130 K. ARAMAKI
applied for a legal restructuring procedure, which led to an issuance by the

court of an order to protect the firm’s assets and a resultant default in obliga-
tions in the interbank market for the first time in postwar history. This event
had grave impacts on interbank market participants, causing them to be
more selective with respect to borrowers, and it became difficult for some
financial institutions to obtain financing in the interbank market.
In mid-November 1997, Hokkaido Takushoku Bank, one of the largest
banks in Japan, announced its inability to continue its business operations,
which was the first failure of a large bank in Japan since the Second World
War, and then, in late November, Yamaichi Securities, one of the “Big
Four” securities firms in Japan, announced closure of its business. A few
days later in the same month, the regional bank Tokuyo City Bank failed,
making it apparent that the financial system was faced with serious sys-
temic pressure. While the financial markets recovered some stability after
new safety net measures were introduced (to be explained later), the crisis
resurfaced in the mid-1998 with the problems of the Long-Term Credit
Bank of Japan (LTCB) which was the second largest LTCB. Under the
newly introduced, more comprehensive safety net measures, the LTCB
and then, the Nippon Credit Bank (NCB), the third largest and smallest
LTCB were nationalized in October and December 1998, respectively.
Instability of the financial sector continued until the NPL problems were
finally resolved by the mid-2000s.
Bank Failures
Under the severe systemic stress, failures of financial institutions reached
an unprecedented level. In total, 181 financial institutions failed in the
1990s and the first half of 2000s. A total of 161 (89%) of 181 failed in five
years from 1997 to 2001, and more than two-thirds were credit coopera-
tives (Fig. 4.1).
The number of financial institutions dramatically decreased by 500
(−44.9%) from 1,080 at the end of March 1990 to 580 at the end of
March 2014. More than 42.4% (212 institutions) of these 500 closures
occurred in five years from the end of March 1997 to the end of March
2002, with the outbreak of the financial crisis of 1997–1998, and 84.0%
(178 institutions) of these 212 institutions were either credit banks or
credit cooperatives. While the decline reflects not only closure due to fail-
ures but also mergers under changing business environments, such a rapid
decline in the number of banks illustrates how serious the impacts of the
crisis were to the Japanese economy.
THE FINANCIAL CRISIS AND ITS IMPACTS, LONG RECOVERY, AND AFTERWARD 131
60
50
40
Credit
cooperative
30
Credit bank
Bank
20
10
Fig. 4.1 Number of failed deposit-taking financial institutions. Source: Financial

Services Agency
Background of the Non-Performing Loan Problems

Behind the crisis were the NPL problems. Even further behind was an
excess capital stock formed in the bubble era in the corporate sector, fol-
lowed by sales stagnation after the collapse of the bubble.
xcess Assets and Sales Stagnation

E
As we saw in Chap. 3, the corporate sector, by the early 1990s, had
amassed physical assets far greater than implied by the preceding trend
(see Fig. 3.16 in Chap. 3). So, in order to be profitable, the corporate sec-
tor needed a sufficiently large amount of sales. However, sales of corpora-
tions suddenly stopped growing after the burst of the bubble and instead
declined during the 1990s (Fig. 3.17 in Chap. 3).
As a result, the Return on Assets (ROA: operating profits/total assets,
%), which was on a declining trend from the high-speed growth period,
further fell in the 1990s (Fig. 4.2).
Earned profits, that is, the accumulated profits stopped growing after
the beginning of the 1990s until the end of 1990s (Fig. 4.3).
Thus, after the collapse of the bubble, the corporate sector was faced
with a difficult problem of low profitability brought about by a combination
of excessively large asset size and sales stagnation. If the sales were expected
132 K. ARAMAKI
(%)
9
8
7
6
5
4
3
2
1
0
FY1980
FY1982
FY1984
FY1986
FY1988
FY1990
FY1992
FY1994
FY1996
FY1998
FY2000
FY2002
FY2004
FY2006
FY2008
FY2010
FY2012
FY1960
FY1962
FY1964
FY1966
FY1968
FY1970
FY1972
FY1974
FY1976
FY1978
Fig. 4.2 Return on Assets (ROA: operating profits/total assets). Source:

Ministry of Finance “Financial Statements Statistics of Corporations by Industry”
(trillion yen)
300
250
200
150
100
50
0
FY1992
FY1994
FY1996
FY1998
FY2000
FY2002
FY2004
FY2006
FY2008
FY2010
FY1980
FY1982
FY1984
FY1986
FY1988
FY1990
Fig. 4.3 Earned profits. Source: Ministry of Finance “Financial Statements

to recover, companies could continue to hold the assets and wait for
the recovery of sales. If not, that is, if sales could not be expected to
recover, companies should dispose of these assets to avoid low profit-
ability for an extended period of time. What happened in reality was a
rolonged sales stagnation (see Fig. 3.17 in Chap. 3), so, the right choice
p
in hindsight was to dispose of the excess of unprofitable assets promptly.2
However, the corporate sector took time to address the problem of excess
assets, which made low profitability linger, gradually eroding the financial
strength of the corporate sector.
From the financial sector’s point of view, the erosion of financial sound-
ness of the borrowing companies was a cause for their declining ability to
repay their debts. The value of collateral was also being eroded after the
burst of the bubble. This was particularly true with commercial mortgage
loans, which were aggressively provided during the bubble. The financial
sector came to have an increasingly difficult problem with their NPLs as
years went by in the 1990s.3
Damage to the Balance Sheet of Borrowers and Lenders

Furthermore, the collapse of the bubble caused damage to the balance
sheet of both borrowers and lenders, as explained in Chap. 3. Land prices
continued to decline, reducing the land-related asset value, while burden
of debts were kept unchanged. Stock prices also continued to decline,
compressing unrealized capital gains that banks and companies had
through stock holdings. Deterioration in the balance sheet soundness
must have discouraged risk-taking behaviors, such as investment and debt
assumption, which in turn placed an additional depressing effects on the
economic recovery.
I ncrease in the Amount of NPLs

Reflecting lingering sales stagnation and the gradual approach by compa-
nies to cope with the excess (unprofitable) assets, the amount of NPLs
incessantly increased from a range of over 10 trillion yen in the first
2
In this case, disposition of assets does not necessarily mean demolition or destruction of
the assets concerned. Typically, disposition of assets is conducted in such a way that the assets
are sold at a price lower than the acquisition cost, entailing losses, and these losses are shared
by relevant parties. It may be possible for the assets to become profitable, as the acquisition
costs are low for the acquirer. Through the sale of assets at a lower price, the combined
amount of assets of the corporate sector will decline.
3
A report by the Deposit Insurance Corporation (DIC) (2005), which analyzed causes of
the failures of 180 financial institutions to which DIC extended financial assistance, con-
cluded that, for 165 (91.7%) of the total 180 failures, the NPL problem was listed among the
causes of the failure (multiple listing). Out of these 165, 83 (46.1%) listed concentration of
credit to real estate-related sector, 49 (27.2%) listed other factors including economic stagna-
tion, and 47 (26.1%) listed concentration of credit to sectors other than the real estate-
related sector as causes of failure.
134 K. ARAMAKI
half of 1990s to around 30 trillion yen in the latter half of 1990s. Against
the background of prolonged stagnation and the break-out of the financial
crisis, the amount of NPLs hit the peak of 42 trillion yen (NPL ratio equal
to 8.4%) in the period ending in March 2002 (Table 4.1).4,5,6,7
4
As the definition of NPL was gradually expanded, there is an issue whether a rigorous
time-sequential comparison is possible.
5
The amount of NPL and the resultant losses arising from the resolution of NPL tend to
increase with the lapse of time if economic stagnation continues. This is because economic
stagnation typically means sales stagnation, and therefore, revenue and profit stagnation of
borrowing companies.
6
The outstanding balance of NPLs is that of “risk-monitoring assets.” There are three
concepts of NPLs: “risk-monitoring assets,” “disclosed assets under the Financial Recovery
Act,” and “NPLs under self-assessment.” “Risk-monitoring assets” is a concept prescribed by
the Banking Act and covers a longer period of time than data under the other two concepts
do. It started to be disclosed from the year ending March 1993 and at that time covered only
those loans to failed borrowers [①] and past due loans (loans for which unpaid interest is
not recorded as revenue for six months or longer) [②]. Past due loans were disclosed only by
major banks. From the year ending March 1996, disclosure under this concept was extended
to cover loans for which interest was reduced or waived [③] and loans to those borrow-
ers for which such support as debt waiver had been extended [④]. Furthermore, from the
year ending March 1998 (for regional banks from the year ending September 1998), the
aforementioned Type ② loans were extended to cover loans past due three months or
longer [⑤], and a new type, “loans for which lending conditions had been eased” [⑥] was
introduced to include, but was broader than loan types ③ and ④ (the term “risk-monitoring
assets” began to be used from this point in time) (Watanabe 2001; Nakagawa 1996). The
second concept, “disclosed assets under the Financial Recovery Act,” was introduced by the
Financial Recovery Act, enacted in October 1998. The act imposed a disclosure obligation
under which major banks were required to disclose credit to legally bankrupt or de facto
bankrupt borrowers (Type ①), credit in danger (Type ②), credit that needs to be monitored
(Type ③), and normal credit (Type ④). It was implemented for major banks from the year
ending March 1999, and for regional banks, from the year ending September 1999. The
third concept, “NPLs under self-assessment” was made necessary by the Early Corrective
Measures implemented from April 1998, under which, if the capital–asset ratio of an indi-
vidual financial institution (to be calculated based on the self-assessment of loan quality) was
lower than the prescribed level (8% for international criterion banks, and 4% for domestic
criterion banks), authorities ordered the financial institutions to take corrective measures
such as the strengthening of capital base. In the self-assessment, borrowers are classified into
five categories: “failed,” “in danger of failing,” “risk of failure,” “to be monitored,” and
“normal.” Furthermore, respective assets are classified into four groups, from Class I (nor-
mal credit) to Class IV (credit impossible to recover or of no worth), depending on the
degree of risk of recovery. Financial institutions were not required to disclose the amount of
NPLs under the self-assessment and only the aggregate amount by type of financial institu-
tion and by classification of NPLs from Class I (normal credit) to Class IV (credit impossible
to recover or of no worth) were disclosed by the authorities (Watanabe (2001)).
7
The NPL ratio is the ratio of “disclosed assets under the Financial Recovery Act” (credit
to legally bankrupt or de facto bankrupt borrowers [①], credit in danger [②], and credit that
Table 4.1 Outstanding non-performing loans (NPLs) and NPL ratio

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Outstanding 12.8 13.6 12.5 28.5 21.8 29.8 29.6 30.4 32.5 42.0 34.8 26.2 17.5
NPLs
(bank)
(trillion yen)
NPL ratio 6.2 5.9 6.3 8.4 7.4 5.8 4.0
(bank) (%)
NPL ratio 6.1 5.4 5.3 8.4 7.2 5.2 2.9
(major
bank) (%)
Note:
1. Data are for the period ending in March of each year
2. Evolution of disclosure requirements of NPLs is explained in detail in footnote 6
3. The concept of the NPL ratio is explained in footnote 7
4. “Bank” consists of city banks, long-term credit banks, trust banks, and regional banks
Source: Financial Services Agency (FSA)
How Was the NPL Problem Addressed?

In this subsection, we will look at how the crisis surfaced and was resolved
in a time-sequential manner, drawing on Nakaso (2001).8
needs to be monitored [③]) to the total credit. The basic concept of both the risk-monitor-
ing assets and the disclosed assets under the Financial Recovery Act is same as is shown by
the fact that both include failed loans, loans past due for three months or longer, and loans
for which lending conditions had been eased. However, the two concepts adopt different
classification methods, that is, while the starting point for risk-monitoring assets is the past
due interest payments and then loans concerned are classified into those to failed borrowers
and other loans (past due loans), under the disclosed assets of the Financial Recovery Act,
division is between credit to failed borrowers and credit to borrowers that have not failed but
have a high probability of non-recovery. In addition, risk-monitoring assets cover only loans,
but disclosed assets under the Financial Recovery Act cover total credit including securities
lending. Also, risk-monitoring assets are based on an asset-by-asset classification but dis-
closed assets under the Financial Recovery Act are based on a borrower-by-borrower
classification).
8
Nakaso (2001) gives a most detailed and clear chronological explanation of the unfolding
of the financial crisis and authorities’ responses.
136 K. ARAMAKI
raditional Approach to the Troubled Banks

T
Until around the 1980s, troubled banks were acquired by healthy banks,
mostly via intermediation by the Ministry of Finance (MOF), and all busi-
ness, such as deposits and loans of failed banks, was in principle transferred
to acquiring banks. This was possible because the acquisition brought to
the acquiring banks such benefits as branch networks of the troubled
banks, which were not easily obtained under the regulations then.
However, from around the late 1980s, it gradually became difficult to
find a healthy bank that was willing to acquire a troubled bank, as the
previous benefit had disappeared under liberalization.
arly Efforts and the Introduction of Full Deposit Guarantee

E
In the early 1990s, troubles with small- and medium-sized banks started to
surface. In April 1992, financial assistance (a grant) within the payoff cost9
from the DIC was extended for the first time to a bank that acquired a troubled
regional bank, and the excess of burden over the payoff costs was covered by
external assistance from the local government and other financial institutions.
In December 1994, two urban credit cooperatives failed, and a new
bank (Tokyo Kyodo Bank [TKB]) was established as an assuming bank of
the two failed banks by equal contributions from the Bank of Japan (BOJ)
and private financial institutions.
Then, in 1995–1996, “Jusen” trouble became a major issue. Jusen
were non-bank financial institutions established in the 1970s by banks and
other financial institutions, originally for housing loans to households, for
which banks did not have expertise at that time. As banks themselves
became engaged in housing loans in the 1980s, Jusen was heavily involved
in loans to real estate sectors, and with the burst of the bubble, they were
left with huge NPLs. As the government could not find a solution under
which all the losses of seven Jusen companies could be covered by founder
banks and other creditor financial institutions, the government decided to
use taxpayers’ money to resolve these Jusen companies. This resulted in
very strong public resentment, making further use of public funds politi-
cally taboo until the crisis broke out later in the 1990s.10
9
Even before the 1996 amendment of the Deposit Insurance Law, DIC had the power to
give financial assistance to the acquiring banks of failed banks, so as to make a deal possible, but
the assistance was limited to the so-called payoff cost. Payoff cost usually refers to the amount
of funds necessary to pay depositors the full insured amount (10 million yen per person, per
bank) when a bank failed, less the remaining value of the failed bank (Nakaso 2001, 4).
10
Nakaso (2001, 6–7)
In June 1996, the Deposit Insurance Law was amended to improve the
safety net, and under the amendment, the payoff cost limit on DIC assis-
tance was removed temporarily until March 2001.
Outbreak of the Financial Crisis in 1997 and 1998 and the Introduction

of a Comprehensive Framework
The financial crisis broke out in autumn of 1997. As stated in the overview
in this subsection, major financial institutions, Sanyo Securities, Hokkaido
Takushoku Bank, Yamaichi Securities, and Tokuyo City Bank, collapsed in
the same month of November 1997.
With the outbreak of the crisis in November 1997, discussions started on
the possible use of public funds to cope with the unprecedented difficulties.
In February 1998, the Law Regarding Emergency Measures for Financial
Stability (the “Emergency Law”) was enacted, under which a public fund
injection scheme to strengthen the capital base of banks via purchase of pre-
ferred stocks, and so forth, was introduced with a limited duration until end
March 2001. A total of 30 trillion yen of public funds, including those for
capital injection, were made available as a temporary measure until March
2001.11 As banks were generally reluctant to be singled out as weak and
requiring capital injection, all major banks collectively applied for capital
injection. As a result, all major 21 banks received a capital injection on March
30, 1998, totaling 1.8 trillion yen, but the amount was regarded as far too
small, and it did not generate a very positive response in the market.
While the measures had some effects on calming the market turmoil
temporarily, in June 1998, problems with the LTCB became evident.12 In
light of the size and complexity of its operation, purchase by new investors
was sought to achieve an orderly wind down, rather than through liquida-
tion. However, mechanisms that enabled winding down of such a large
bank were non-existent at that time. The Diet discussion in the summer of
1998 produced significant legislation.
First, a law, the Law Concerning Emergency Measures for the
Reconstruction of the Financial Functions (the “Reconstruction Law”)
was enacted in October 1998, which introduced a comprehensive frame-
work for resolution of failed banks.
11
A total of 30 trillion yen of public funds, including those for capital injection, were made
available, with 17 trillion yen assigned to the Special Account of the DIC to cover the losses
of failed financial institutions and 13 trillion yen allocated for capital injection into banks.
12
This was just when the supervisory power of the MOF was taken over by the newly
created Financial Supervisory Agency (FSA).
138 K. ARAMAKI
Under the law, a failed bank could either be placed under the Financial
Reconstruction Administration (FRA), or temporarily nationalized. Under
the FRA, the authorities designate an administrator who replaces existing
management of a failed bank and tries to find a healthy bank to purchase
the business of a failed bank. When the administrator cannot find buyer,
he can transfer the business of a failed bank to a bridge bank, which the
DIC establishes. Under nationalization, large-scale banks with systemic
risk can be purchased by the government, and the authorities will desig-
nate a new management. It was generally conceived that financial institu-
tions with more systemic implications would be nationalized. For both
institutions under FRA and nationalized banks, business operations were
to be continued, with liquidity provision directly from BOJ in the case of
institutions under FRA and with liquidity support provided by the DIC in
the case of nationalized banks. In the latter case, the DIC was to borrow
from the BOJ to finance such liquidity support. Pursuant to the
Reconstruction Law, the LTCB was nationalized in October 1997, and
NCB, which was heavily exposed to the real estate industry and suffering
from a large amount of NPLs, was nationalized in December 1980.
Second, the other law that was newly introduced was a strengthened
capital injection scheme (again, effective through March 2001) tied into
the early correction measure.13 This measure was introduced by the
Financial Function Early Strengthening Law (“Early Strengthening Law”)
that replaced the Emergency Law in October 1998, and some 7.5 trillion
yen was injected into 15 banks in March 1999. The capital injection was a
significant step to address the undercapitalization of Japanese banks. The
amount injected was more than four times as large as the previous injection
in March 1998 (1.8 trillion yen), after which the Japan premium (extra
interest that Japanese banks were required to pay when they sought over-
seas funding) began to decline. Under the Reconstruction Law, the LTCB
was nationalized in October 1998. The size of public funds made available
for the new framework was doubled from 30 trillion yen to 60 trillion yen.
With the new comprehensive safety net framework in place, the authorities
were able to deal with a failed bank directly, without necessarily finding an
assuming bank beforehand. For viable but undercapitalized banks, large-
scale injections also became possible. The authorities quickly embarked on
a systematic clean-up operation, fully utilizing the new framework.
13
The early correction measure introduced in April 1998 is the scheme under which the
authorities order a bank to take corrective measures, such as the submission of a management
improvement plan or strengthening of its capital base, based on its capital–asset ratio.
overnment-led Promotion of NPL Resolution Pursued in the First Half

G
of 2000s under Prime Minister Koizumi
After such a comprehensive scheme for strengthening viable banks through
capital injection and for smooth resolution of unviable banks was placed
into operation, Koizumi became the president of the Liberal Democratic
Party (LDP) and started the Koizumi administration in April 2001, under
which resolution of the NPL problem was actively pursued:
In April 2001, a strong encouragement for writing off NPLs was stated in
the Emergency Economic Package adopted by the government. Major
banks were required to remove from their balance sheets the existing
NPLs classified as “in danger of bankruptcy” or worse,14 in principle,
within two years and those NPLs newly classified as such, in principle,
within three years (“Two Year–Three Year Rule”). “The Financial
Revival Program” was announced by the government in October 2002,
aimed at halving the NPL ratio of major banks by March 2005 from the
level at the time (8.4% as of March 2002).
In January 2002, equity holdings by banks were restricted, and an entity
was established to purchase equities held by banks and firms (the BOJ
also started to purchase equities from banks).
In April 2003, the Industrial Revitalization Corporation was established,
which bought NPLs from non-main financing banks and endeavored to
revive the borrowers through cooperation with the main financing bank
(existed from April 2003 to June 2007).
In May 2003, public funds were injected into a large financial group,
Resona Group, to strengthen its capital base, and this became a turning
point for the NPL problems.15
Although a large regional bank (Ashikaga) was found to be insolvent

and nationalized in November 2003, the goal of halving the NPL ratio of
major banks was achieved as of the end March 2005, and the NPL prob-
lem was finally resolved.
14
Refers to “Bankruptcy,” “De facto bankruptcy,” and “In danger of bankruptcy.”
15
Nakaso (2014) wrote that, triggered by public funds injection into Resona Bank, stock
prices gradually started to rise, and it was finally felt that the crisis was gradually waning.
Nishimura (2011) pointed out that public funds injection into Resona Bank with no writing
off of stocks shows a clear example of a soft landing approach, which the administration of
the time was taking, despite its hard pressures on banks to dispose of NPLs.
140 K. ARAMAKI
In April 2005, the full deposit protection, in principle, was terminated,

and the crisis came to an end.16
Why Was the NPL Problem Not Resolved Sooner?
Why Did the Private Sector Take So Long to Resolve the NPL Problem?
Adoption by the Corporate Sector of Gradual Resolution

The crisis broke out seven years after the burst of the bubble. Why did the
crisis break out so late? As we have seen, the fundamental problem was the
hangover of the excess (low-profitability) assets in the corporate sector. What
was needed is a prompt resolution to these excesses. However, the corporate
sector did not swiftly dispose of the excesses and chose to take time to deal
with the issue. The reason for the gradual approach included initially an opti-
mistic expectation for the future course of the economy (from another per-
spective, delay in recognizing the seriousness of the problem). Later in the
process, there was a possibility that concern for the acute shock that could
result in the economy by prompt resolution of the excesses might have
affected the pace of the resolution.17 The collective decision-making system,
under which a decision tends to be made based on prior consensus incorpo-
rating interests of related parties, and the corporate governance system,
under which it is difficult to reflect views of people outside the management
of companies, may have been also behind the gradual approach.
Financial Sector Also Took a Gradual Approach

Two Methods of Disposition of NPLs
The financial sector seems to have followed the similar gradual approach to
the problem. The financial institutions have two options in coping with
NPLs.18 One is indirect disposition, registering loan loss reserves on the lia-
16
The full deposit protection, which was introduced in 1996, was scheduled to be termi-
nated by end March 2001 but was extended to end March 2002 for time deposits and to end
March 2003 for checkable deposits. The full protection of checkable deposits was extended
further to end March 2005.
17
Supplement 2 in this chapter gives a very rough estimate of the size of the excess assets
(it is estimated that excesses accounted for nearly three-tenths of all assets), and an estimate
of an increase in the number of unemployed people and a rise in the unemployment rate if
excesses were promptly disposed of.
18
In the case where loans with the total face value of 100 incurred a loss of 10, there are
two types of disposition.
bility side of the balance sheet. In this case, the troubled assets continue to be
held. The other is direct disposition, removing the troubled assets from the
balance sheets, and at the same time, reducing capital. In the case of direct
disposition, the troubled assets may be seized, and in a more serious case, the
borrower might be liquidated, leading to an increase in unemployment,
reduction in wages, and a fall in investment. Banks generally favored indirect
disposition and continued to hold relevant assets on their balance sheets.19,20
What Is the Cost of Holding NPL?

Under the gradual approach to the NPL problem, the troubled assets
continued to stay on the banks’ balance sheets. What sort of problems did
this bring about? A possibility of credit crunch and negative effects on
efficiency are among the costs frequently mentioned.
Indirect disposition (registering loan loss reserves)

(Asset) Loans 100
(Liabilities & Capital) Debt 80, Capital 20
→(Asset) Loans 100
(Liabilities & Capital) Debt 80, Loan loss reserve 10, Capital 10
Direct disposition (removing the troubled asset)
(Asset) Loans 100
→(Asset) Loans 90
Direct deposition can be done through such measures as seizing and selling collaterals
(factory, office, machines, etc.) or resolving the debtor.
19
Financial institutions tended to regard it as their mission to assist those borrowing com-
panies, which were considered viable but experiencing temporary difficulties, through reduc-
tion of interest rates or the rescheduling of loan repayments, and such loans were not
regarded as NPLs. This approach was later modified in the process of the resolution of NPL
problems, and those loans for which conditions were alleviated were included in the category
of NPLs.
20
The introduction of the BIS capital–adequacy ratio, agreed to in the late 1980s, may
have acted as another constraint on banks. Under the agreement, banks were required to
clear the minimum capital–asset ratio of 8% by end March 1993. Himino (2005) pointed out
that, the capital–asset ratio of Japanese city banks was as low as 3%, if calculated based on the
original proposal of the United States and the United Kingdom in 1987. Japanese authorities
requested that unrealized capital gains of securities held by banks had to be included in capi-
tal, and it was agreed in late 1987 that 45% of unrealized capital gains could be included in
capital. Most of Japanese banks cleared the requirement by end March 1990, partially helped
by this treatment. After the burst of the bubble, however, continuous decline in stock prices
continued to depress banks’ capital, increasing the instability of bank operations (Komine
2011, 324–26).
142 K. ARAMAKI
① Credit Crunch
It is argued that if NPL continues to be held on a bank’s balance

sheet, it reduces available resources for new lending, thus bringing
about a credit crunch. As for the possibility of this negative effect, we
need to know if the problem of lending (or investment) stagnation
observed after the burst of the bubble was due to the banks’ unwilling-
ness to lend or due to the borrowers’ unwillingness to borrow. In this
regard, we should note that the lending stance of financial institutions
was generally not tight, excepting a short period immediately after the
burst of the bubble and the crisis periods in the late 1990s (see
Fig. 3.7 in Chap. 3). Also, as Fig. 3.22 in Chap. 3 shows, the outstand-
ing balance of long-term debt of companies started to stagnate after
the collapse of the bubble and then fell sharply after 1998. So, it is
possible that the tightening of the lending attitude after the crisis was
responsible for the sharp decline in long-term debt beginning in 1998.
However, it seems to be difficult to regard the eased lending attitude
as causing stagnation of long-term debt in the period prior to the crisis.
The credit crunch was generally not observed in the 1990s before the
crisis.
② Negative Effects on Economic Efficiency
It is also argued that those companies with difficulty in serving their

borrowings are inefficient and allowing them to survive will lower the
efficiency of the whole economy (Zombie company arguments). For this
argument, a counterargument similar to the credit crunch applies. If there
was no credit crunch in Period I (initial adjustment period over
1991–1997), then the problem was not the existence of arguably ineffi-
cient companies but the insufficient demand for investment in productive
and efficient areas. So, it is not the elimination of the allegedly inefficient
companies but finding productive and risk-taking companies that was
really needed at that time.
There may be some truth in the Zombie company argument, though.
The corporate sector suffered long from the excess capacity overhang, and
the sector recorded a very stagnant performance in investment. Positive
risk-taking for the future by the corporate sector was contained for a long
time after the burst of the bubble.
There were two types of problems. One relates to the case where a
company itself is solvent but suffers from redundant unprofitable capacity.
The other relates to the case where the company holding assets itself is
insolvent. In the former case, early recognition and disposition of the
unprofitable assets is needed from the viewpoint of efficiency. If this is not
done, those assets that are not profitable continue to place burden on the
company, depressing risk-taking. Banks could have encouraged companies
to dispose of excess assets more promptly. However, the corporate sector
took time to resolve the excess capacity overhang; as is explained later (in
detail in Chap. 6), it took about 15 years to get rid of the excess assets,
lengthening investment stagnation. While postponing resolution is not
beneficial to the company, why did it opt for delaying the decision? The
answer may be found in the structure of governance of a company that
makes a drastic decision difficult to take without a crisis.
In the latter case of an insolvent company, usually it cannot continue to
obtain funding if its financial position is properly assessed. Figure 4.4 shows
that operating profits of the companies with capital less than 10 million yen
nearly disappeared after the collapse of the bubble. These companies
counted as many as 1.6 million (78.7% of total 2.0 million at that time) and
accounted for 29.9% of total employment by the corporate sector as of
1990 (but only 10.8% of total investment as of 1990).21 Stagnation of
wages (and to a lesser extent investment) is partly accounted for by these
companies’ poor performance. How could these companies with no profits
stay in the market? In the long stagnation period, the government provided
a loan insurance scheme for small- and medium-sized enterprises (SMEs),
under which 100% (later reduced to 80%, in principle) of loans were cov-
ered by government-subsidized funds, if defaulted. This scheme may have
helped those SMEs that temporarily had difficulty in funding while remain-
ing basically viable. It is also possible this scheme may have saved unprofit-
able and unviable companies, depressing the efficiency of the economy, at
the cost of the taxpayers.22
21
The number of companies with capital less than 10 million yen declined to 1.3 million
(i.e., 54.4% of total 2.4 million) in 1997, and their share in total employment declined to
15.9%. This decline reflects changes in capital requirements under the 1991 amendment of
the Commercial Law, which raised the minimum capital to 10 million yen for stock compa-
nies, with the transition period lasting until end March 1996.
22
This scheme is under the jurisdiction of the SME Agency of the Ministry of Economy,
Trade and Industry and is widely supported by political circle. The ratio of insurance has
been in principle reduced to 80%. As of February 2016, 2.8 million cases of loans are insured
and the outstanding balance insured amounts to as much as 25.8 trillion yen.
144 K. ARAMAKI
(million yen)
35000000
30000000
1 bil. or
25000000 more
20000000 100 mil.–

< 1 bil.
15000000
50 mil.–
10000000 < 100 mil.
5000000 10 mil.–
< 50 mil.
0
< 10 mil.
FY1960
FY1964
FY1968
FY1972
FY1976
FY1980
FY1984
FY1988
FY1992
FY1996
FY2000
FY2004
FY2008
FY2012
-5000000
Fig. 4.4 Operating profits by companies’ capital size. Source: Ministry of

Finance, “Financial Statement Statistics of Corporations by industry”
Why Did the Government Take So Long to Solve the NPL Problem?

Adoption of a “Step-by-Step” Approach and Its Background
Adoption of a Gradual Approach for Resolution
We have seen that the private sector took a gradual approach to the NPL
problem. Now, let us see why the government took so long to solve the
NPL problem.
The government also took a step-by-step approach to the NPL problem.
In August 1992, administrative guidelines23 were issued by the MOF,
the supervisory authority for the financial sector at that time. The guide-
lines stated that, while encouraging financial institutions to promptly for-
mulate their NPL resolution policy, NPLs should be actively resolved in a
planned and staged manner, prescribing a gradual approach to resolution.
The stance of the government became more proactive later in the 1990s.
For example, in April 1995, the government stated in “The Emergency
Economic Measures under the Yen Appreciation” that NPLs should be
disposed of within about next five years so that the resolution of the prob-
lem could be seen. However, the government approach was still based on
23
Ministry of Finance, “Kinnyu gyosei no tomen no unnyo hoshin” (On the current policy
of the financial sector supervision), August 18, 1992.
promotion or encouragement, and the initiative was basically expected to

come from the financial institutions’ side.
Non-availability of a Comprehensive Resolution Framework

This approach may have reflected the expectation of economic recovery
(particularly, the expectation of bottoming out of land prices) and the
government’s concern over the negative impacts on the economy of
rapidly resolving the NPL problem (e.g., increase in bankruptcy and
unemployment). The more fundamental constraint that hindered the
government from a swift resolution, however, may have been the lack of
an institutional framework for resolution of unviable banks and for a
capital injection scheme for viable banks.
Without capital injection, the government cannot pressure viable banks
to dispose NPLs beyond banks’ capabilities. Without a comprehensive
framework for failed bank resolution, including nationalization of large
banks, the government cannot actively pursue the goal of dissolving unvi-
able banks, as it would push the situation out of control.24
Then, the next question is why the comprehensive resolution framework
and the capital injection scheme were not introduced earlier? An MOF staff
member who served as director-general of the Banking Bureau of the MOF,
which was in charge of banking sector oversight, in the early 1990s, later
stated that, after having studied the case of the prewar financial crisis of 1927
(Showa Kinnyu Kyoko), he concluded that, unless banks become insolvent
and unable to pay, provision of public funds for banks will never be accepted
by general public. Provision of funds will be regarded not for the protection
of depositors but for the rescue of banks, resulting in confusion and an
increase in costs to the taxpayers.25 This may explain part of the delay in
24
Fukao (2009) pointed out that the estimated combined amount of net business profits
(inclusive of losses due to disposition of NPLs) of banks (city banks, long-term credit banks,
and regional banks), a concept similar to operating profits, was negative for 10 straight years
from FY 1993 to FY 2002; that is, after the burst of the bubble, banks could not cover credit
risk by their profits from their main business operations. Banks recorded surplus in terms of
final profits in 5 out of the 10 years, through sales of assets. He also pointed out that the
accumulated losses of banks arising from disposition of NPLs amounted to 96.8 trillion yen
over 14 years from March 1992 to March 2006, equivalent to 19% of GDP in 2006.
25
Matsushima, and Takenaka (2011, 225–6). “Nihon Keizai no Kiroku Jidai Shogen
Shu Oraru Hisutori” (Records of the Japanese Economy—Testimony of the Era—
Collection of Oral History) 2011 Economic and Social Research Institute, Cabinet
Office, Japanese Government (“Baburu/ Defure ki no Nihon Keizai to Keizai Seisaku
(Rekisi Hen) 3” (“the Japanese Economy and Economic Policy in the Period of Bubble
146 K. ARAMAKI
fundamental responses by the MOF. In fact, earlier attempts for the

introduction of public funds faced fierce criticism. In August 1992, then
Prime Minister Miyazawa mentioned a need to use public funds to solve
the NPL problem, but he soon withdrew it in the face of objections
from all fronts, including banks themselves.26 In December 1995, when
the government decided to use public funds to resolve unviable housing
loan companies (“Jusen”), criticism throughout the nation mounted.27
Insufficiency of Disclosure Requirements

The lack of or the late introduction of the comprehensive resolution
framework was a product of various relevant factors. We have seen that the
general public or the political circle did not regard the use of public funds
for the financial sector as appropriate, at least by mid-1990s. Since percep-
tion is basically formed by available information, an important question is
whether the authorities in charge of NPL problem, that is, the MOF and
BOJ at the time, recognized the seriousness of the NPL problem as of the
first half of the 1990s and, also, what information was made available to
the public?
As for the first question, the starting point is disclosure requirements
imposed on banks regarding NPLs. Until the beginning of the 1990s,
there was virtually no disclosure on NPLs. From the business year end-
ing end of March 1993, banks started to disclose NPLs, but the cover-
age of the initial disclosure was limited to loans to borrowers who had
become legally bankrupt (in the case of major banks, loans past due for
six months or longer were disclosed as well).28 So, by disclosure alone,
and Deflation Vol. 3 (History)”) 2011 Economic and Social Research Institute, Cabinet
Office, Japanese Government) pp. 225–226.
26
See Komine (2011, 473–6); Nishino (2003); and Nihon Keizai Shimbun Sha (2000).
27
When dissolving Jusen, public funds were used to avoid negative impacts on the financial
system by imposing loan loss onto agriculture-related financial institutions that had lent
heavily to Jusen. However, according to a book written by a journalist (Nishino 2003), the
agricultural sector demanded that saving the agricultural-related financial institutions should
not be used in the explanation as objectives of the use of public funds. In the absence of a
clear and easily understandable explanation, the general public, and therefore, political circle,
considered that the public funds were used to bail out Jusen, for which cases of fraudulent
activities were widely reported in the media.
28
Disclosure requirements were gradually strengthened. See footnotes 6 and 7 in this
chapter.
it would have been impossible to make a comprehensive assessment of the

NPL problem in the early 1990s.
Nakaso (2001) wrote “the Bank of Japan had detected by early 1993
that potential risk in the financial system could be larger than it had been
widely believed.” A banking Bureau official later stated that, even prior to
that, that is, as of summer of 1992, the Banking Bureau of the MOF rec-
ognized that if the stock price fell to around 12,000 yen (it was about
14,000 yen around that time), some banks could become insolvent, and
that if it happened, the Bureau would enact a special law to introduce
public funds while liquidity was being provided by the BOJ. If the enact-
ment of such a special law was delayed, an emergency law for morato-
rium could be enacted.29 However, because stock prices temporarily
stabilized soon afterwards, such a response was not placed into
operation.
As for the size of NPLs, it is stated that, in August 1992, the Banking
Bureau was informed by the BOJ that the size of NPLs would exceed 40
trillion yen, and in early 1994, the Banking Bureau itself estimated the size
of NPLs to be 42 trillion yen.30 However, they thought that if the land
prices stopped falling (land prices had fallen by some 50% by that time), it
would be possible for banks to dispose of the NPLs using their business
profits.31
If these statements are correct, then both the MOF and the Bank of
Japan recognized the seriousness of the NPL problem as of 1992–1993. If
a crisis broke out due to a further fall in stock prices, then the Banking
Bureau thought that public funds would be introduced to resolve the prob-
lem; and if a crisis did not happen and if land prices stopped falling, then the
NPLs could be disposed of by using banks’ business profits. One possible
reason why, despite such a recognition, a fundamental response was
not taken is that the government held an optimistic expectation for the
29
Matsushima and Takenaka (2011, 225).
30
The Ministry of Finance announced that the size of NPLs of large banks was 7–8 trillion
yen in April 1992 and around 12 trillion yen in October 1992. However, this covered only
major banks and did not cover all financial institutions. Also, the assets covered were limited
to bankrupt or past due claims. As for claims on non-bank financial institutions, including
Jusen, creditor financial institutions did not grasp the actual situation, and therefore, they
were not classified as bankrupt or past due.
31
Matsushima and Takenaka (2011, 220–1).
148 K. ARAMAKI
future course of stock and land prices (and the economy as a whole),
which was a crucial factor in the NPL problem. In fact, in the early stage
after the collapse of the bubble, there was a serious concern that the land
price surge might return if policy response was eased.32 Even after the
land price dropped substantially, it was difficult even to imagine that
the land prices would continue to fall for more than a decade. The govern-
ment, banks, corporations, media, and people at large were still trapped by
“Tochi Shinwa” (land myth), and it might have delayed an appropriate
response.
By contrast, Nakaso (2001) referred to a dilemma that the authorities
including the BOJ faced. Nakaso argued, if the BOJ called for introduc-
tion of a comprehensive safety net framework, it could trigger a financial
crisis. Without a clear strategy on how to address the issue, the authorities
continued with a piecemeal approach to the NPL problem. This is a logi-
cal argument, but with hindsight, postponing a comprehensive response
only aggravated the situation, leading to a serious financial crisis in the late
1990s.33
As has been repeatedly pointed out, the core problem was excess
(unprofitable) assets in the corporate sector. Unless the corporate sector
removed these excesses, the economy could not recover fully. What was
needed for the financial institutions was to help borrowing companies
remove these excesses, not to help them continue to hold these excesses.
The financial sector, however, did not act in this way.
What could have been done then, under the circumstances, when a much
needed comprehensive framework did not exist? If we are to make a mere
32
The official discount rate, which was raised to 6.0% in June 1990, but was lowered
beginning in July 1991. The aggregate lending limit, which was introduced in March 1990,
was lifted in December 1991. A Banking Bureau executive at that time said later, “When we
lifted the aggregate lending limit, most of the newspaper articles criticised (it), by writing ‘If
policy reaction is eased, land price will never fail to rise again’” (Matsushima and Takenaka
2011, 313).
33
In January 1997, Prime Minister Hashimoto (LDP) declared the intention to start dras-
tic reforms in six areas, including fiscal structure and the financial system. Directed by Prime
Minister Hashimoto, the Ministry of Finance, then the supervisory authority of banks and
securities firms, started examination of comprehensive liberalization of the Japanese financial
system called “Japan’s Financial Big Bang,” and reform plans were authorized by advisory
councils attached to the MOF in June 1997. Those reforms were surely necessary for Japan,
but their timing was not right. With hindsight, when the financial sector was fragile, as evi-
denced by series of failures of financial institutions, the greatest care should have been paid
to maintain stability of the sector and markets without embarking on drastic reforms.
theoretical argument with hindsight, probably we should have had a finan-

cial crisis or extensive bank and company failures in the early 1990s. If a
crisis was unavoidable, we should have had one while Japan’s banking sec-
tor, corporate sector, and also the government still held far more strength to
cope with a crisis, as compared with five years later. If a crisis had happened,
Japan could not have avoided sharp deterioration of the economy and insta-
bility of the society, at least for some time.34 However, if a comprehensive
framework for strengthening the financial system, including a capital injec-
tion scheme introduced during the crisis, it could have been possible to
restore a sound financial system and economy more swiftly than actually
happened. Then, Japan’s economy might have recovered from the shock of
the collapse of the bubble in a relatively short period of time and could have
returned to a relatively high-growth path similar to the one in the period
before the bubble. In reality, all relevant parties made their maximum efforts
to containing a risk of crisis (it is their duty), and it was unfortunate that
Japan still had sufficient strength to delay a crisis for some time. Japan suc-
ceeded in controlling the pending problem that they faced, but left a more
serious problem for the future. This point will be highlighted by the analysis
of the case of Scandinavia in the next subsection.
How Were Banking Crises Handled by Other Countries?

(Scandinavian Case)
In order to find out what should have been done, let us look at cases in
other countries.35 Response to the collapse of the bubble by the
Scandinavian countries is sometimes referred to as a success, so in this
subsection, we examine these cases.
The Scandinavian countries had a banking crisis in the early 1990s,
which had substantive commonalities in background but big differences in
outcomes with Japan.
Under financial liberalization, started by the 1980s and favorable eco-
nomic conditions, rapid credit expansion and an asset bubble emerged in
Scandinavian countries in the 1980s. With the burst of the asset price bubble
34
Supplement 2 in this chapter gives a very rough estimate of impacts on employment of
a prompt resolution of excess assets. According to the estimate, if the total excess assets had
been disposed of in fiscal 1991, the number of unemployed people would have increased by
more than 12 million, and the unemployment rate would spiked by more than 10 times,
increasing from an actual 2.1% to an estimated 21.2%.
35
Explanation in this part is based on IMF (1995).
150 K. ARAMAKI
in the late 1980s (Norway) and at the beginning of 1990s (Finland and
Sweden), these countries were faced with severe banking crises in the early
1990s (started in Norway in the late 1980s) (Figs. 4.5, 4.6, and 4.7).
As the NPL problem developed into a systemic banking crisis rather
quickly, the three governments responded by decisive measures.
In Norway, the loan loss problem surfaced in late 1980s, first with finan-
cial companies, spreading to banks, and even large banks were placed in
serious difficulty by the end of 1990. Substantial funds were injected, and
500 6
Norway
450 GDP
(right scale) Real estate prices (left scale) 5
400
350 4
300
3
250
Consumer prices (left scale)
2
200
150 1
Bank share prices (left scale)
100
0
50
0 –1
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
Fig. 4.5 Real GDP growth rate and asset price (1980 = 100): Norway. Source:
IMF (1995) “The Nordic Banking Crises: Pitfalls in Financial Liberalization?”
IMF Working Paper WP/95/61
1400 5
Sweden
GDP (right scale)
1200 4
3
1000
2
800
1
Real estate prices
600
(left scale) 0
400
–1
Consumer prices (left scale)
200 –2
0 –3
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
Fig. 4.6 Real GDP growth rate and asset price (1980 = 100): Sweden. Source:
600 7
Finland
500 GDP (right scale) 5
3
400 Real estate prices
(left scale) 1
300
Consumer prices –1
200 (left scale)
–3
100 –5
0 –7
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
Fig. 4.7 Real GDP growth rate and asset price (1980 = 100): Finland. Source:
by the end of 1991 the government had become the sole or majority owner
of the three largest commercial banks in Norway.
In Sweden, while problems surfaced with financial companies in 1990,
large banks faced with financial difficulties in 1991. The Swedish govern-
ment injected funds into these large banks (including the largest bank
which was government owned), by way of such measures as direct pur-
chase of new equities and provision of loan guarantees from 1991.
In Finland, as the saving banks were most severely hit, most support was
directed to Skopbank (the central institution for the saving banks). Faced
with a liquidity crisis in September 1991, the Bank of Finland (BOF) took
over Skopbank. In April 1992, a fund, Government Guarantee Fund
(GGF), was established, and the GGF acquired Skopbank from the BOF in
September 1992 and injected capital. Forty-one savings banks were merged
into the Savings Bank of Finland (SBF), which was subsequently taken over
by the GGF, which then made capital injections.
Furthermore, Sweden and Finland used explicit blanket guarantees
on bank liabilities (Norway did not explicitly announce it). In Sweden, a
technique to split a troubled bank into a “good bank” and a “bad bank”
(an asset management company handling NPLs of the troubled bank)
was used.
By mid-1990s, GDP growth recovered, and the Scandinavian cases
were generally regarded as successes in handling banking crises (Fig. 4.8).
152 K. ARAMAKI
(%)
8
2
Norway
0 Sweden
Finland
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
-2
-4
-6
-8
Fig. 4.8 GDP growth rate: Norway, Sweden, and Finland. Source: IMF (2014)
World Economic Outlook database Oct. 2014
Scandinavia vs. Japan: Why the Difference?

There is a big difference between Scandinavian case where solid growth
returned soon after the crisis and Japan’s case where a long stagnation fol-
lowed after the collapse of the bubble and the financial crisis. Why this
difference?
It seems that strong government intervention into the financial sec-
tor, including capital injection and nationalization, is necessary in
order to effectively deal with a problem of the financial sector facing a
systemic risk. Such intervention can be made possible only when there
is a strong political will to rescue financial system using tax money.
How can such a political will be formed? Only through a crisis, as was
learned by a MOF official from the Showa financial crisis? If that is the
case, why the difference? While Scandinavian countries faced a crisis
very shortly after the collapse of the bubble, Japan did not have a crisis
soon after the collapse of its bubble. In Japan, all the parties concerned
made maximal efforts to avoid an early eruption of a crisis under a situ-
ation in which a comprehensive legal framework for orderly resolution
of a crisis was lacking. These actions delayed the formation of a politi-
cal will that would be necessary to take drastic measures to fundamen-
tally strengthen the financial system. After all, Japan experienced a
worst scenario to face a serious financial crisis after seven years of
stagnation.
Summary of the Financial Crisis

The financial crisis broke out seven years after the burst of the bubble. The
government’s macroeconomic policy supports, in terms of repeated eco-
nomic measures and monetary easing after the bubble collapse, might
have given relief to troubled corporations and banks. However, with con-
tinued sales stagnation, the continued fall in asset prices, particularly land
prices, and a weak economic recovery, the financial position of corpora-
tions and, therefore, of banks deteriorated, causing NPL problems to
grow more and more serious year by year. The problem behind the NPLs
was an excess assets hangover, so it was necessary to dispose of these exces-
sive assets swiftly in order to avoid prolonged profit stagnation and recover
positive risk-taking behaviors of companies. However, companies took
time to address the problem. Banks typically did not press companies to
dispose of these excesses promptly. Behind these behaviors were optimistic
expectations for the future and a problem with governance. At the same
time, there seems to have been growing concern about the hugely nega-
tive impacts on the economy if a rapid resolution was conducted.
The government let banks take the initiative and, as a result, took a
gradual approach to the problem. In tackling the NPL problem, the lack
of a comprehensive framework for resolution of unviable banks including
nationalization and capital injection for viable banks, seem to have placed
a fundamental constraint on the way government dealt with the problem.
It may have been possible to introduce these policy tools sooner and
resolve the NPL problem more quickly, but duties of all relevant parties
were to prevent a crisis, and Japan unfortunately had sufficient strength to
delay a crisis at that time. With hindsight, Japan probably needed a strong
will to resolve the problems of both corporate and banking sectors—when
the country had more strength to cope—through strong government
interventions, even if such action could have triggered a crisis. If the par-
ties had acted in that way, the Japanese economy could have returned to a
reasonably high–growth path after a relatively short period of time, and
would not have experienced the lost decade or decades.
Impacts of the Financial Crisis
undamental Changes That Were Brought about by the Financial Crisis

F
Fundamental changes were brought about in the Japanese economy by
the financial crisis. In this section, we will first look at what changes
took place, and we note that most of these changes were related to
company behaviors. As a further analysis of company behaviors will be
154 K. ARAMAKI
conducted in Chap. 6, we take just a brief look at what happened in this

subsection.
On the macro level, the economic conditions deteriorated. The real growth
rate dropped further, from 1.7% in 1991–1997 (Period I: Initial Adjustment)
to 0.4% in 1998–2002 (Period II: Financial Crisis and Its Impacts), although
this decline also reflected effects of the dot.com bubble collapse in 2000–2001.
In this deceleration process, the growth contribution of private investment
further dropped from −0.1% in 1991–1997 to −0.2% in 1998–2002.36
The number of corporate bankruptcies, which had started to rise after
the start of the 1990s, further went up and stayed high in and after the
financial crisis (Fig. 4.9).
Business conditions, as judged by the enterprises, plummeted, going below
the level recorded immediately after the collapse of the bubble (Fig. 4.10).
The lending stance of financial institutions also dramatically changed,
sharply shifting from excess of “eased” over “tight” to excess of “tight”
over “eased” (Fig. 4.11 [reproduction of Fig. 3.7 in Chap. 3]). A similar
tightening of lending stance occurred immediately after the collapse of the
bubble. However, at that time, tightening of lending stance was not so
25,000
20,000
15,000
10,000
5,000
Fig. 4.9 Number of corporate bankruptcies. Source: Tokyo Shoko Research
36
The expected growth rate held by companies for the next three years declined further
from 2.2% in Period I (Initial Adjustment Period, 1991–1997) to 1.0% in Period II (Financial
Crisis and Its Impacts Period, 1998–2002), as explained in Chap. 3.
(%)
60
40
Large
20 companies
Semi-large
companies
0
Small- and
medium-
-20 sized
companies
-40
-60
Jul-93
Jul-98
Sep-92
Sep-97
Jan-91
Jan-96
Nov-91
Nov-96
Mar-90
May-94
Mar-95
May-99
Mar-00
Fig. 4.10 Economic conditions, as judged by companies. Note: The chart shows
the share of “good”-the share of “bad.” Source: Tankan Business Survey, BOJ
strong for SMEs, which were more dependent on lending than for larger
companies but, after the financial crisis, the sharp tightening of lending
stance was observed across company size.
Against the background of the sharp deterioration of the economy, fun-
damental changes took place in employment and company behaviors, and
deflation started at the same time.
Fundamental Change ①: Unemployment Rate Climbed Up

Although the unemployment rate was increasing in Period I (1991–1997),
after hitting the bottom of 2.0% in February 1992, it stopped rising briefly
from late 1995 to mid-1997. However, it started to rise sharply from 3.5% in
October 1997, shortly before the failure of large financial institutions, to
4.0% in April 1998, 4.5% in November 1998, and 4.8% in June 1999. It
reached 5.5% in 2002–2003 (Fig. 4.12 [reproduction of Fig. 3.11 in Chap.
3]). The number of unemployed increased by 0.86 million in a year and eight
months from 2.38 million in October 1997 to 3.24 million in June 1999.
156 K. ARAMAKI
(%)
40
30
20
Large companies
10
Semi-large
0 companies
Small- and
-10
medium-sized
companies
-20
-30
-40
Mar-90
Jan-91
Nov-91
Sep-92
Jul-93
May-94
Mar-95
Jan-96
Nov-96
Sep-97
Jul-98
May-99
Mar-00
Fig. 4.11 Lending stance of financial institutions, as judged by companies, Japan

1990–2000. Note: The chart shows the share of “eased”-the share of “tight.”
Source: Tankan Business Survey, BOJ
(%)
6
1998–2012
4.6% 2013–2017
5
3.4%
1991–1997
4
1985–1990 2.8%
2.5%
3 1974–1984
1956–1973 2.1%
1.5%
2
Fig. 4.12 Unemployment rate. Source: Ministry of Internal Affairs and

Communications
Fundamental Change ②: Nominal Wages Started to Decline

After the financial crisis, nominal wages started to decline from the begin-
ning of 1998. Since then, the nominal wages has shown a declining trend
over a long period, and the average of year-on-year change on a monthly
basis in 15 years, from January 1998 to December 2012, was −0.8%. The
cumulative decline of the index (2010 = 100), from 113.6 in 1997 to
98.9 in 2012, is −12.9% (Fig. 4.13).
Fundamental Change ③: Shift of Employment toward Non-

Regular Work Accelerated
The share of non-regular workers of total employees stayed fairly flat in
the first half of 1990s but switched to a rising trend in the second half of
the 1990s, and continued to rise thereafter at a rather high pace (Fig. 4.14).
At the same time, the number of regular employees started to decline
rapidly after the financial crisis. After hitting a peak of 38.1 million in
February 1997, the number of regular employees declined by 1.7 million
(−4.5% from February 1997) to 36.4 million in February 2001. The pace
(%)
6
0
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-05
Feb-06
Feb-07
Feb-08
Feb-09
Feb-10
Feb-12
Feb-13
Feb-14
Feb-11
-2
-4
-6
Fig. 4.13 Nominal wages (year-on-year change, three-year moving average).

Note: Nominal wage is the total monthly cash earnings per employee (three-
month moving average of the year-on-year growth rate in establishments with five
employees or more). Source: Ministry of Health, Labor, and Welfare, “Monthly
labor survey”
158 K. ARAMAKI
(%)
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
Fig. 4.14 Share of non-regular employees in total number of employees, exclud-

ing executives. Source: Statistics Bureau, Ministry of Internal Affairs and
Communications “Labor force survey”
of decline accelerated from January to March in 2002, losing another 3.1

million (−8.0% from February 2001) before hitting a bottom of 33.3 mil-
lion in the period January–March 2005. As a whole, 4.8 million (12.6% of
the peak in 1997) regular employment positions were lost in the eight-
year period from February 1997 to January–March 2005 (Fig. 4.15).
Fundamental Change ④: Switch of Companies from Financial

Deficit to Financial Surplus Sector
Furthermore, a change took place in saving and investment behaviors of
companies. Companies (nonfinancial enterprises) had been reducing the
size of financial deficit after the burst of the bubble, but they switched to
a financial surplus sector from 1998.37 The amount of financial surplus hit
a peak in 2003, and thereafter, started to decrease but still stayed positive
even in recent years (Fig. 4.16).
37
Financial surplus/deficit corresponds to the difference between the amount of financial
investment and the amount of fundraising, which is conceptually equal to net lending/net
borrowing (formerly called “the difference between savings and investment”) in the national
account.
(10 thousand persons)

3900
3800
3700
3600
3500
3400
3300
3200
3100
3000
2900
Fig. 4.15 Number of regular workers. Source: Statistics Bureau of Japan, “Labor
Force Survey—Special Survey”
(％)
15.0
10.0
Financial
institution
5.0
Nonfinancial
enterprise
0.0
General
80 83 86 89 92 95 998 001 004 007 010 government
19 19 19 19 19 19 1 2 2 2 2
-5.0 Household
Foreign
-10.0 sector
-15.0
Fig. 4.16 Financial surplus/deficit by sector (in percent of GDP). Note: Years
are fiscal year. Source: Bank of Japan, “Flow of Funds”
160 K. ARAMAKI
Fundamental Change ⑤: Deflation Started

Among significant changes that occurred in Japan, the decline in price
level (deflation) has attracted the biggest attention. The Consumer Price
Index (CPI) (excluding fresh foods) hit a peak in 1997–1998, and started
to gradually decline. On a year-on-year change basis, CPI (excluding fresh
food) started to record a decline from July 1998, and excepting short
periods of global price hikes of food and natural resources before the GFC
and in more recent years, it continued to record a fall, that is, basically for
nearly 15 years from July 1998 to April 2013—but it was a mild deflation.
The average rate of changes of CPI (excluding fresh food) from the previ-
ous year in the period July 1998 to April 2013 was −0.3%, and the cumu-
lative price decline over the 15-year period was −3.6% (Fig. 4.17).
esponse by the Government
R
Faced with the financial crisis, the focus of policy was shifted from pre-
crisis long-term, structural measures, such as fiscal consolidation and the
financial big bang, to full-fledged crisis management measures, which
were composed of the following, as explained before:
(％)
10
0
Jul-89
Jan-80
Aug-81
Mar-83
Oct-84
May-86
Dec-87
Feb-91
Sep-92
Apr-94
Nov-95
Jun-97
Jan-99
Aug-00
Mar-02
Oct-03
May-05
Dec-06
Jul-08
Feb-10
Sep-11
Apr-13
Nov-14
Jun-16
-2
-4
Fig. 4.17 Consumer Price Index (excluding fresh food) (year-on-year change).
Source: Statistics Bureau, Ministry of Internal Affairs and Communications
Introduction of a Comprehensive Resolution Framework

for Financial Crisis
A framework for resolution of failed (unviable) banks and for capital injec-
tion to viable banks was introduced.
Macroeconomic Policy
In fiscal policy, six economic stimulus packages were implemented after
the financial crisis (April and November 1998, November 1999, October
2000, October and December 2001).
As for monetary policy, a reduction of policy rate (uncollateralized
overnight call rate) to 0.25% (September 1998) and the adoption of a zero
interest rate policy (February 1999–August 2000) were implemented, and
a Quantitative Easing (QE) policy was put into force (March 2001–March
2006).
With these supportive policies, the economy started to recover beginning
in April 1999, but the recovery was weak and soon started to contract again
starting November 2000, with the stagnation of the world economy trig-
gered by the collapse of the dot.com bubble and the sudden deceleration of
the US growth from the second half of 2000. In Japan, production substan-
tially shrank, and the unemployment rate reached a historic high of over 5%
in 2001. In this way, the stagnation of the Japanese economy further aggra-
vated and entered the second decade with the impact of the financial crisis.
2 Period III (2003–2007) Long Recovery

Long Recovery
The economy, which entered the contraction phase in November 2000,
finally started to recover from the beginning of 2002, and this time the
recovery was not as short-lived as previous ones, and recorded the longest
expansion, after the Second World War, of six years and one month
(Fig. 4.18 (reproduced from Fig. 3.9 in Chap. 3)).
Background of the Long Recovery

Why did the economic expansion last so long this time? The recovery in
2002–2007 (Period III: Long Recovery), averaging 1.7%, was driven, by
(1) private investment growth, with a growth contribution of 0.5% on
average; and by (2) net exports, with a growth contribution of 0.8%. We
will first look at private investment.
162 K. ARAMAKI
3000
2500
2000
1500
1000
500
0
1997
1998
1999
2000
2000
2001
2002
2003
2004
2005
2005
2006
2007
2008
2009
2010
2010
2011
2012
1990
1990
1991
1992
1993
1994
1995
1995
1996
limination of Three Excesses

E
We have seen in Chap. 3 that stagnation in private investment in Period I
was brought about, first, by the continued stock adjustment of supply capac-
ity, under the prolonged sales stagnation and downward adjustment of
growth expectation, and, second, by deterioration of balance sheets of com-
panies due to the collapse of the bubble. Both these factors related not to
the “flow” side but to the “stock” side (i.e., assets and liabilities) of com-
pany behaviors. There is an argument with a similar viewpoint called the
“three excesses” argument. The contention is that companies in Japan
developed “three excesses,” as a result of the formation and collapse of the
bubble, that is, the assumption of excessive capital stock (excess assets),
excessive debt, and excessive employment. These excesses had depressing
impacts on positive activities of companies such as investment. These
excesses were eliminated during the first half of 2000s, and it is said that the
removal of such a longstanding burden led to the recovery of a positive
growth contribution of private investment, which made the long recovery
possible.
Elimination of Excessive Capital Stock

Excessive production capacity, as indicated by company response to a survey
(Tankan) by BOJ, was almost eliminated during the first half of 2000s
(Fig. 4.19).
(％)
40
30
20
10
0
Jun-74
Mar-76
Dec-77
Sep-79
Jun-81
Mar-83
Dec-84
Sep-86
Jun-88
Mar-90
Dec-91
Sep-93
Jun-95
Mar-97
Dec-98
Sep-00
Jun-02
Mar-04
Dec-05
Sep-07
Jun-09
Mar-11
Dec-12
Sep-14
-10
-20
Fig. 4.19 Production capacity (“excessive”–“insufficient”). Source: Bank of Japan,

“Tankan Survey”
Elimination of Excessive Debt

Interest-bearing debt relative to cash flows also decreased in the first half
of the 2000s, to the level in the pre-bubble era, indicating that excess debt
has been eliminated (Fig. 4.20).
Figure 4.21 (reproduction of Fig. 3.22 in Chap. 3) also shows that the
outstanding balance of long-term debt of companies fell sharply after 1998.
Elimination of Excessive Employment

Employment conditions as judged by companies showed that excessive
employment which they had kept for a long time beyond the collapse of
the bubble, was also eliminated, and employment conditions turned to
insufficient employment by the mid-2000s (Fig. 4.22).
Companies also strengthened their balance sheets by accumulating
profits after the financial crisis (see Fig. 4.3 in this chapter) and gradually
enhanced their liquidity position (Fig. 4.23). These developments seem to
have promoted positive behavior of companies.
avorable External Environments

F
The second background of the long recovery from the beginning of the
2000 was the favorable external economic environments. The world econ-
omy experienced a fairly long period of high and stable growth, which was
164 K. ARAMAKI
(%)
14
12
10
0
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
1960
1962
1964
1966
1968
1970
1972
Fig. 4.20 Interest-bearing liabilities/cash flow. Note: Interest-bearing liabilities

= short-term and long-term borrowings + bond, cash flow = current profits ×
(1/2) + depreciation. Source: Ministry of Finance, “Financial Statements Statistics
(trillion yen)
450.0
400.0
350.0
300.0
250.0
200.0
150.0
100.0
50.0
0.0
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
FY1960
1963
1966
1969
1972
Fig. 4.21 Long-term debt of companies. Source: Financial Statements Statistics

of Corporations, Ministry of Finance
(%)
30
20
10
0
Jun-74
Mar-76
Dec-77
Sep-79
Jun-81
Mar-83
Dec-84
Sep-86
Jun-88
Mar-90
Dec-91
Sep-93
Jun-95
Mar-97
Dec-98
Sep-00
Jun-02
Mar-04
Dec-05
Sep-07
Jun-09
Mar-11
Dec-12
Sep-14
-10
-20
-30
-40
-50
Fig. 4.22 Employment conditions as judged by companies (“excessive

employment”—“insufficient employment”). Source: Bank of Japan, “Tankan
Survey”
(trillion yen)
250.0
200.0
150.0
100.0
50.0
0.0
Fig. 4.23 Cash and deposit holdings by nonfinancial companies. Source: Bank
of Japan, “Flow of Funds”
once later called the “Great Moderation,” after bottoming out in 2002
until the eruption of the GFC in 2008 (Fig. 4.24). Thanks to such exter-
nal environments, growth contribution of net export to the Japanese
economy significantly rose from 0.2% in Period I and 0.1% in Period II to
0.8 in Period III.
166 K. ARAMAKI
(%)
8
Japan
World
6
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
-2
-4
-6
-8
Fig. 4.24 Real GDP growth rate of the world and Japan. Source: IMF (2017)
World Economic Outlook database, October 2017
Fundamental Changes Remained

In this way, in the long recovery period in 2003–2007, because companies
had overcome the aftereffects of the collapse of the bubble through
improvements of their balance sheets and also due to the favorable exter-
nal environments, the growth rate recovered to 1.7% in Period III, from
1.7% in Period I and 0.4% in period II. The growth contribution by pri-
vate investment switched to positive (0.5%) in Period III from −0.1% in
Period I (1991–1997) and −0.2% in Period II (1998–2002).
However, despite these favorable developments during the long recov-
ery period, fundamental changes that occurred in the behaviors of corpo-
rations continued.
The unemployment rate started to decline from the peak of 5.5% in
April 2003 to a level just below 4.0% in 2007. The level was still far higher,
however, than the pre-crisis average of 2.8% (see Fig. 4.12).
Nominal wages recovered a positive growth only in 2005 and 2006
(Fig. 4.10).
Increase in the share of non-regular workers somewhat decelerated from

around the mid-2000s but basically maintained its rising trend (Fig. 4.14).
The excess of savings over investment in the corporate sector declined,
but the sector continued to be the net saver (Fig. 4.16).
CPI (excluding fresh food) stayed in the neighborhood of zero infla-
tion (Fig. 4.17).
These developments show persistence of what may be called defensive
behaviors of companies, such as restraining investment and cutting labor
costs. The declining trend of the ratio of investment to cash flow, which
became clear after the burst of the bubble, continued at a moderate pace,
even in the long recovery period (Fig. 4.25).
Why do the companies continue to restrain investment? We should
note that companies strengthened foreign direct investment (FDI) relative
to domestic investment after entering the 2000s. The ratio of FDI to pri-
vate investment (nominal) increased from the average of 3.8% in the 1990s
to an average of 7.9% in the 2000s, more than twice as high as in the
1990s (Fig. 4.26).
Figure 4.27 provides an example. The electric machinery and appliances
sector, which recorded a level of domestic investment that was higher than
(%)
140
120
100
80
60
40
20
Fig. 4.25 Investment/cash flow. Source: Ministry of Finance, “Financial

(billion yen)
100,000.0 14.0
90,000.0
12.0
80,000.0
70,000.0 10.0
60,000.0 8.0
50,000.0
40,000.0 6.0
30,000.0 4.0
20,000.0
2.0
10,000.0
0.0 0.0
Private FDI FDI/private

investment investment
(RHS)
Fig. 4.26 Private investment and Foreign Direct Investment. Note: Private
investment is in nominal terms. Foreign direct investment, in terms of yen, is
obtained by converting the FDI, in terms of dollars, using the period’s average
exchange rate. FDI/Private Investment is the ratio of two values, both in three-
year moving average. Source: Tabulated using relevant data from Cabinet Office,
JETRO, and IMF
(million yen)
5,000,000
4,000,000
3,000,000
2,000,000 Electric
machinery
1,000,000 and
appliances
0
Automobiles
FY1961
FY1964
FY1967
FY1970
FY1973
FY1976
FY1979
FY1982
FY1985
FY1988
FY1991
FY1994
FY1997
FY2000
FY2003
FY2006
FY2009
FY2012
-1,000,000 and parts

-2,000,000
-3,000,000
-4,000,000
Fig. 4.27 Nominal investment by the electric machinery and appliances sector
and the automobiles and parts sector. Source: Ministry of Finance, “Financial
that of the automobile and parts sector throughout the 1980s and 1990s,
significantly reduced the level of domestic investment, particularly after
entering the 2000s. By contrast, the automobile and parts sector main-
tained a relatively high level of investment, even after the financial crisis.
Another example of defensive behaviors of companies is found in the labor
cost reduction. Restraint of labor cost (salary and bonus) in terms of labor
share in value added (Fig. 4.28), which became clear after the financial crisis,
was strengthened after entering the 2000s and continued until the GFC.
Thereafter, the share of labor cost in value added increased, as the value
added sharply shrank after the GFC, but thereafter it started to decline again.
What Did the Government Do in the Long Recovery Period?

Characteristics of Economic Policies in the Long Recovery Period
under the Koizumi Administration (April 2001–September 2006)
and the First Abe Administration (September 2006–August 2007)
How were economic policies managed in Period III when the economy
underwent a long recovery. Most of the economic policies in this period
focused on the long-term agenda and were not, in general, friendly to
short-run growth.
First, policy returned to fiscal consolidation. The total size of the initial
budget decreased by 3.6% in five years under the Koizumi administration.
Expenditure related to public works was cut by 23.7% from 9,435 billion yen
in FY 2001 (before Koizumi) to 7,201 billion yen in FY 2006 (when Koizumi
left) on an initial budget basis. The share of public fixed capital formation in
GDP was halved in a decade from an average of 7.8% in the latter half of
1990s to an average of 3.8% in the latter half of 2000s (Fig. 4.29).
Second, government-led promotion of the resolution of NPLs was
strongly pursued, as explained before. The “Financial Revival Program”
(the so-called Takenaka Plan) (October 2002), which aimed at halving the
NPL ratio of major banks (8.4% at that time) by March 2005, was enforced
(the goal was achieved in 2005).
Third, promotion of structural reform was strongly promoted under
slogans such as “Structural reforms that do not allow any sanctuaries” or
“No growth without reform.”
Fourth is the “Great Intervention,” which should have had short-term
economic impacts. About 35 trillion yen in total were used for interven-
tion in the foreign exchange market from January 2003 to March 2004.
However, the yen appreciated from 119.37 yen /dollar on December 30,
170 K. ARAMAKI
(%)
66
64
62
60
58
56
54
52
Fig. 4.28 Labor cost/value added. Note: Value added = salaries and bonuses for
employees and executive members + expenses for fringe benefits + rental fees +
taxes and other official charges + operating profits; labor costs = salaries and
bonuses for employees + expenses for fringe benefits. Source: Ministry of Finance,
(%)
10
9
8
7
6
5
4
3
2
1
0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Fig. 4.29 Share of public fixed capital formation in real GDP. Source: Cabinet
Office
2002, to 105.77 yen/dollar on March 31, 2004. The Great Intervention

did not bring about yen depreciation but worked to prevent further appre-
ciation of the yen.
Japanese Economy Started to Show Other Significant Changes

Thus, the Japanese economy finally overcame the negative legacy of the
collapse of the bubble, eliminating excesses, by the mid-2000s, but it
became clear that the corporate sector continued to show defensive behav-
iors. Furthermore, the Japanese economy started to show other significant
changes from the 2000s.
First, the growth contribution by consumption started to decline.
Contribution to growth by consumption was relatively high in Period I
(1991–1997) at an average of 1.0% in 1991–1997, when the average
growth rate over the period was 1.7%, accounting for nearly two-thirds of
the growth. The growth contribution of consumption declined to 0.4% in
Period II (1998–2002), when the average growth rate fell to 0.4%. In
Period III (2002–2007), while the growth rate recovered to 1.7%, the
contribution of consumption stayed at 0.6%, accounting for just over one-
third of the entire growth rate (Fig. 4.30).
Behind the declining growth contribution by consumption was a con-
tinued fall in real wages since the financial crisis (Fig. 4.31).
(%)
6.0
4.0
Real GDP
growth
2.0 rate
Growth
contribution
0.0
by
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2012
2011
consumption
-2.0 Average
growth
contribution
-4.0 by
consumption
-6.0
Fig. 4.30 Real GDP growth rate and growth contribution of private consump-
tion. Source: Cabinet Office
172 K. ARAMAKI
120.0
115.0
110.0
105.0
100.0
95.0
90.0
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
1990
1991
1992
1993
1994
1995
1996
1997
Fig. 4.31 Real wage (2015 = 100). Note: Real wage is obtained by deflating
total cash earnings in establishments with five or more employees by CPI. Source:
Ministry of Health, Labor, and Welfare, “Monthly labor survey”
As the nominal wages kept falling, the household savings ratio continued
to fall after the financial crisis and finally fell below zero in 2013 (Fig. 4.32).
Another change in the Japanese economy was an increasing dependence
on trade. The trade dependency ([exports + imports]/GDP) consistently
rose after the war, then became flat from the mid-1970s, and in the 1980s
stayed at a slightly lower level. However, the trade dependency rate signifi-
cantly rose from the mid-1990s through the long recovery period (from
15.4% in 1990 to the average of 24.4% in 2003–2007) (Fig. 4.33). This
development implies that the economy’s vulnerability to external shocks has
increased, posing a threat to the stability of economic performance.
One additional change to note is the growth potential of the Japanese
economy. The corporate sector continues to be a net saver (Fig. 4.16).
On the basis of Financial Statement Statistics, the amount of investment
in nominal terms is smaller than the amount of depreciation, that is, net
investment is negative, in 13 out of 15 years from fiscal 1998 to fiscal
2012 (Fig. 4.34). By contrast, the government sector continues to be
the biggest user of the savings. The fact that the government sector, not
the private sector, has been a net investor for a long time, since around the
time of the financial crisis, poses a concern over the future growth potential
of the Japanese economy.
(%)
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
FY1994
FY1995
FY1996
FY1997
FY1998
FY1999
FY2000
FY2001
FY2002
FY2003
FY2004
FY2005
FY2006
FY2007
FY2008
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
FY2015
-2.0
Fig. 4.32 Household savings ratio. Source: Cabinet Office
(%)
40.0
35.0
Trade
30.0 dependence
25.0 Export
(in GDP
20.0 ratio)
15.0 Import
(in GDP
10.0
ratio)
5.0
Net export
0.0 (in GDP
ratio)
1955
1959
1963
1967
1971
1975
1979
1983
1987
1991
1995
1999
2003
2007
2015
2011
-5.0
-10.0
Fig. 4.33 Trade dependence, export, import, and net export (in GDP ratio).
174 K. ARAMAKI
(trillion yen)
70
60
50
40
Nominal
30 investment
Depreciation
20
Nominal
10 investment–
Depreciation
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
-10
-20
-30
Fig. 4.34 Nominal investment, nominal amount of depreciation, and nominal

net investment. Source: Ministry of Finance, “Financial Statements Statistics of
S ummary of Period III (Long Recovery Period)

The expansionary macroeconomic policies to support the economy were
placed into force to their full extent, under the sharp deterioration of the
economy after the financial crisis that erupted in the late 1990s. Then,
the long recovery started in 2002 and lasted for more than six years. The
background of the long recovery included, first, the fact that the corporate
sector had finally got rid of the excesses that it had assumed in the bubble
period (“three excesses”) and restored sound balance sheets, and second,
favorable external environments. However, even under the long recovery,
the corporate sector continued to contain investment relative to cash flow,
squeeze labor costs (the unemployment rate stayed high and a shift to
non-regular employment continued), accumulate profits, strengthen the
liquidity position, and remain an excess saving sector, maintaining a defen-
sive stance. At the same time, deflation continued.
During the long recovery, some additional changes in the Japanese
economy became more apparent. One is a structural shortage of domestic
demand. In addition to the continued restraint on investment, consump-
tion gradually reduced its growth contribution, reflecting the continued
fall in real wages. In parallel, the trade dependence has increased, possibly
raising external vulnerability.
Furthermore, the restraint on investment by the corporate sector and

the use of savings by the government sector pose a concern for the long-
term growth prospects of the Japanese economy.
3 Period IV (2008–2012): GFC and After

In this section, we briefly look at Period IV (2008–2012), the GFC, and after.
External Shocks and Their Impacts on the Japanese Economy

The Japanese economy underwent a series of shocks in Period IV
(2008–2012).
In 2008, the GFC broke out, and Japan, together with Germany, was
most severely hit among the major advanced countries by the subsequent
global recession. In 2009, the European debt crisis started. Furthermore,
Japan was hit by the East Japan Great Earthquake in March 2011, and due
to the interruption of production networks and the increase in imports of
energy due to the nuclear power plant accident, Japan’s goods and services
account fell into deficit (Fig. 4.35). However, the yen rate surged, hitting
a record high of 75.32 yen to the dollar in the New York market on October
31, 2011, allegedly due to the global search for safe assets. Despite weak-
ening economic conditions, the yen rate stayed high, frequently recording
a historic level below 80 yen to the dollar in 2011 and 2012 (Fig. 4.36).
(trillion yen)
30.0
25.0
20.0
15.0 Current
Account
10.0 Goods and
Services
5.0
Account
0.0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
-5.0
-10.0
-15.0
Fig. 4.35 Current account and goods and services account. Source: Ministry of
Finance
176 K. ARAMAKI
(yen)
140
120
100
80
60
40
20
0
Oct-09
Mar-10
Aug-10
Jan-11
Jun-11
Nov-11
Apr-12
Sep-12
Feb-13
Jul-13
Dec-13
May-14
Jan-06
Jun-06
Nov-06
Apr-07
Sep-07
Feb-08
Jul-08
Dec-08
May-09
Fig. 4.36 Yen to dollar nominal exchange rate. Note: Spot rates at 17 pm,
monthly average. Source: BOJ
Under the sharp yen appreciation, the overseas/domestic investment

ratio of manufacturing industries increased sharply from 2010. Thus, Period
IV was a time when Japan’s external vulnerability was severely felt (Fig. 4.37).
4 Problem with the Japanese Economy, after

Overcoming Aftereffects of the Bubble and the
Shock of the Financial Crisis (Demand Structure
and Growth Potential)
This chapter has examined the process of the financial crisis that broke out
in the latter half of the 1990s and its impacts on the Japanese economy.
After the bubble burst, while the corporate sector took time to dispose of
excess assets and liabilities, cost and risk of excess (unprofitable) assets grad-
ually shifted to the banking sector, and a financial crisis broke out seven
years after the collapse of the bubble. The government was unable to
promptly resolve the NPL problem. The background for this includes opti-
mistic expectations held by the government for the future course of econ-
omy and land prices in the initial stage, concern in the subsequent stage for
the huge negative impacts on the economy that could arise from prompt
resolution of the excesses, and also non-existence of a comprehensive
framework necessary to resolve the financial crisis. With the breakout of the
(%)
80
70
60 All
industries
50
Manufacturing
40
30 Automobiles
20 Non-
manufacturing
10
0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Fig. 4.37 Overseas investment/domestic investment. Note: Overseas invest-
ment is on a consolidated basis, and domestic investment is on an unconsolidated
basis. Source: Development Bank of Japan, “Investment plan survey fiscal years
2015・2016・2017”, August 4, 2016
crisis, fundamental changes took place in the Japanese economy, such as a

surge of the unemployment rate, expansion of non-regular employment,
decline of nominal wages, switch of the corporate sector to a net saver posi-
tion, and emergence of deflation. These changes, in principle, stayed with
the economy even during the long economic recovery that started in the
early 2000s.
After reviewing economic developments from Periods II through IV,
we have found the following characteristics and problems with the current
Japanese economy after it overcame the negative legacy of the bubble.
First, private investment increased in recent years, but its level continued
to be constrained relative to cash flow.
Second, companies continued to restrain labor costs through reduction in
nominal wages and a shift from regular to non-regular employment.
Third, the growth contribution of consumption declined against the back-
ground of continued fall in real wages.
Fourth, dependence on foreign demand rose, possibly raising Japan’s vul-
nerability to external shocks.
Fifth, the government continued to be the biggest user of savings, with
possible negative effects on potential growth.
178 K. ARAMAKI
To put everything together, the Japanese economy seems to have had

two problems after overcoming the aftereffects of the formation and col-
lapse of the bubble and the financial crisis, that is, insufficiency of domestic
demand coupled with growing dependence on external demand, and pos-
sible decline in growth potential. The background of these problems is the
continuation of defensive behaviors of companies, as is observed in their
restraint on investment and labor costs. What has caused such a defensive
stance of companies? How should we tackle them? These are the key ques-
tions and challenges that the Japanese economy currently faces after it has
overcome the aftereffects of the bubble and the direct impacts of the
financial crisis.
Supplement 1
Chronology in Period II (1998–2002), Period III (2003–2007),

and Period IV (2008–2012)
1997
January Prime Minister Hashimoto (LDP) declared intention to start drastic
reforms in six areas, including fiscal structure and the financial system
April Consumption tax rate increased from 3% to 5%
June BOJ law amended (its independence strengthened)
June Comprehensive financial liberalization (Japan’s “Financial Big
Bang”) authorized by advisory councils to MOF
July Thai baht recorded a sharp fall (start of the Asian currency crisis)
November Sanyo Securities filed a petition for protection under the Corporate
Rehabilitation Law, causing default in the interbank market
November Hokkaido Takuchoku Bank announced its inability to continue
November Yamaichi Securities announced closure of business
November Fiscal Structure Reform Act enacted
1998
April Comprehensive economic measures decided
May Fiscal Structure Reform Act amended
October Government decided to nationalize the Long-Term Credit Bank of
Japan (first nationalization of private bank after the war)
November Emergency economic measures decided (historically largest size)
December The Nippon Credit Bank nationalized
1999
February BOJ introduced the zero interest rate policy
2000
August BOJ lifted zero interest rate policy
2000–2001
Collapse of the dot.com bubble
2001
March Government declared Japanese economy was under moderate
deflation for the first time after the war
March BOJ introduced Quantitative Easing Policy (QEP)
April Koizumi administration started (return to the fiscal consolidation
and policy orientation for structural reform)
2002
January The economy hit a bottom (start of the long economic recovery)
October Financial Services Agency (FSA) formulated financial revival program
(aimed at halving the NPL ratio of major banks by end March 2005)
(continued)
180 K. ARAMAKI
(continued)
2003
January 2003– Great intervention
March 2004
2008
September Lehman Brothers collapsed (start of the GFC of 2008–2009)
2009
September The Democratic Party took the power
October Misreporting of fiscal position by Greek government uncovered
(start of the European debt crisis)
2011
March East Japan Great Earthquake
2012
December Second Abe administration and Abenomics started
Supplement 2
Impacts on Employment of Prompt Disposition of Excess Assets

In this supplement, we will conduct a very rough estimate on what impacts
would have been imposed on employment if excess assets had been speed-
ily disposed of.
Fig. 4.38 shows developments in total assets of corporations (excluding
financial and insurance companies), based on Financial Statement Statistics
of Corporations by Industry (MOF). We can see that there is a bump
(excess assets) in the period from the mid-1980s to the first half of 2000s.
The figure also shows an approximate line (a trend line) for the entire
period, except for the years from fiscal 1985 to 2004 when there was a
bump, that is, a trend line for the period from fiscal 1960 to 1984 and
then the period from fiscal 2005 to 2016. If we regard the difference
between the actual size of the total assets and the amount indicated by the
trend line as excess assets, then the excess assets account for nearly three-
tenths of the total assets in the first half of 1990s as indicated in Fig. 4.39
which shows the ratio of the excess of total assets over the amount implied
by the trend line to the total assets.
Now, let us assume that the whole personnel resources—the combined
number of executive members and employees—of companies (excluding
financial and insurance companies) in the Financial Statement Statistics of
Corporations by Industry) are deployed evenly and proportionately to the
assets and that, if an asset is disposed of, then the whole personnel staff
(trillion yen)
1800
1600 y = 30.931x – 137.36
1400
1200 Total assets
1000
800
600
400
200
0
FY1960
FY1962
FY1966
FY1968
FY1970
FY1974
FY1976
FY1978
FY1982
FY1984
FY1986
FY1990
FY1992
FY1996
FY1998
FY2000
FY2004
FY2006
FY2008
FY2012
FY2014
FY2016
FY1964
FY1972
FY1980
FY1988
FY1994
FY2002
FY2010
-200
Fig. 4.38 Total assets of corporations (excluding financial and insurance compa-
nies) and their trend line. Total assets (for the red line). Trend line for the entire
period except for 1985–2004. Source: Ministry of Finance, “Financial statement
statistics of corporations by industry”
(％)
35
30
25
20
15
10
0
FY1994
FY1995
FY1996
FY1997
FY1998
FY1999
FY2000
FY2001
FY2002
FY2003
FY2004
FY2005
FY2006
FY2007
FY2008
FY2009
FY2010
FY1985
FY1986
FY1987
FY1988
FY1989
FY1990
FY1991
FY1992
FY1993
Fig. 4.39 Share of excess assets in total assets: FY1985~FY2010. Source:

Ministry of Finance, “Financial statement statistics of corporations by industry”
deployed to the asset are entirely dismissed and become unemployed.

Fig. 4.40 shows, for each year from fiscal 1985 to 2010, first, the number of
additional people that would have become unemployed if all the excess
assets estimated for the year had been disposed of in that year and if the
entire personnel staff deployed to these assets had become unemployed;
second, the resultant (elevated) unemployment rate; and third, the actual
unemployment rate (as of December each year). For example, if all the
182 K. ARAMAKI
(10 thousand
(%) persons)
25 1400
Unemployment rate
1200 resulting from
20
1000 resolution of excess
15 assets
800
Actual unemployment
10 600 rate
400 Additional unemployed
5 resulting from
200
resolution of excess
0 0 assets (RHS)
FY2003
FY2005
FY2007
FY2009
FY1985
FY1987
FY1989
FY1991
FY1993
FY1995
FY1997
FY1999
FY2001
Fig. 4.40 Additional number of people unemployed and the unemployment rate
resulting from prompt resolution of excess assets. Source: Ministry of Finance,
“Financial statement statistics of corporations by industry”
excess assets had been disposed of in fiscal 1991, additional unemployment

amounting to more than 12.5 million would have occurred, and the unem-
ployment rate would have risen to 21.2%, that is, 10 times as high as the
actual unemployment rate that year of 2.1%. The figure shows that similarly
huge negative impacts would have occurred in any year in the first half of the
1990s. Considering that the estimate assumes an extreme case—that the
entire personnel staff deployed to an asset will be dismissed and become
unemployed if the asset was disposed of—then, in reality, the resultant direct
impacts would have been smaller than estimated. On the contrary, in the
case where disposition of excess assets led to abolition of relevant business
operations, and indirect impacts spread to other parties such as business
partners, secondary effects could have been added to the aforementioned
direct impacts, producing an upward risk. No matter what the case may be,
the magnitude of excess assets created in the 1980s seems to have been of
such a scale that their rapid disposal would have seriously shaken the basis of
the Japanese economy. It is unrealistic just to criticize delays in disposing
excesses, as is done in the many arguments. It is implied that very strong
intervention by the authorities was necessary, if extreme confusion and a
sharp increase in the instability of the society was to be avoided.
Considering that the aforementioned total assets included such assets as
liquid assets and securities held for investment purposes, we would like to
conduct another estimate that uses physical assets (excluding land) instead
of total assets. Fig. 4.41 shows developments in physical assets (excluding
(trillion yen)
500 0.3
y = –3.4224x + 455
400 0.25
300 0.2 Physical assets

(excluding land)
Physical assets
200 0.15 (excluding land)/sales
y = 5.6607x – 16.335 Trend line
(before bubble)
100 0.1 Trend line (after
financial crisis)
0 0.05
FY1960
FY1962
FY1964
FY1966
FY1968
FY1970
FY1972
FY1974
FY1976
FY1978
FY1980
FY1982
FY1984
FY1986
FY1988
FY1990
FY1992
FY1994
FY1996
FY1998
FY2000
FY2002
FY2004
FY2006
FY2008
FY2010
FY2012
FY2014
FY2016
-100 0
Fig. 4.41 Physical assets (excluding land) of corporations (excluding financial

and insurance companies), their trend lines, and the ratio of physical assets to sales.
Source: Ministry of Finance, “Financial statement statistics of corporations by
industry”
land) and an approximate line (trend line) for the period from fiscal 1960 to
1984. If we regard the difference between the actual amount of physical
assets (excluding land) and the amount calculated by the trend line as excess,
then it can be shown that the size of excess assets amounted to greater than
four-tenths of the entire physical assets (excluding land) around the mid-
1990s. This implies that prompt disposal of excesses would have created
negative impacts greater than calculated in the preceding estimate.
Fig. 4.41 shows an approximate line (trend line) for the period from
fiscal 1998 onward. The trend of physical assets (excluding land) is entirely
different for the period between before the bubble and after the financial
crisis. The figure also shows the ratio of physical assets (excluding land) /
sales. The ratio swiftly rose from the 1980s, hit a peak in fiscal 1998,
sharply fell until the mid-2000s, and stabilized thereafter. It is implied that
in the 1990s, two processes were simultaneously ongoing, one, efforts to
overcome the collapse of the bubble (disposition of excess assets) and,
two, adjustment to new environments where sales do not grow (restraint
on asset size or its downward adjustments). In other words, going forward
from some point in time in the 1990s, possibly from the financial crisis,
companies began to exhibit investment behavior that assumes that the
domestic economy will not expand in the future.
184 K. ARAMAKI
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Ikeo (Non-Performing Loans and the Financial Crisis), Cabinet Office
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CHAPTER 5
Deflation and Monetary Policy
In Chaps. 2, 3, and 4, we examined the mechanism of the three decade-

long difficulties of the Japanese economy, basically in a time-sequential
manner. In this and the next chapters, we will look at the issues that are
more directly relevant to the current Japanese economy, that is, the long
economic stagnation after the collapse of the bubble and deflation.
This chapter considers the issue of deflation and monetary policy. We
will first look at the evolution of deflation in Japan and then list major
arguments regarding the causes of deflation. In light of the fact that many
arguments have been presented contending that deflation is a monetary
phenomenon, we will assess monetary policy management with a view to
finding causes of deflation, from the collapse of the bubble until just before
the adoption of the Quantitative and Qualitative Monetary Easing (QQE)
under Governor Kuroda, by dividing the whole period into two: first, the
period from the collapse of the bubble to the adoption of the zero interest
rate policy (ZIRP), which corresponds roughly to the period before the
economy fell into deflation and was placed under the zero lower-bound
constraint on interest rate; and second, the period from the lifting of ZIRP
to the Quantitative Monetary Easing Policy (QEP) implemented from
2001 to 2006, which corresponds to the period under deflation and the
zero lower-bound constraint. In Chap. 6, with a view to finding the
mechanism of economic stagnation and deflation in the real sector, we

190 K. ARAMAKI
will analyze corporate behaviors, drawing mainly on the financial state-

ment statistics that cover all the profit-making companies in Japan. Other
factors, including external factors that may have relevance to the stagna-
tion and deflation, will be briefly examined as well in Chap. 6.
1 Deflation in Japan from the 1990s

Changes in the Consumer Price Index (CPI, excluding fresh food) from
the previous year were largely negative from July 1998 until 2013, except
for a brief period of price rise in 2006–2008, which reflected energy and
food price surge in the global market (Fig. 5.1, reproduced from Fig.
4.17 in Chap. 4). So, the Japanese economy was under deflation, defined
as a continued decline in the general price level, basically for nearly
15 years from July 1998 to April 2013, but it was a mild deflation. The
average rate of changes of CPI (excluding fresh food) from the previous
year for the period from July 1998 to April 2013 was −0.3%, and the
cumulative price decline over the 15-year period was −3.6%.
(%)
10
0
Jan-80
Aug-81
Mar-83
Oct-84
May-86
Dec-87
Jul-89
Feb-91
Sep-92
Apr-94
Nov-95
Jun-97
Jan-99
Aug-00
Mar-02
Oct-03
May-05
Dec-06
Jul-08
Feb-10
Sep-11
Apr-13
Nov-14
Jun-16
-2
-4
Fig. 5.1 The Consumer Price Index (excluding fresh food): Changes from the pre-
vious year. Source: Statistics Bureau, Ministry of Internal Affairs and Communication
DEFLATION AND MONETARY POLICY 191
Changes of the GDP deflator from the previous year have been almost
consistently negative from the mid-1990s. The phenomenon of deflation
is more clearly shown in the development of the GDP deflator, as com-
pared with CPI (Fig. 5.2).1
(%)
8
CPI (excluding
fresh food)
4 (year-on-year
change)
GDP deflator
(year-on-year
2
change) base
year = 2000
GDP deflator
0 (year-on-year
change) base
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
year = 2011
-2
-4
Fig. 5.2 The GDP deflator and Consumer Price Index (excluding fresh food)
(year-on-year change). Source: Cabinet Office, Statistics Bureau, Ministry of
Internal Affairs and Communications
1
The GDP deflator is a deflator that covers the entire economic activities, including invest-
ment and exports, while CPI covers only private consumption. Two points should be noted.
First, prices of investment goods such as machinery tend to reflect price-reducing techno-
logical progress. Second, price movements of imports are excluded from the calculation of
the GDP deflator (i.e., if import prices rise at a higher pace than domestically produced
goods, then the GDP deflator tends to be lowered more than otherwise), while rise in import
prices are reflected in CPI (household sector consumes imported goods, too). Therefore, the
GDP deflator tends to record a lower rate of increase than that of CPI, if prices of domesti-
cally produced goods, including those for exports, rise less than import prices.
192 K. ARAMAKI
2 Major Arguments on the Causes of Deflation

What caused such chronic but mild deflation? Cabinet Office (2001) lists
three factors:
① Supply-side structural factors, such as inflow of low-priced imports

from China and other emerging countries, IT, and other technologi-
cal innovations (supply factor arguments)
② Demand factors caused by a lack of strength of the economy (demand
factor arguments)
③ Financial factors, including declining intermediation function of
banks due to excessive debts of corporations and the problem of non-
performing loans (NPLs), and resultant stagnating money stock
growth (financial sector- problem arguments)
In particular, as a type of argument that falls under the demand factor

views, extensive arguments have been presented that blame the Bank of
Japan’s (BOJ) monetary policy management, some examples of which are
as follows:2
Shinpo (2002) argued that the substantial fall in the inflation rate in
Japan was due to the deterioration in macro supply/demand balance, that
the deterioration in macro supply/demand balance was largely caused by
a fall in the growth rate of money supply, and that the delay in interest rate
reduction after the burst of bubble is responsible for a fall in the rate of
increase in money supply (Shinpo 2002, 82).
Iwata (2001, 111) wrote, “The average rate of increase of money supply
over 1991–2000 was 2.7%. In light of the long-term relationship between
money supply and price, this [i.e., 2.7% increase] was low enough to let the
Japanese economy fall into deflation from the mid-1990s.” (The words in
brackets were added by the author.)
Before assessing monetary policy in detail in the following sections, we
will look at the aforementioned three factors briefly.
Supply Factor Arguments: Did Supply-Side Structural Factors

Cause Deflation?
We look at supply-side factors drawing on Nishizaki et al. (2011).
2
Translated by the author of this book into English from the original text.
Import Penetration
Japan’s import penetration ratio significantly rose from 6% at the end of
1980s to around 12% in the latter half of 2000s (Fig. 5.3).
Changes from previous year of prices of imported and import-
competing goods that are included in CPI were lower than the changes of
prices of other goods in CPI from around mid-1990s, suggesting import
penetration of low price products contributed to lowering price level
(Fig. 5.4).
he Technological Progress and Deregulation

T
Cumulated changes in the GDP deflator by sector, from 1990 to 2009,
show price decline was greater in IT-related fields where technological
progress is thought to be most pronounced (Fig. 5.5).
Furthermore, it may be pointed out that, during 20 years from the
1990s, while CPI (excluding fresh food) on the whole increased moder-
ately, prices of those goods that are in the deregulated sectors, such as
communication, or in the area where import liberalization advanced, such
as certain agricultural products, significantly decreased (Fig. 5.6).
The foregoing implies that supply-side structural factors played a role in
reducing prices of certain categories of goods and services. Did these sup-
ply factors cause deflation?
Fig. 5.3 Import penetration. Note: Import penetration rate = import/domestic

demand (in real term). Source: Nishizaki et al. (2011)
(%, Changes from (%, Changes from
previous year) previous year)
4 30
3
20
2
10
1
0 0
-1
-10
-2
-20
-3
-4 -30
96 97 98 99 00 01 02 03 04
Fig. 5.4 Price developments in imports and import-competing products. Note:

Imports and import-competing products (GDP statistics with base
year = 2000), other products (GDP statistics with base year = 2000),
imports and import-competing products (GDP statistics with base year = 1995),
other products (GDP statistics with base year = 1995), Yen—dollar
exchange rate (RHS). Source: Nishizaki et al. (2011)
(%)
40
20
–20
Cumulated
changes from
–40
1990 to 2009
–60
2000 → 2009
–80 1990 → 2000
–100
–120
–140
P
ta al
sa &
ra e &
en c
tio
ic
io
D
es Re
pm tri
le il
te
le
t
rv
at
G
ho eta
su c
c
ui ec
nc
in nan
ru
Se
ic
eq l
R
un
E
st
Fi
on
m
om
C
Fig. 5.5 Cumulated changes in GDP deflator from 1990 to 2009 by sector (%).
Source: Nishizaki et al. (2011)
(%)
10
5
0
–5
–10
–15
–20
–25
–30
–35
–40
fo ss
ts
e d
n
na inte
e
e
ty
)
ry nce
ar ke
ef
od
th an
in
io
ng
uc
in
sh (le
ci
Be
w
at
li
ol
a
tri
ra
od
e
ic
m
as
fre PI
d
ic
ec
O
pr
rte
un
R
C
El
m
po
C
om
ai
Im
D
C
Fig. 5.6 Price changes from 1990 to 2009 of deregulation-related products.
Source: Nishizaki et al. (2011)
There is a counterargument. It is theoretically possible for supply-side

factors (increase in efficiency or cost reduction due to the availability of low
cost inputs, technological progress, or deregulation) to bring about defla-
tion. However, such structural changes are basically favorable to the econ-
omy and are expected to produce an expansion of production, which does
not seem to be in line with Japan’s case where the growth rate continued
to decline from the 1990s.3 So, even if we admitted the price-reducing
effects of these (favorable) supply factors, this mechanism would not be
3
Noguchi (2002) criticized the supply-side structural interpretation of deflation by con-
tending that positive shocks on the supply side, such as technological progress and availability
of less expensive materials from abroad, will shift the (upward sloping) short-term aggregate
supply curve to the right, bringing about a reduction of price level, and that this shift is
expected to produce an expansion of production, which does not seem to be in line with
Japan’s case in which the growth rate continued to decline from the 1990s. So, under this
argument, even if we admit the effects of price decline due to these (favorable) factors on the
general price level, it is clear that this mechanism was not dominant in the functioning of the
Japanese economy during the stagnant decades. We need to find out what was a dominant
196 K. ARAMAKI
able to sufficiently explain developments in the Japanese economy during

the stagnant decades. We need to find a mechanism under which both
deflation and stagnation are simultaneously brought about.
Demand Factor Arguments: Is Economic Stagnation

Due to Demand Shortage Responsible for Deflation?
As we saw in Chap. 3 (Fig. 3.5), the Japanese economy generally suffered
from a negative output gap, that is, demand was in short of production
capacity. When supply capacity is greater than demand, there can be two
interpretations. One is that demand is in short relative to the sustainable
demand level, and the other is that supply capacity is in excess relative to
the sustainable demand level. In either case, resultant excess supply could
produce downward pressures on price, and therefore, could contribute to
deflation. Demand factor arguments for deflation seem to presuppose that
demand is in short, that is, demand is lower than a sustainable level, and
therefore, demand could (or should) be raised. So, under this argument,
factors that have brought about such demand shortage are regarded as the
ultimate cause of deflation. In preceding chapters, we have seen that the
most depressing factor on the economy during the stagnation was private
investment. Consumption has supported growth, while its contribution
gradually declined. Government expenditure also has supported the econ-
omy until the beginning of the 2000s. Net exports played a relatively small
role under the appreciation of the yen. So, demand shortage arguments
seem to implicitly or explicitly assume the potential of macroeconomic
policies for activating investment activities (and possibly net exports) and,
based on that presumption, question the appropriateness of the actual
macroeconomic policy management. From this viewpoint, those argu-
ments that blame monetary policy management can be typically classified
as demand factor arguments for deflation. We will assess the role of mon-
etary policy in causing demand shortage and deflation in the next
section.4
mechanism that operated through the Japanese economy, which produced both stagnation
and deflation.
4
There are some arguments that refer to the quantity theory of money in their understand-
ing of deflation. However, the quantity theory of money, which advocates that the quantity
of money supplied in the economy determines the general price level, may be relevant in the
Other demand factor arguments blame fiscal policy management. We

have already seen, however, that fiscal supports were repeatedly injected
into the economy during the stagnation, and as a result, the government
debt deteriorated to the world’s worst level. As the government cannot
continue to support the economy forever, the real cause of stagnation
(under this argument, demand shortage) needs to be found elsewhere.5
In contrast to the demand shortage argument, the excess supply argu-
ment contends that supply capacity was in excess and, therefore, what was
needed was not policies to stimulate demand but policies to remove excess
capacity. An examination focused on supply capacity (i.e., asset side) will
be conducted in Chap. 6.
Financial Sector Problem Arguments: Was the Problem

in the Financial Sector to Blame?
It is often argued that the deficiency in the financial sector’s intermediation
function due to the NPL problem was responsible for the stagnation of pri-
vate investment and the economy at large. However, the lending attitude of
financial institutions was generally not tight, excepting periods immediately
after the burst of the bubble and around the financial crisis (see Fig. 3.7 in
Chap. 3). The financial sector could not be responsible for the stagnant
investment for the major part of the 1990s before the financial crisis.
Some empirical analyses confirm this observation.
Miyao (2004) wrote, “Judging from existing empirical analyses, the time
of financial crisis in 1997–78 is the only occasion where credit crunch might
have had significant effects on real investment, and therefore, credit crunch
cannot be considered as a major cause of long stagnation in the 1990s.”6
Motonishi and Yoshikawa (1999) also wrote, “an extremely poor per-
formance of corporate investment is the most important factor to explain
the long stagnation of the Japanese economy … the effects of the real fac-
tor7 on investment are much more significant than those of the financial
very long-term or under the extreme circumstances such as hyperinflation, but for other,
more realistic cases, the theory does not seem to be of practical use.
5
The timing of fiscal policy management may be questioned. Yoshikawa (1999) criticized
the timing of fiscal consolidation efforts in 1997, on the grounds that they were undertaken,
despite economic indicators showing that the economy might have entered a contraction
phase by mid-1997, and argued that it is impossible to achieve fiscal consolidation under a
recession.
6
Translated by the author.
7
Refers to the worsening real profitability, in particular.
198 K. ARAMAKI
factor … during the same period (i.e., 1992–94), the financial factor was
supportive. However, beginning 1997 … the credit crunch finally occurred.”
So, at least, as far as demand shortage or the stagnation in Period I
(1991–1997) is concerned, the financial sector problem does not seem to
be a major factor.
As we have seen here, neither the supply factor or financial sector prob-
lem arguments for deflation is sufficiently convincing. Therefore, in the
next section, we will look at the issues of monetary policy management in
the context of the demand factor arguments for deflation, which have
been extensively debated for the last two decades.
3 Assessment of Monetary Policy Before Kuroda’s

QQE: Is Monetary Policy Responsible for Falling
into Deflation and Being Unable to Get
Out of Deflation?
In this section, we will look at the monetary policy management in the
periods before the QQE, which was introduced by Governor Kuroda of
BOJ in April 2013 as the first arrow of Abenomics (Abenomics will be
examined in Chap. 7), by dividing the whole period into two, namely, the
period up to the introduction of zero interest rate policy (1991–1999)
(basically the period before the economy fell into deflation and was placed
under the zero lower-bound constraint on interest rate) and the period
thereafter (the period after the economy had been placed under deflation
and the zero lower-bound constraint).
Brief Chronology prior to the Adoption of QQE: What Did the BOJ

Do after the Bubble Burst?
How the monetary policy was handled after the burst of the bubble until
the implementation of the QQE by Governor Kuroda is briefly shown
below:
July 1, 1991–September 8, 1995—BOJ reduced official discount rate nine

times (6.0→0.5%)
March 31, 1995–September 9, 1998—BOJ promoted decline in over-
night, uncollateralized call rates three times (2.25%→0.25%)
February 12, 1999—BOJ introduced ZIRP (BOJ promoted decline in
overnight call rates [0.25→0.15%] and later encouraged a further decline)
August 11, 2000—BOJ lifted ZIRP (BOJ promoted increase in overnight

call rates [0→0.25%])
March 19, 2001—BOJ adopted the QEP
March 9, 2006—BOJ lifted the QEP and shifted to ZIRP. At the same
time, the BOJ made public the Bank’s thinking on price stability (price
increase of 0~2% given as within the range of price stability, as indicated
by members of the monetary policy meeting)
July 14, 2006—BOJ lifted ZIRP
October 31, 2008—BOJ promoted decline in overnight call rate
(0.5→0.3%)
December 19, 2008—BOJ promoted decline in overnight call rate
(0.3→0.1%)
February 14, 2012—BOJ introduced a “price stability goal for medium
and long term,” which was judged to be within the positive range of 2%
or lower on a year-on-year basis and set a price stability goal at 1% for
the time being
January 22, 2013—BOJ introduced a “price stability target” of 2% in
terms of year-on-year change of the CPI (excluding fresh food)
April 4, 2013—BOJ introduced the QQE
How Should We Assess BOJ’s Monetary Policy up to and including

the Adoption of ZIRP in 1999: Is Monetary Policy Responsible
for Stagnation and Falling into Deflation?
As stated before, we divide the whole period before the QQE into two,
that is, the period up to the introduction of ZIRP and the period after
that, and in this subsection, we assess management of monetary policy in
the first period, drawing on the relevant research papers, including the
work by Ahearne et al. (2002) and papers by BOJ.
S ufficiency and Swiftness of Monetary Policy Response

Before the adoption of ZIRP, the BOJ reduced the official interest rate nine
times and promoted decline in the overnight call rate three times. As a result,
both policy rates and long-term interest rates significantly declined, with the
short-term interest rate approaching zero (Fig. 5.7). In 1998, then Governor
Hayami (BOJ 1998b) stated that most of the available measures to support
the economy had been put in place in the area of monetary policy, while
200 K. ARAMAKI
Percent
9
8 Call rates (overnight, uncollateralized)
7
6 Government bond yield (10-year)
5
4
3
Euro-yen
2 futures (3-month)
1 Official discount rate
0
1991 92 93 94 95 96 97 98 99
Fig. 5.7 Interest rates. Source: Mori et al. (2001)
stressing the importance of early restoration of financial system soundness

and bold structural reforms.8
In assessing the monetary policy in the 1990s, with reference to the
experience in the United States under the Great Depression, Mori et al.
(2001), from the BOJ, wrote, “while Japan was faced with a tremendous
decline in asset prices, which came close to that experienced in the US
during the Great Depression, the CPI has so far remained stable. In other
words, a rapid and self-sustaining price decline known as deflation, as was
experienced in the US during the Great Depression … has been success-
fully avoided” (Figs. 5.8 and 5.9).
By contrast, Ahearne et al. (2002), of the Federal Reserve Board (FRB),
presented a different view:
Japanese monetary policy during 1991–95 appeared appropriate based on

the expectations for the economy that prevailed at that time. However,
inadequate allowance for downside risk was built into monetary policy, as
evidenced by the fact that once actual inflation and growth numbers came
in weaker than expected, interest rates ended up being higher than were
called for under the Taylor rule. (Ahearne et al. 2002, 20)
Hayami, Yu (1998) “Azia Keizai to Nihon no Yakuwari” (The Asian Economy and the
8
Role of Japan), keynote speech by Governor Hayami of Bank of Japan, October 29. (BOJ
Home Page, https://www.boj.or.jp/en/index.htm/).
Fig. 5.8 Stock price:

Japan in 1990s and US
in the Great Depression.
Source: Mori et al.
(2001)
Fig. 5.9 Consumer

Price Index: Japan in
1990s and US in the
Great Depression. Source:
Mori et al. (2001)
202 K. ARAMAKI
... had the BOJ loosened monetary policy to the extent modeled in the
simulations9 at any time up until early 1995, inflation could have been kept
positive through the end of the decade. (Ahearne et al. 2002, 21)
Given the inability of conventional monetary policy to stabilize an economy
under deflation, … there is a clear asymmetry of costs to deflation and infla-
tion ... given the very low rate of inflation and negative output gap that
existed in 1994–95, some precautionary further lowering of interest rates
would have been valuable to reduce the probability of deflation. (Ahearne
et al. 2002, 21–22)
A more expansionary monetary policy in 1994 might have avoided the sharp
increase in real long-term interest rates and hefty yen appreciation that
occurred that year. (Ahearne et al. 2002, 38)
Using real-time ... data, ... Japan was “too loose” on average from 1990
through 1994. Using revised data, Japanese policy was “too tight” over the
same period (Ahearne et al. 2002, 19).
This argument is presented in Fig. 5.10. The figure gives three rates,

the actual policy rate (Call Money Rate), the optimum policy rate calcu-
lated based on the Taylor rule, using data that were available when the
policy was adopted (Real-time Taylor Rule), and the optimum policy rate
calculated based on the Taylor rule using data that became available after
the policy had been adopted (Revised Taylor Rule). The actual policy rate
as of 1994 was sufficiently eased if assessed using data available at that
Fig. 5.10 Taylor rule analysis of US and Japanese interest rates. Source: Ahearne
et al. (2002)
9
Simulation using the FRB/Global model.
time, but it was too tight if assessed using data that became available after-
ward. This is an argument that, as Japan’s economy was moving closer to
deflation, we should have been prepared for a downside risk.
Jinushi et al. (2000) presented a similar analysis and argued that the
actual call rate stayed high, as compared with the optimum call rate calcu-
lated using the Taylor rule.
It is true that, after the collapse of the bubble, the BOJ adopted “his-
torically unprecedented accommodative monetary policy” (Mori et al.
2001, 80). However, it was not recognized by the BOJ nor by the govern-
ment in general that the Japanese economy was faced with an unprece-
dented economic situation, that is, the formation and collapse of the huge
bubble, with its potentially far-reaching and serious negative impacts on
the economy, if not managed speedily and properly. Considering this, it
can be argued, with some hindsight, that the BOJ should have and could
have acted more aggressively with downside risk in mind, as argued in
Ahearne et al. (2002). However, a question still remains: had the BOJ
acted more aggressively, would the subsequent stagnation have been
avoided? Drawing on the discussion in this chapter, the answer seems to
be no. What is crucial when examining this point is how we interpret the
deflationary gap that the Japanese economy experienced. In other words,
the point is whether the Japanese economy was in a demand shortage or
whether supply capacity was in excess in light of the sustainable demand
level. Those arguments blaming the BOJ, including Ahearne et al. (2002),
seem to presume that demand was in short, so monetary policy could have
helped raising demand. If supply was in excess, however, what monetary
policy could do seems to be more limited than generally assumed. Through
lower interest rates and an eased liquidity provision, monetary policy
could favorably stimulate lending and investment, support asset prices
such as land and stocks, and affect foreign exchange rates. If supply capac-
ity was in excess of sustainable demand, then the most important task
should be the removal of such excess. More aggressive monetary easing
could have prevented stagnation to some extent in the first half of the
1990s, but it could not have (or rather should not have) raised demand to
such an unsustainable level that would make excessive assets profitable.
In this connection, we should rather remind ourselves of the fact that the
monetary policy was aggressively tightened from 1989 to 1990, raising the
discount rate five times, from 2.5% to 6.0% in little more than a year. Together
with the introduction of the aggregate lending limit by the Ministry of Finance
(MOF), this aggressiveness seems to have overkilled the economy, as is
204 K. ARAMAKI
shown by the nosedive of money stock growth (Fig. 3.6 in Chap. 3). Such
a tightening was reversed just one year later in 1991. The discount rate
was lowered seven times from 6.0% to 1.75% in just over two years,
between July 1991 and September 1993. A mishandling of monetary pol-
icy, if there ever was one, seems to be more relevant in the tightening
phase (1989–1990), rather than in the easing phase (1991–1993, and
1995).
Whether or not the monetary policy management was appropriate,
adjustments in the real sector that we saw in Chap. 4—disposition of
excesses, particularly unprofitable supply capacity, and relevant debt in
the corporate sector—had to be conducted in any event. So, the major
problem was not with the financial sector but with the borrowing compa-
nies that had accumulated unprofitable assets. Unless such excesses
formed during the bubble were removed, the economy could not have
recovered its strength (including, particularly, the positive risk-taking
behaviors such as investment). The BOJ could have done more to avoid
stagnation, but unless policies targeting more prompt disposition of
unprofitable assets and relevant debt in the corporate sector were taken,
stagnation was bound to continue.10 This mechanism is examined in
detail in Chap. 6.
10
Why could the removal of unprofitable assets from the balance sheets of corporate sector
not be conducted more speedily? There is an argument that funding from financial institu-
tions had an element of introducing capital rather than pure borrowing. Under this argu-
ment, when an investment project financed by financial institutions failed, financial
institutions acted as if they were a provider of capital and shared responsibility of failure,
through alleviation of repayment conditions and/or providing additional funds. Such behav-
iors helped delay the necessary adjustments and made it possible for companies to continue
to hold the unprofitable project. Probably, the best solution was to remove unprofitable
assets together with relevant debt from the rest of the borrower, that is, splitting a borrower
into a “good company” and a “bad company,” with the latter proceeding to a bankruptcy
procedure. See Harashima (2005) for an interpretation of bank loans as provision of
capital.
I nterpretation of Price Stability: How Should We Assess the BOJ’s

Interpretation of “Price Stability,” Prescribed in the BOJ Law
as the Goal of Monetary Policy?
The second point made by Ahearne et al. (2002) in assessing BOJ’s policy
was its interpretation of price stability. Then Governor Hayami (BOJ
1998a) stated that “price stability” refers to “the absence of inflation or
deflation.”11 However, Ahearne et al. (2002) pointed out “zero inflation
on average over time will likely imply shorter periods of deflation as well
as inflation. In the event, these risks [of deflation and the associated pos-
sibility that interest rates would hit their zero lower bound] became real-
ity and the ability of conventional monetary policy to pull the economy
out of recession was substantially undermined” (Ahearne et al. 2002,
15–16).
Here, again, it is pointed out that risk of deflation was not properly
recognized at that time. This lack of sufficient risk awareness may have
been common not only to the BOJ but also to other authorities, media,
and the general public.12
11
Manuscript of the press conference by Governor Hayami on July 21, 1998 (BOJ
1998a). The same statements were found in the manuscript of the press conference by
Governor Hayami on August 13, 1998. Such statements are also found in press releases by
the Monetary Policy Committee. For example, see Bank of Japan (1998c) “Kinnyu Shijo
Chosetsu Hosin no Henko ni tuite” (On the Changes of Monetary Adjustment Policies,
September 9, 1998).
12
Around the beginning of the 2000s, an argument that distinguishes between “good
deflation” and “bad deflation” attracted some attention. Under this argument, deflation
caused by such factors as technological progress or structural reform is said to be beneficial
to the economy. Then BOJ Governor Hayami contended in a press conference on March 10,
2000, that price declines arising from reductions in production and distribution costs due to
technological progress and a distribution revolution were beneficial to consumers. This con-
tention can be classified as a “good deflation” argument. The Annual Economic and Fiscal
Report FY 2001, pp. 43–49, of the Cabinet Office argued that the good deflation arguments
have problems: First, the arguments do not properly distinguish between changes of prices
of specific items (relative price change) and deflation (decline in general price level). Second,
decline in general price level does do harm to the economy. Under deflation, the burden of
debt in real terms increases, depressing investment. If the nominal interest rates or nominal
wages do not fall to the same extent as the general price level falls, the real interest rates or
the real wages rise, depressing investment and employment. Deflation may be beneficial to
the lenders for whom the real value of interest and principal repayments increase and those
employees whose employment and wages are protected; it is disadvantageous to borrowers
206 K. ARAMAKI
ommunication: How Should We Assess BOJ’s Communication

C
Technique, Especially in Relation to the BOJ’s Discomfort with the
Short-Term Interest Rate Close to Zero and Its Inclination
for Structural Reforms?
The third point made by Ahearne et al. (2002) relates to the BOJ’s
communication.
Then Governor Hayami stated, shortly after the introduction of ZIRP,
that in the area of monetary policy, the BOJ had been doing everything
possible, and progress in structural reform was important,13 showing his
inclination toward structural reform, and thereafter gradually started to
emphasize by-products of ZIRP, including reduction of interest income
of households.14 After entering 2000, Governor Hayami called the zero
interest rate abnormal,15 or an emergency measure to deal with an emer-
gency situation, and started to mention that it should be normalized as
soon as possible.16 This line of comments were continued to be made by
the Governor until ZIRP was lifted in August 2000.
and new entrants to labor markets who may be squeezed out. In total, deflation discourages
investment and is detrimental to employment, bringing about significant damage to the
economy. Some media favored the “good deflation” argument. For example, Mainichi
Newspaper on March 17, 2001, in an article entitled “Deflation, Do Not Stop Prices from
Falling,” argued that price drops in recent years were due to import penetration or deregula-
tion, and therefore desirable. The article criticized the government’s interpretation of the
price developments at that time as deflation, as stated in the government monthly economic
report on March 16, 2001. The government report wrote that, if deflation is defined to
mean continuous decline in prices, then the Japanese economy is under a mild deflation.
13
The manuscript of the press conference by the Governor on May 20, 1999 (BOJ 1999a).
Governor Hayami also stated in another press conference that the BOJ had been providing
sufficient funds to the financial markets under the zero interest policy, and even if additional
finance was provided, further monetary easing effects would not be expected. See the manu-
script of the press conference, September 21, 1999 (BOJ 1999c).
14
In a press conference on August 17, 1999, Governor Hayami stated that there were four
by-products in relation to the zero interest policy: a distributional problem of reducing inter-
est income of the household, a concern that structural reforms may be delayed, moral hazard
of the market participants, and decline in market function. See manuscript of press confer-
ence by Governor Hayami on August 17, 1999 (BOJ 1999b). For similar comments, see
manuscripts of press conference by the Governor on February 15, 2000 (BOJ 2000a).
15
Manuscript of press conference by the Governor on March 10, 2000 (BOJ 2000b).
16
Manuscript of a press conference on April 12, 2000 (BOJ 2000c). In a press conference
on June 14, 2000, Governor Hayami said “(it) is an emergency measure adopted under an
emergency situation. Interest rate is something that goes up and down under the demand/
supply conditions like price; clearly, zero interest rate should not be continued limitlessly. We
Deputy BOJ Governor Yamaguchi (1999) stated that “monetary policy

cannot replace the necessary structural policies or adjustments. The deci-
sive monetary easing and active interventions to support the financial sys-
tem by the Bank of Japan no doubt averted deflation or financial panic in
Japan. On the other hand, those policy decisions might have dampened
the restructuring efforts at Japanese financial institutions.”
However, in this regard, Ahearne et al. (2002, 15) pointed out
“Investors’ sense that policymakers were eager to move rates off their zero
floor no doubt kept longer-term interest rates elevated.”
In this respect, probably, the problem was not with the communica-
tion itself but with the policy thinking. The BOJ was conducting mone-
tary policy with a significant focus on nominal interest rate. Without keen
awareness of the cost of deflation, the BOJ seems to have thought mon-
etary policy tools had been thoroughly exhausted (and should be recov-
ered as soon as possible), and there was not much for the BOJ to do to
stimulate the economy.17
How Should We Assess Monetary Policy after the Japanese Economy

Had Fallen into Deflation? (Assessment of Monetary Policy
After ZIRP)
As we have seen, from around 1998, the Japanese economy fell into
chronic but mild deflation, and the interest rate dropped to zero in the
following year. A question for this subsection is what monetary policy
can do when deflation has set in under a situation in which the nominal
interest is zero (monetary policy options under the zero interest rate).
have always a desire to recover space of maneuvering of monetary policy. See manuscript of
press conference by the Governor on June 14, 2000 (BOJ 2000d). In a press conference on
July 19, 2000, Governor Hayami stated that as the interest rates adjust monetary conditions,
the situation where interest rate is zero is a very distorted situation, while it may not be
appropriate to refer to the degree of freedom of monetary policy. See manuscript of press
conference by Governor, July 19, 2000 (BOJ 2000e).
17
The thought that monetary policy tools had been exhausted was later denied by the
policy actions of the BOJ itself, which included quantitative easing and its move to inflation
targeting. However, whether these policy actions contributed to the removal of the funda-
mental cause of the long economic stagnation is a different matter.
208 K. ARAMAKI
onventional Transmission Mechanism of Monetary Policy

C
In the case of monetary easing by the BOJ, traditionally, effects are
expected to work in the following manner (effects flow from ① to ⑥).
① Purchase by the BOJ of bonds and bills in the market.

② Increase in the BOJ current account balances (i.e., part of base
money) held by commercial banks
③ Decrease in the interest rates in the interbank market
④ Decrease in the other short-term market rates and the medium- and
long-term interest rates (including securities yields)
⑤ Decrease in the bank lending rates
⑥ Increase in investment and consumption by enterprises and households
roposed Options under the Zero Interest Rate

P
Once the short-term interest rates reach zero, this conventional channel
ceases to operate: Then, what policy options do we have? There have been
a lot of debates on the issue, and the proposed options include the follow-
ing (not mutually exclusive):18
Type A: Measures to Reduce Long-Term (Nominal) Interest Rate
(a) Purchase of long-term government bonds

–– This affects demand and supply conditions in the market, raising
the price and reducing the yields (interest rates) to these bonds.
(b) Commitment to maintain current accommodating policy for the
future (“policy duration effect”)
–– Long-term interest rates depend on the expected course of the
short-term interest rate in the future, and therefore, the
expected duration of the accommodating policy in the future
affects the long-term interest rate.
(c) Purchase of other more risky assets
18
The classification in the text basically followed Tanaka Takayuki, “Zero Kinri Seiyakuka
niokeru Rifureshon Seisaku Rongi-Nichign ha Nani wo Okonai Nani wo Okonawa
Nakattaka-”(Reflation Policy Debate under the Zero Lower Bound Constraint on Interest
Rate—What Did the BOJ Do and Not Do?), downloaded on January 19, 2015, http://
ir.acc.senshu-u.ac.jp/index.php?active_action=repository_view_main_item_detail&page_
id=13&block_id=52&item_id=1426&it em_no=1
–– The long-term interest rate consists of the expected short-term

interest rate and the risk premium, and purchase of risky assets
can lower the risk premium and the long-term interest rate.
(d) Provision of abundant base money (portfolio rebalancing effects)
–– Purchase of assets by the central bank from the market with the
consideration deposited in its current account held by private
banks (i.e., base money increase) causes portfolio rebalancing
in the private sector (the added base money will be disposed of
through acquisition of other assets including stocks, real estates,
and credit, thereby promoting investment).
Type B: Measures to Raise the Expected Rate of Inflation

to Reduce the Real Interest Rate
(e) Inflation targeting (Krugman 1998)

Commitment by the central bank to achieve a positive rate of infla-
tion helps raise the expected rate of inflation, reducing the real
interest rate.
(f) Price level targeting (Swenson 2003)
If the target level of prices is missed, the required rate of inflation to
achieve the target within a specified time frame becomes greater.
(g) Purchase of government bonds coupled with fiscal stimulus (heli-
copter money)
This action can create demand, but amounts to fiscal policy with
monetization.
Type C: Measures for Other Purposes
(h) Currency depreciation by intervention in the foreign exchange

market (Bernanke 2000)
–– This action promotes exports.
OJ Economists’ Views
B
BOJ’s economists were very skeptical of these unconventional policies at
that time:
210 K. ARAMAKI
Aggressive operations19 should be regarded as a high-risk, high return policy

option.
An important question here is what would happen to the term premiums
requested for long-term interest rates.
A term premium might reflect both risk premium on uncertainty about
future inflation and credit risk regarding government bonds.
It is probable that a massive increase in the outright purchase of govern-
ment bonds is seen by the public as a loss of fiscal discipline … it would likely
result in the further downgrading of Japanese Government Bonds (JGBs),
thus leading to the situation where government bond price formation is to
a large extent determined from the viewpoint of credit risk.
In addition, if uncertainty about the outlook for inflation increases due
to the decisive outright purchase of government bonds, inflation risk pre-
mium also rises.
The … risk is that the BOJ might incur a substantial capital loss, resulting
in a serious burden on the government’s budget in the future. (Fujiki et al.
2001, 111–12)
Okina and Oda (2000) also argued that the introduction of inflation
targeting might hinder the flexibility of monetary policy operation.
doption of QEP by the Bank of Japan

A
In spite of these cautious views, the BOJ restarted reducing the policy
interest rate on February 28, 2001, after a brief lifting of ZIRP from
August 11, 2000, and further adopted QEP on March 19, 2001.
QEP had three distinctive characteristics:
(a) The policy target was changed from the overnight call rate to the
amount of deposits held by private banks with the BOJ’s current
account (a component of the base money).20
(b) It was committed that this policy would be maintained until the
change in CPI from the previous year stably recorded 0% or over.
(c) An increase in the amount of outright purchase of long-term gov-
ernment bonds was clearly indicated.
QEP lasted nearly five years before it was lifted on March 3, 2006.
Meantime, the BOJ increased the targeted balance in BOJ’s current
19
The aggressive outright purchase of long-term government bonds.
20
The base money is composed of deposits with the BOJ and cash (notes and coins in
circulation). As of February 2001, the amount of base money was 68.4 trillion yen, with
notes amounting to 56.4 trillion yen (87%), coins 4.2 trillion yen (6.4%), and deposits with
the BOJ 4.2 trillion yen (6.5%).
account nine times (4 trillion yen →30~35 trillion yen), and also increased
the amount of long-term JGB purchase four times (400 billion yen →1.2
trillion yen per month).
Although this policy is a novel step forward, some cautious comments
are presented on the BOJ’s QEP as follows (Adachi 2013):
Considering the upward bias of the CPI (as the weight is fixed, based on
the share of the adopted items in consumption in the base year), a 0%
increase is not sufficient for overcoming deflation.
The time schedule for overcoming deflation is not clear.
Furthermore, as implied by the subsequent emphasis on “policy duration

effects” by BOJ executives, the BOJ apparently expected the commitment of
the policy for the future to have an effect of flattening the yield curve and
lowering the long-term interest rate. Under the classification mentioned pre-
viously, the BOJ was still working within the interest rate transmission chan-
nel categorized as Type A (i.e., nominal interest rate reduction).
ow to Assess the Effects of the Bank of Japan’s QEP?

H
Ugai (2007), who extensively surveyed empirical analyses of the effects of
BOJ’s QEP, concluded as follows:
The survey confirm[ed] a clear effect whereby the commitment to maintain
the QEP fostered the expectations that the zero interest rate would con-
tinue into the future, thereby lowering the yield curve centering on the
short- to medium-term range. .... Portfolio rebalancing ... effect, if any, was
smaller than that stemming from the commitment.
The QEP contained financial institutions’ funding costs and staved off
financial institutions’ funding uncertainties .... The QEP’s effect on raising
aggregate demand and prices was often limited, due largely to the then pro-
gressing corporate balance-sheet adjustment, as well as the zero lower
bound constraint on interest rates. (Ugai 2007, 1)
Shirakawa (2002), who reviewed one year experience under Quantitative

Easing (QE), stated that increase in reserve money did not give clear
effects on prices of financial assets (long-term government bonds, stocks,
and foreign exchange), and that it did not cause increase in money supply
or in total assets of deposit-taking financial institutions.
As Ugai (2007) pointed out, while QEP might have contained funding
uncertainty of the financial institutions, its effects on real economy (aggre-
gate demand and supply conditions) and also price level seem to have been
very much limited.
212 K. ARAMAKI
Now, let us look at some relevant data. Figure 5.11 shows develop-
ments in the rate of change in M2 and CPI (excluding fresh food) from
the previous year. It appears that the rate of change in both CPI (exclud-
ing fresh food) and M2 declined after entering the 1990s, implying that
movements in money stock and CPI may be related to each other.
However, Fig. 5.12 shows that the rate of change in base money, on
which the BOJ has a substantial degree of influence, does not seem to be
related to the rate of change in M2, casting doubts on the effectiveness of
quantitative easing.
Loans by Banks Did Not Respond

Loans held by banks hit a peak of 493.0 trillion yen in December 1997,
and then decreased to a bottom of 395.9 trillion yen in June 2005. After
that, loans started to slowly recover, but the outstanding amount as of
December 2012, that is, before the start of Abenomics, was 433.8 trillion
yen, lower than the level in December 1997. Meanwhile, JGB holdings by
banks increased by 5 times, from 31.1 trillion yen in December 1997 to
161.2 trillion yen in December 2012. Under QEP, the decline in the out-
standing balance of loans ended, but the pace of increase in loan balance
was rather slow (Fig. 5.13). We will look at developments after Abenomics
started in Chap. 7.
(%)
35
30
25 M2 (average
balance)(year-
20 on-year
change)
15
CPI (excluding
10 fresh
food)(year-on-
5 year change)
0
Jan-70
Nov-72
Sep-75
Jul-78
May-81
Mar-84
Jan-87
Nov-89
Sep-92
Jul-95
May-98
Mar-01
Jan-04
Nov-06
Sep-09
Jul-12
May-15
-5
Fig. 5.11 M2 and Consumer Price Index (excluding fresh food) (year-on-year
change). Source: Bank of Japan, Statistics Bureau, Ministry of Internal Affairs and
Communications
(%)
60
50
40 M2 (average
balance)(year-
30 on-year
20 change)
Base money
10 (average
0 balance) (year-
on-year
Jan-70
Nov-72
Sep-75
Jul-78
May-81
Mar-84
Jan-87
Nov-89
Sep-92
Jul-95
May-98
Mar-01
Jan-04
Nov-06
Sep-09
Jul-12
May-15
-10 change)
-20
-30
Fig. 5.12 Base money and M2 (year-on-year change). Source: Bank of Japan
(trillion yen)
700
600
500
400
300
200
100
0
Oct-93
Mar-95
Aug-96
Jan-98
Jun-99
Nov-00
Apr-02
Sep-03
Feb-05
Jul-06
Dec-07
May-09
Oct-10
Mar-12
Aug-13
Jan-15
Jul-16
Government bond Loan
Fig. 5.13 Loans and government bonds held by domestic banks. Source: Bank
of Japan
214 K. ARAMAKI
4 Summary of the Examination in This Chapter

Let us summarize what we learned on the issue of deflation and monetary
policy, drawing on the analysis in this chapter.
As for the cause of deflation, there might have been some supply-side
factors at work, such as penetration of low-priced goods from emerging
economies, technological progress, and deregulation, but these supply-
side factors21 by themselves cannot explain why the Japanese economy
experienced both deflation and economic stagnation. These supply-side
factors may make production more efficient and bring about benefits to
the economy. However, this is different from what actually happened. We
need to explain the situation in which both economic stagnation and
deflation emerge simultaneously.
Another argument on the cause of deflation contends that problems
with the financial sector gave birth to a credit crunch and depressed invest-
ment. This may fall under the category of (broadly-defined) demand-side
factor arguments. However, the lending attitude of the financial institu-
tions was an eased one for the major part of the 1990s. This implies that
investment stagnation was not due to shortage of supply of funds but due
to shortage of investment demand; and the interpretation that financial sec-
tor problems caused demand shortage and deflation is not convincing.22
Another argument on the cause of deflation is related to demand-side
factors. As we saw in Chap. 3, the most depressing effect on growth after
the burst of the bubble came from stagnation of private investment.
Although there are arguments that criticize the volume and the timing of
demand injection through fiscal policy that was conducted on a very large
scale over the first 10 years of stagnation, more extensive debates were made
on the appropriateness of monetary policy. The analysis in this chapter made
clear that there might have been some problems in monetary policy in rela-
tion to sufficiency and swiftness of the easing, its interpretation of price
stability, and communication. So, if managed differently, it is possible that
monetary policy could have given greater support to the economy.
21
These factors must have been at work, albeit to a different degree, in other advanced
economies.
22
The situation changed with the outbreak of the financial crisis in the late 1990s, and the
lending attitude of the financial institutions was suddenly tightened. This fact implies that we
need to look at effects of the financial crisis on the behaviors of financial institutions and
companies.
However, it is not clear whether we could have avoided the long stag-
nation, if the monetary policy had been more aggressive and speedy. This
depends on whether we find the origin of the problem in the 1990s in
demand shortage or in excess supply. The argument of this book is that
the root cause of the investment (and economic) stagnation was in excess
(non-profitable) assets in the corporate sector. Under this view, what was
fundamentally needed was not to raise demand but remove these excesses.
To this end, monetary easing could be of no more help than buying time.
It seems that mishandling of monetary policy was more significant in
1989–1990, when extremely aggressive monetary tightening was con-
ducted, together with the introduction of an aggregate limit on real estate-
related lending by the MOF, crushing the bubble and overkilling the
economy. Those unprofitable investments in facilities and real estate-
related projects, undertaken by companies and local authorities partly
under the promotion by central government, which could not expect suf-
ficient demand, were destined to fail. So, intentional crushing of the bub-
ble was not necessary. Preventing the bubble from developing further was
what was essentially needed. It may have been beyond the ability of human
beings to contain (not crush) the bubble while keeping the economy on a
stable growth path. It is regrettable that policies not from an economic
efficiency or risk-control viewpoint but from an egalitarian viewpoint were
adopted to cope with the bubble, with little concern or awareness of dan-
gers of these policies to the economy.
After Period I passed, the Japanese economy experienced the financial
crisis. Simultaneously, the economy fell into deflation. ZIRP and QEP by
the BOJ could not bring the economy out of deflation. At this stage, on
top of the overhang of excess assets, which was the origin of the problem,
the economy may have become trapped in a vicious circle caused by
deflation.
If deflation continues, deflation may be incorporated in expectations of
enterprises. If a decline in nominal sales amount (nominal revenue) is
expected, the real burden of expenses with fixed nominal value, such as
wages, interest payments, and principal repayments, becomes heavier. Then,
new investment or employment may be contained, resulting in a reduced
investment and consumption demand. This may lead to a further decline in
sales, and the whole process enters into a declining cycle, making deflation
a chronic phenomenon. This process possibly acted as an extra depressing
factor on the Japanese economy, in addition to the fundamental burden of
excess assets and liabilities that the corporate sector continued to bear.
216 K. ARAMAKI
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CHAPTER 6
Deflation and the Mechanism
of Corporate Behavior
1 Mechanism of the Long Stagnation and

Deflation Viewed through Corporate Behavior
In Chap. 5, we examined the causes of deflation mainly from the viewpoints
of the appropriateness of the monetary policy. So far, however, we cannot
say that we have obtained a convincing explanation of the causes of long
stagnation and deflation after the burst of the bubble, including the con-
tinuation of the situation after the excesses of the corporate sector had been
removed. We have been arguing that the fundamental problem was in the
corporate sector. So, in this chapter, we examine company behaviors that lay
behind the macroeconomic developments, through the analysis of financial
statements of companies. As we have seen, during the long stagnation, par-
ticularly after the financial crisis, fundamental changes took place in the
Japanese economy—a sharp increase in unemployment rate, a rapid decline
in regular employment and a shift to non-regular work, a fall in nominal
wage, a switch of the corporate sector from excess investment to an excess
savings position, and a mild but chronic fall in the Consumer Price Index
(CPI) (deflation). Almost all these changes (employment, wages, pricing,
and investment) are related to company behaviors. So, in order to under-
stand the mechanism of these phenomena, or the cause of the stagnation
and deflation, we need to see what happened to companies.
Much of the following analysis is based on “the financial statement statis-
tics of corporations by industry” (Ministry of Finance [MOF]). These statis-
tics annually provide, based on a survey sample of about 36,000 companies,

222 K. ARAMAKI
estimated data for all of the profit-making companies (about 2.7 million
companies) in Japan, such as sales, wages, profits, assets, liabilities, and
capital. The statistics also give breakdowns by sectors and by company size
classified by capital size. All data are in nominal terms. We first look at
profit and loss, then assets and liabilities, and finally net assets. Drawing
on these analyses, we then present our views on the whole mechanism of
stagnation and deflation after the collapse of the bubble, and we further
explore the reason why companies continued to restrain investment and
wages even after the companies had eliminated excesses.
Profits and Losses of Companies

From the combined profit and loss statements of all the profit-making
corporations, we see that the total amount of sales of companies in Japan
suddenly stopped growing at the beginning of the 1990s, and started to
show a declining trend from around the mid-1990s to the beginning of
2000s (Fig. 6.1). As sales stopped growing, wages also stopped growing
(trillion yen) (trillion yen)

1,800 200
1,600 180
1,400 160
140
1,200
120 Sales
1,000
100 Wages
800
80 (RHS)
600
60
400 40
200 20
0 0
FY1980
FY1984
FY1988
FY1992
FY1996
FY2000
FY2004
FY2008
FY2012
FY2016
FY1960
FY1964
FY1968
FY1972
FY1976
Fig. 6.1 Sales and wages (all industries excluding financial and insurance compa-
nies). Note: Wages = salaries + bonuses + expenses for fringe benefits for employ-
ees. Source: Ministry of Finance, “Financial Statements Statistics of Corporations
by Industry”
DEFLATION AND THE MECHANISM OF CORPORATE BEHAVIOR 223
(trillion yen) (％)

70 14.0
60 12.0
50 10.0 Operating
profits
40 8.0
Ratio of
30 6.0 wages to
sales
20 4.0 (RHS)
10 2.0
0 0.0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 6.2 Ratio of wages to sales and operating profits. Source: Ministry of
Finance, “Financial Statements Statistics of Corporations by Industry”
by the mid-1990s. By the first half of the 1990s, however, wages contin-
ued to grow gradually, and they became more or less flat (did not decline)
thereafter.1
Reflecting such developments in sales and wages, the ratio of wages to
sales rose until the late 1990s, and the operating profits stagnated (Fig. 6.2).
With the outbreak of the financial crisis, the ratio started to decline and it
continued to do so until 2007. Then, the ratio jumped due to the sales
collapse after the Global Financial Crisis (GFC), but subsequently started
to decline again. Operating profits, which had been stagnating, started to
rise after entering the 2000s, but drastically fell with the GFC, after which
it resumed its rise. Over a quarter of a century after the burst of the bubble,
the operating profits have not shown a stable rising trend, while develop-
ments in most recent years may show some upward movements.
Different from developments in operating profits, current profits (and net
profits after tax) recovered a rising trend from the end of the 1990s, reflect-
ing improvements in non-operational profits from the early 1990s, which
cover such items as interest and dividends received and interest paid. Since
then, current profits have been rising with substantial fluctuations (Fig. 6.3).
1
Companies in Fig. 6.1 exclude financial and insurance companies. The same applies to all
subsequent figures.
224 K. ARAMAKI
(trillion yen)
80
70
60
50 Operating
profits
40
Non-
30 operational
profits
20
Current
10 profits
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2014
FY2011
-10
-20
Fig. 6.3 Operating profits, non-operational profits, and current profits (all
industries excluding financial and insurance companies). Source: Ministry of
However, companies’ behaviors have changed in an important respect, as

compared with the period before the bubble. Until 1980s, an increase in
current profits was accompanied by increase in wages. Since the mid-1990s,
an increase in current profits is not reflected in an increase in wages (Fig. 6.4).
To summarize what we have seen in relation to developments in profits
and losses of companies from the 1990s:
First, sales stopped growing from the beginning of 1990s and started to
decline from around the mid-1990s.
Second, wages continued to grow for some time, but they became flat
before the mid-1990s.
Third, the ratio of wages to sales rose substantially after entering the 1990s
(after the financial crisis, the ratio started to decline but then rose again
significantly, due to the GFC).
Fourth, the operating profits sharply declined and stayed low throughout
the 1990s (they rose in the 2000s but declined due to the GFC).
Fifth, current profits recovered a rising trend from the end of the 1990s,
reflecting improvements in non-operational profits.
Sixth, improvements in current profits, however, have not led to an increase
in wages (improvements in current profits and wages have been
de-linked).
(trillion yen)
80
70
60
50 Current
profits
40
Changes
30 in wages
20 from
previous
10 year
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2014
FY2011
-10
-20
Fig. 6.4 Current profits and changes in wages from previous year. Source:
Ministry of Finance, “Financial Statements Statistics of Corporations by Industry”
Assets and Liabilities of Companies

Next, we will look at the balance sheets of companies. Figure 6.5 shows
developments in assets and liabilities of companies. We can see that there
is a bump in both assets and liabilities in the latter half of 1980s and
throughout 1990s. Both assets and liabilities started to expand from the
mid-1980s at a pace that was much faster than the trend in the preceding
years. The pace of expansion of both assets and liabilities slowed down
after entering the 1990s, and they started to decline from the mid-1990s.
The bump disappeared, and adjustments seem to have been completed in
the early 2000s. While assets resumed growth in the early 2000s, liabilities
continued to be stagnant.
Figure 6.6 shows developments in assets with their breakdown into fixed
and liquid assets. The low growth (or shrinking) of total asset size mainly
reflected decline in liquid assets, whereas fixed assets continued to grow,
albeit at a lower rate from the 1990s until recent years (Fig. 6.6).
A breakdown of liquid assets shows that the shrinkage in liquid assets
that we saw in Fig. 6.6 seems to reflect stagnation in business activities, as
shown in the developments in notes and accounts receivables and inven-
tory assets (Fig. 6.7). Cash and deposits started to decline after entering
the 1990s, became flat in the 2000s, and then started to increase from
around the GFC.
226 K. ARAMAKI
(trillion yen)
1800
1600
1400
1200
1000 Assets
800 Liabilities
600
400
200
0 FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
Fig. 6.5 Assets and liabilities of companies (all industries excluding financial and
insurance companies). Source: Ministry of Finance, “Financial Statements Statistics
(trillion yen)
1,800
1,600
1,400
1,200 Assets
1,000 Fixed
assets
800
liquid
600 assets
400
200
0
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
Fig. 6.6 Assets and their breakdown between fixed and liquid assets (all indus-
tries excluding financial and insurance companies). Source: Ministry of Finance,
(trillion yen)
800
700 Liquid assets
600 Cash and deposits
500 Notes and accounts
receivable
400
Inventory assets
300
Securities held for
200 trading purposes or
100 maturing within one
year
0
FY1960
FY1964
FY1968
FY1972
FY1976
FY1980
FY1984
FY1988
FY1992
FY1996
FY2000
FY2004
FY2008
FY2012
FY2016
Fig. 6.7 Liquid assets and their components (all industries excluding financial
and insurance companies). Source: Ministry of Finance, “Financial Statements
As opposed to liquid assets, fixed assets continued to grow even after

entering the 1990s, at a lower rate than before. However, a breakdown of
fixed assets shows that physical assets (excluding land),2 such as buildings and
machinery, continued to increase up to the mid-1990s, started to decline
from around the financial crisis, and became flat recently. By contrast, securi-
ties held for investment purpose have been consistently increasing (Fig. 6.8).
Figure 6.9 shows securities held for investment purposes by companies,
their breakdown into stocks and bonds, and the outstanding balance of
foreign direct investment (FDI) (converted into yen using the year-end
exchange rate). It shows that stocks account for most of the securities held
for investment purpose, and the increase in FDI, particularly, since the
early 2000s, seems to account for a substantial part of expansion of stock
holdings (Fig. 6.9).3
2
Physical assets (excluding land) is the sum of “expenditure for construction that is not
completed” and “other physical assets (excluding land)” in the financial statement statistics
of corporations by industry.
3
The ratio of outstanding FDI (converted to the yen using the year-end exchange rate) to
stocks held for investment purposes has been around between 30% and 40% from the latter
half of 1990s to the beginning of 2010s. It showed a sharp increase since the first half of
2010s, reaching a level above 50% in fiscal 2016.
228 K. ARAMAKI
(trillion yen)
900
800
700 Fixed assets
600 Land
500 Physical
assets
400
(excluding
300 land)
200 Securities
100 held for
investment
0 purposes
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 6.8 Fixed assets and their major components (all industries excluding finan-
cial and insurance companies). Source: Ministry of Finance, “Financial Statements
(trillion yen)
350
Securities
300 held for
250 investment
purposes
200 Of which stocks
150 Of which bond
Outstanding
100 balance of
50 external
FDI
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 6.9 Investment securities and Foreign Direct Investment. Note: Data for
outstanding balance of external FDI are obtained by multiplying calendar year-end
balance of FDI (in US dollars) by year-end yen–dollar exchange rate. As data for
securities for investment purposes are as of the fiscal year end (that is, end March
of the following year), there is a three-month discrepancy in timing between these
two data. Source: Ministry of Finance, “Financial Statements Statistics of
Corporations by Industry,” Japan External Trade Organization (JETRO)
To summarize the developments in assets of profit-making corpora-

tions from the 1990s:
First, the decline in liquid assets after the collapse of the bubble reflects
stagnation in business activities.
Second, by contrast, fixed assets continued to increase. This is because,
while physical assets including buildings and machinery started to
decline from around the time of the financial crisis, an increase in securi-
ties held for investment purposes more than made up for such a decline.
Third, it is possible that the increase in securities held for investment pur-
poses from around the mid-2000s was substantially accounted for by an
expansion of outward FDI.
Let us look at the liability side next. Liabilities consistently expanded

from the 1960s, and the pace of expansion accelerated in the latter half of
1980s. Liabilities continued to expand after entering the 1990s but
declined from the mid-1990s, becoming flat from the first half of 2000s.
A breakdown shows that liquid liabilities became flat after entering the
1990s and started to decline from around the mid-1990s. Fixed liabilities
started a decline in the latter half of the 1990s (Fig. 6.10).
A breakdown of liquid liabilities into major components shows that
notes and accounts payable stopped growing after entering the 1990s and
then followed a declining trend. This appears to reflect a stagnation of
business activities, as is shown in the development in liquid assets.
However, short-term borrowing (borrowing maturing within one year)
continued to increase until the mid-1990s. This may be because compa-
nies coped with the general deterioration of business environments by
resorting to short-term borrowing. This could also be related to the fact
that physical assets kept rising up to the latter half of the 1990s, as we saw
before. That is, investment planned in the 1980s may have taken years to
be completed, and therefore, investments continued to be implemented
even in the 1990s. Under the worsening investment environments, matu-
rity shortening of funding may have occurred (Fig. 6.11).
Developments in fixed liabilities show that fixed liabilities continued to
increase, albeit at a lowering pace, even after entering the 1990s, but
started to sharply decline after the financial crisis. A breakdown of fixed
liabilities shows that, as the amount of corporate bonds were more or less
flat, developments in fixed liabilities almost solely reflected developments
in long-term borrowing (Fig. 6.12).
To summarize developments in liabilities:
230 K. ARAMAKI
(trillion yen)
1,200
1,000
800 Liabilities
Fixed
600 liabilities
Liquid
400 liabilities
200
0
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
Fig. 6.10 Liabilities and their breakdown between liquid and fixed liabilities (all
(trillion yen)
700
600 Liquid
liabilities
500
Notes and
400 accounts
payable
300
Borrowing
200 maturing
within one
100 year
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 6.11 Liquid liabilities and their major components (all industries excluding
financial and insurance companies). Source: Ministry of Finance, “Financial
(trillion yen)
600
500
Fixed
liabilities
400
Long-term
borrowing
300
Bond
200
100
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 6.12 Fixed liabilities and their components (all industries excluding finan-
cial and insurance companies). Source: Ministry of Finance, “Financial Statements
First, while the declining growth rate of liabilities reflects stagnation of

economic activities, it should be noted that both short-term and long-
term borrowing continued to increase until the mid-1990s, albeit at a
decreasing pace.
Second, the decline in liabilities from the latter half of the 1990s was due
substantially to the decline in borrowing, in particular, the sharp decline
in the long-term borrowing after the financial crisis. This indicates that
companies drastically changed their behavior in the direction of reduc-
ing borrowing after the financial crisis.
Net Assets of Companies

Finally, we take a look at developments in net assets. Net assets substan-
tially changed in two phases: first, after entering the 1990s, and, second,
after the financial crisis. Net assets gradually increased in the 1970s and
1980s, with the pace of the increase rising in the latter half of the 1980s.
The pace of net asset growth slowed down after entering the 1990s,
almost leveling off in the mid-1990s. However, the pace of growth of
net assets suddenly accelerated after the financial crisis (Fig. 6.13). The
232 K. ARAMAKI
(trillion yen)
800
700
600 Net assets
500 Capital
400 Capital
surplus
300 Earned
200 surplus
100
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 6.13 Net assets and their components (all industries excluding financial and
insurance companies). Source: Ministry of Finance, “Financial Statements Statistics
major factor behind the increase was an increase in earned surplus supported
by an increase in profits, which was substantially supported by improve-
ments in non-operational profits that we have seen in this chapter (Fig. 6.14).
Such a move to strengthen the net assets position can be found also in
developments in the capital/asset ratio. The capital/asset ratio of compa-
nies was on a rising trend from the mid-1970s and throughout the 1980s.
Then, it decelerated after entering the 1990s and almost stopped growing
after the mid-1990s. However, it started to sharply rise after the financial
crisis and has reached a historic high in recent years (Fig. 6.15).
We have looked at developments in profits and losses, assets and liabilities,
and net assets of companies based on combined financial statements. What do
they imply? Developments in these financial statement data indicate that the
financial crisis seems to have fundamentally changed the behaviors of compa-
nies. It appears that priorities in the management of companies changed;
strengthening their balance sheet position was given priority over other objec-
tives. The reason behind this was the drastic change in financial environments.
We have seen in Chap. 4 that the lending attitudes of financial institutions was
sharply tightened at the outbreak of the financial crisis, across companies of all
capital sizes, including small- and medium-sized enterprises (SMEs) that were
(trillion yen)
350
300
250 Earned surplus
200 Accumulated
profits
150
Earned surplus
100 other than
50 accumulated
profits
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
-50
-100
Fig. 6.14 Earned surplus and its components. Source: Ministry of Finance,
(%)
45
40
35
30
25
20
15
10
5
0
FY1982
FY1984
FY1986
FY1988
FY1990
FY1992
FY1994
FY1996
FY1998
FY2000
FY2002
FY2004
FY2006
FY2008
FY2010
FY2012
FY2014
FY2016
FY1960
FY1962
FY1964
FY1966
FY1968
FY1970
FY1972
FY1974
FY1976
FY1978
FY1980
Fig. 6.15 Capital/assets ratio. Note: Capital/asset ratio = (net assets-right to

purchase newly issued stocks)/(liabilities + reserves under special law + net assets).
Source: Ministry of Finance, “Financial Statements Statistics of Corporations by
Industry”
most dependent on borrowing (see Fig. 4.11 in Chap. 4). In addition to

the rising uncertainty for the future caused by the failure of big financial
institutions, the sharp deterioration of funding environments from outside
made it necessary for companies to fundamentally review their business
234 K. ARAMAKI
operations so that they could survive.4 Figure 6.16 shows the number of

manufacturing companies by capital size. We see that the number of smaller
companies with capital less than 100 million yen hit a peak in 1995, and
thereafter, was on a declining trend. Their numbers started to sharply
decline after the financial crisis, particularly after entering the 2000s. The
financial crisis seems to have had a greater impact on relatively smaller com-
panies and reduced their viability. The number of companies with capital
equal or greater than 100 million yen and less than 1 billion yen had been
increasing until the 2000s, and thereafter, became flat and declined after
the GFC. The number of big companies with capital 1 billion yen or greater
was also slowly declining beginning around the GFC.
Equal or
(No.) (No.)
greater than 1
8000 500,000 bil. yen capital
7000 450,000 size
400,000 Less than 1 bil.
6000
350,000 yen and equal
5000 300,000 or greater than
100 mil. yen
4000 250,000
capital size
3000 200,000
Less than 100
150,000
2000 mil. yen capital
100,000 size (RHS)
1000 50,000
0 0
FY2002
FY2005
FY2008
FY2011
FY2014
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
Fig. 6.16 Number of manufacturing companies by capital size (all industries

excluding financial and insurance companies). Source: Ministry of Finance,
4
Particularly, for small- and medium-sized companies that were highly dependent on bor-
rowing from financial institutions, borrowing from financial institutions had been function-
ing as funding similar to capital contributions for which only interest payments were required
and repayment of principal was not expected. Therefore, faced with curbing of new loans (or
possibly, forcible collection of outstanding loans) by financial institutions after the financial
crisis, these companies had no choice other than trying to defend themselves by, for example,
strengthening their net asset positions.
Changes in Assets/Liabilities and Net Assets and The

Interpretation: Strengthened Defensiveness of Companies
Let us summarize once more how the asset and liability structure and net
asset position have changed over the last three decades from the mid-1980s:
First, the size of assets and liabilities started to expand from the mid-1980s at
a much faster pace than indicated by the trend in the preceding periods.
Second, the growth of both assets and liabilities slowed down after enter-
ing the 1990s and then declined from mid-1990s to early 2000s.
Third, after that, while assets resumed growth in early 2000s, liabilities
showed little growth to date.
Fourth, stagnation of assets after entering the 1990s was due to the decline
in liquid assets caused by stagnant business activities.
Fifth, fixed assets continued to grow, albeit at a slower pace even after
entering the 1990s (they are growing even now).
Sixth, however, in the fixed assets, physical assets (excluding land) started
to decline after the financial crisis, and this continued until recent years.
Seventh, on the other hand, in place of physical assets (excluding land), secu-
rities held for investment purposes significantly increased, making up for
the decline in physical assets (excluding land), and became a driving force
of supporting an increase in fixed assets or assets as a whole. Increase in
cash and deposits also supported growth of assets after the GFC in 2008.
Eighth, stagnation of liabilities, after entering the 1990s, also reflected
stagnation of economic activities. At the same time, both short-term
and long-term borrowing continued to increase at least up to the mid-
1990s (this corresponds to the fact that physical assets (excluding land)
were on a rising trend until around the financial crisis).
Ninth, the decline in liabilities from around the mid-1990s reflects a
decline in short-term and long-term borrowing (this has been particu-
larly distinct after the financial crisis).
Tenth, the growth of net assets accelerated in the second half of the 1980s,
slowed down after entering the 1990s, and halted around the mid-1990s.
However, net assets suddenly started a sharp increase, reflecting an
increase in earned surplus supported by an increase in profits.
How should we interpret these developments? One interpretation,

which draws not only on what we found in this chapter but also on what
we learned in the preceding chapters, is as follows:
236 K. ARAMAKI
The problem started with the rapid expansion of the asset size of the
corporate sector from the mid-1980s and the sudden stop of sales growth
and the subsequent fall of sales after the burst of the bubble at the begin-
ning of the 1990s. These developments indicate that the corporate sector
came to have a huge amount of assets for which they could not expect
sufficient sales or demand, that is, excessive (unprofitable) assets. This lay
at the heart of the difficulties of the Japanese economy after the collapse
of the bubble.
Under the circumstances, the corporate sector initially took the follow-
ing responses. First, they restrained investment but did not swiftly remove
excessive assets. Second, they maintained existing employment (regular
employment showed a moderate increase until the second half of the
1990s). Third, they restrained wage increases, but the combined amount
of wages paid by the corporate sector continued to increase for some time
(accordingly, the wage/sales ratio significantly increased in the 1990s).
Fourth, as a result, operating profits stagnated, and companies tried to
secure current profits by improving non-operational profits (interest pay-
ments, etc.). So, current profits started to increase from the end of the
1990s, but different from the pattern than existed until the 1980s; the
improvements in current profits did not lead to an increase in wages (per-
formance of companies and wage increases had become de-linked). Such
response by the corporate sector, in the period from the collapse of the
bubble but before the breakout of the financial crisis, may be regarded as
a passive response in that they did not swiftly dispose of the excess assets
and liabilities, maintained employment, and accepted a wage increase for
some time. If we focus on the corporate behavior, this first stage of the
economic stagnation may be termed “the period of passive response.”
Although the corporate sector employed what may be called a tradi-
tional approach that placed importance on securing employment and took
time to dispose of excessive assets, the costs and risk of holding excessive
(unprofitable) assets started to be shifted to the financial sector, in the
form of increasing non-performing loans (NPLs) and a financial crisis
broke out in late 1990s. Faced with the crisis, the corporate sector
addressed the problem of excessive assets in a dramatically different way,
and with this change, the stagnation entered the second stage.
To explain the process, after the crisis broke out, the lending attitude of
financial institutions was suddenly tightened, including for small- and
medium-sized borrowers for which the tightening of lending was rela-
tively moderate in the period immediately after the burst of the bubble. In
the face of such adverse changes in funding environments, the corporate

sector seems to have started to forcefully strengthen its capital base to
survive. The net asset position and the capital asset ratio started to rise
sharply after the financial crisis. Strengthening of the net asset position was
achieved mainly through the accumulation of profits. Under the prolonged
sales stagnation, the only options open to companies to secure profits were
reduction of labor costs, cutback of interest payments through repayment
of debts, and sales of assets. Therefore, the companies embarked on full-
fledged labor cost reduction through nominal wage cuts and reductions in
regular workers, replacing them with non-regular workers. They also
started to make substantial repayments of debts and disposition of assets.
Furthermore, companies strengthened their stance to restrain investment,
with a result that the size of physical assets, such as buildings and machin-
ery, started to decline. What these responses by companies in the second
stage of stagnation indicate is that previous company behaviors that placed
priority on securing employment and investing and holding physical assets
had been significantly altered to the one that presumed continuation of
stagnation, or low growth. Although current profits recovered a rising
trend from the end of the 1990s, companies now gave first priority to
strengthening their net asset position and pursued labor cost reduction,
restraining investment and reducing physical assets. If we focus on corpo-
rate behavior, the second-stage economic stagnation in and after the finan-
cial crisis may be referred to as “the period of crisis response.”
Thanks to such defensive behaviors, that is, restraint on wages and
restraint on physical investment (“two restraints”), excessive assets and
liabilities, as well as excessive employment that had been formed during
the bubble period, were eliminated (as Fig. 6.5 indicates, the size of total
assets returned to the level implied by the long-term trend line by the mid-
2000s). However, even after the elimination of excesses, such defensive
behaviors of companies continued and became long-lasting or perpetu-
ated. It may be said that, with the continuation of defensive behaviors of
companies, economic stagnation changed in nature and entered a third
stage. If we focus on corporate behavior, this period could be called “the
period of continued defensiveness.” Such corporate behaviors placed
downward pressures on consumption (through wage restraint) and invest-
ment (through sales stagnation), bringing about structuralized demand
shortage.
If we interpret the mechanism of economic stagnation in this way, how
should we explain the mild decline of general price levels (deflation), which
238 K. ARAMAKI
has been another big issue of the Japanese economy? Our conclusion is
that we should regard deflation as brought about by structuralized demand
shortage under the long-lasting defensive attitude of companies. To
expound, labor cost reduction through nominal wage cuts and replace-
ment of regular employment with non-regular employment placed a
downward pressure on general price levels. At the same time, defensive
behaviors of companies imposed negative impacts on consumption
through stagnant wages. Structuralized demand shortage due to such
downward pressure on consumption and prolonged restraint on invest-
ment must have worked as a chronically depressing pressure on general
price levels. If this is the case, it is likely that deflation is not the cause of
the economic stagnation that Japan suffered for such a long time, but it is
the outcome of the stagnation, or the consequence of the defensive behav-
iors of companies triggered by the financial crisis. This interpretation,
however, does not deny the possibility that deflation may have added an
extra burden on the economy through a mechanism that discouraged
employment and borrowings, making an exit from the low-growth cycle
more difficult.5
2 Mechanism Behind the Continued Defensive

Attitude of Companies
In the preceding section, drawing on observed changes in corporate
behavior since the latter half of 1980s, we have divided the period of long-
term economic stagnation extending over more than two decades after the
collapse of the bubble, into three periods, focusing on the responses of
companies: “Period of passive response” (first stage of stagnation) from
the collapse of the bubble in the beginning of the 1990s to the period
before the financial crisis in the latter half of the 1990s, “Period of crisis
response” (second stage of stagnation) from the financial crisis to the mid-
2000s, when removal of excess assets and liabilities were completed, and
“Period of continued defensiveness” (third stage of stagnation) since the
mid-2000s, when the excesses had been eliminated.
5
In addition to such behavioral changes of companies, however, it is possible that external
factors contributed to the nominal wage decline and emergence of deflation. This issue is
examined later in this chapter.
In this section, we will address the question of why companies continued

to restrain investment and wages even in the period after the negative legacy
of the collapse of the bubble was overcome (that is, in the third stage of
stagnation: “Period of continued defensiveness”). There are two types of
views on this issue. In the first view, companies’ behavior is judged as irra-
tional. The mindset of companies stand at the heart of the arguments. It is
argued that, since it took as long as 15 years from the collapse of the bubble
to the elimination of the excess assets and liabilities and because low growth
and deflation continued for these years, the mindset or habitual mental
attitude of companies changed irrationally into an excessively defensive one.
From this viewpoint, it is most important to change such mindsets of com-
panies. In contrast, the second viewpoint regards company behaviors as
rational. Restraint on investment and wages is regarded not as the outcome
of the defensive mindset but as the outcome of the rational choice made by
companies in the internal and external economic environments. In this sec-
tion, we examine whether the restraint on investment and wages that
appears to be structuralized is due to an irrational deep-seated defensive
mindset or based on rational considerations. We first look at investment
restraint to be followed by wage restraint.
Mechanism of Investment Restraint
echanism of Investment Restraint in the First and Second Stages

M
of Stagnation
Before examining investment restraint in the third stage of stagnation, let
us look at the mechanism of investment restraint in the first and second
stages of stagnation. As we have repeatedly emphasized, the most impor-
tant background is the excess assets (and excess liabilities) of the corporate
sector that resulted from the excessive investment in the bubble period
from the mid-1980s (see Fig. 6.5). Almost as important is the sudden
termination of sales growth of companies after the collapse of the bubble
(see Fig. 6.1). Due to the sudden cessation of sales growth, physical assets
such as structure, machinery, and equipment became excessive relative to
the volume of sales. Figure 6.16 shows the ratio of physical assets (exclud-
ing land) to sales, which is an inverse of a type of total asset turnover ratio.6
This ratio shows how much physical assets companies hold per unit of
6
The total asset turnover ratio is usually defined as the value of sales divided by total assets.
In the text, the term, physical assets (excluding land), is used instead of total assets.
240 K. ARAMAKI
sales. The ratio hit a bottom by the beginning of the 1980s, and then fol-
lowed a rising trend. The pace of the rise accelerated after entering the
1990s, but it started to decline from the mid- through the second half of
the 1990s (Fig. 6.17).
With these developments in mind, let us conduct a very rough estimate
of the amount of excessive supply capacity (physical assets).7 We first assume
that a company has some criterion on the desirable physical assets/sales
ratio, or how much physical assets it wishes to hold per unit of expected
sales. As companies usually need physical assets in order to produce goods
or services, it is realistic to assume that a company would wish to strike
some balance between the size of physical assets and the volume of sales. As
Fig. 6.17 shows, this ratio changes over time, and it is difficult to know
what level of the ratio a company regards as appropriate. Figure 6.18 shows
estimates of excess physical assets. Estimates of excess physical assets
(％)
0.35
0.3
All industries
0.25 Manufacturing
0.2 Non-
manufacturing
0.15
0.1
0.05
0
FY1960
FY1963
FY1966
FY1969
FY1972
FY1975
FY1978
FY1981
FY1984
FY1987
FY1990
FY1993
FY1996
FY1999
FY2002
FY2005
FY2008
FY2011
FY2014
Fig. 6.17 Ratio of physical assets (excluding land) to sales. Note: Physical assets
= expenditure for construction that has not been completed + other physical assets
such as structure, machinery, and equipment (excluding land). Source: Ministry of
7
Estimation is conducted as follows. It is assumed that the physical assets/sales ratio was opti-
mum and that there was no excess assets in FY 1990. The optimum size of physical assets is cal-
culated for each of the subsequent years by multiplying the amount of sales in each year by the
physical assets/sales ratio in FY 1990. That part of the actual size of physical assets that is greater
than the estimated “optimum” size of physical assets in each year is regarded as excess assets.
(trillion yen)
120
100
Excess
80 physical
assets
60 (estimate)
40 Investment
20 Depreciation
Fig. 6.18 Estimated excess physical assets, investment, and depreciation (all
are obtained by, first, assuming that the physical assets/sales ratio as of FY

1990 (0.16) was desirable (in other words, there was no excess supply
capacity in FY 1990); second, calculating the optimum size of physical
assets using the actual sales amount in each of the subsequent years (by
multiplying sales amount by 0.16); and, third, subtracting the optimum
from the actual size of physical assets. The size of estimated excess physi-
cal assets increased rapidly from FY 1990, hit a peak in FY 1998, and
thereafter sharply declined. The actual amount of investment and the
amount of depreciation are shown in the same figure. The figure shows
that, during the period when excess physical assets were increasing and
stayed at a high level, net investment declined, and that, after the financial
crisis, the amount of investment dropped below the amount of deprecia-
tion, that is, net investment was negative. Investment started to increase
from the beginning of the 2000s, catching up with the level of deprecia-
tion around the mid-2000s when the estimated excess physical assets
declined substantially.
This calculation explains why stock adjustment was not finished swiftly
after the collapse of the bubble. After entering the 1990s, while investment
declined, net investment was still positive and supply capacity continued to
be added. On the contrary, sales amount leveled off and then tended to
242 K. ARAMAKI
decline, with the result that excess supply capacity did not decline, increas-
ing rather until the latter half of the 1990s. The presence of such excess
supply capacity brought about by sales stagnation and the growth of sup-
ply capacity placed a continuous downward pressure on investment, mak-
ing the recovery in the first stage of stagnation weak.
After the financial crisis (or in the second stage of stagnation), compa-
nies’ responses drastically changed, and disposition of excess assets and
liabilities rapidly progressed. In this stage, restraint of investment was fur-
ther strengthened and physical assets started to decline. Investment
restraint in the second stage of stagnation was implemented in order to
carry out disposition of excesses that had been delayed and, therefore, was
an unavoidable process.
echanism of Investment Restraint in the Third Stage of Stagnation

M
Due to the positive disposition by companies of excess assets, they were
eliminated by the mid-2000s, and against this background, real gross pri-
vate investment, which had been stagnant in the 1990s, started to increase
from the first half of the 2000s (later, it sharply declined due to the GFC,
but began to rise afterward) (Fig. 6.19).
After the disposition of excess assets was completed, was the problem of
investment restraint by companies that had lasted for more than 10 years
(billion yen)
90,000.0
80,000.0
70,000.0
60,000.0
50,000.0
40,000.0
30,000.0
20,000.0
10,000.0
0.0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2012
2013
2014
2015
2011
Fig. 6.19 Real gross private investment. Source: Cabinet Office

solved? Not necessarily. Figure 6.20 shows developments in cash flows and

investment. While the level of private investment had been broadly the
same as the level of cash flow for more than 30 years, until the beginning
of the 1990s, the private investment/cash flows ratio substantially declined
in the latter half of 1990s. The ratio hit the bottom and became flat there-
after. Even after the mid-2000s, when the negative legacy of the collapse
of the bubble was finally eliminated, the level of private investment stayed
substantially at a lower level than the level of cash flows. Why did the com-
panies restrain investment in relation to the level of cash flows?
According to the first of the two interpretations previously mentioned
on the cause of continued investment restraint, it is claimed that c ompanies
assumed an excessively defensive attitude and were strongly reducing risk-
taking in response to both the shocks of the collapse of the bubble and the
financial crisis, and that such defensiveness has led companies to give pri-
ority to liquidity holding and to restrain investment, even after their bal-
ance sheets have been normalized.
(trillion yen) (％)

80 180
70 160
60 140
Private
120
50 investment
100 Cash flow
40
80 Private
30 investment
60
/Cash flow
20
40
10 20
0 0
FY1991
FY1994
FY1997
FY2000
FY2003
FY2006
FY2009
FY2012
FY2015
FY1961
FY1964
FY1967
FY1970
FY1973
FY1976
FY1979
FY1982
FY1985
FY1988
Fig. 6.20 Cash flow, private investment, and private investment/cash flow.
Note: Private investment =①Difference from previous year in (a) expenditure for
construction that has not been completed, (b) other physical assets (excluding
land), (c) intangible assets other than software, and (d) software + ②depreciation.
Cash flow = current profits × (1/2) + depreciation. Source: Ministry of Finance,
244 K. ARAMAKI
If such a defensive mindset of companies is the fundamental cause of

continued restraint on investment, in order to increase investment and
growth, policy measures may be regarded as necessary and appropriate
that would alter irrationally defensive attitudes. Such policies could include
encouraging the industrial community politically to increase investment
and to strengthen the governance structures of companies so as to enhance
appropriate risk-taking instead of primarily defending the company.
However, the second of the two interpretations claimed that continued
investment restraint after excessive assets and liabilities had been removed
by the mid-2000s was the outcome of rational choices made by compa-
nies. In other words, there is a good reason for the caution exercised by
companies toward domestic investment.
As we have already seen, companies started to reduce physical assets
(excluding land) and expand security holding for investment purposes
from the latter half of the 1990s. Most of the securities held for invest-
ment purposes that companies are increasingly holding are stocks. If we
compare the outstanding balance of outward FDI (converted into yen by
end-period exchange rate) with the outstanding amount of securities held
for investment purposes, the former accounts for approximately 30–50%
of the latter. The increase in security holding for investment purposes
seems to reflect active FDI by companies (Refer to Fig. 6.9).
Figure 6.21 shows, first, the amount of dividends received from abroad
in relation to FDI recorded in the Balance of Payments (BOP) statistics,
and, second, the share of such dividends received from abroad in the
amount of non-operational revenue of companies (all industries excluding
financial and insurance companies). The ratio of dividends received in rela-
tion to outward FDI to the amount of non-operational revenue of compa-
nies (excluding financial and insurance companies) increased by 4.5 times
from 4.2% in 1996 to 18.7% in 2014 (however, the share substantially
declined in most recent years due to a sharp fall in dividends received)
(Fig. 6.21).
These data indicate that companies placed a greater importance
than before on foreign investment, as compared with domestic invest-
ment, and that they have been allocating cash flow accordingly after
the financial crisis, particularly, after entering the 2000s. If so, why?
First, after the burst of the bubble, the expected growth rate of domes-
tic economy held by companies significantly declined and stayed at a
(trillion yen) (%)

5 20
4.5 18
4 16
Dividends
3.5 14 received
3 12
Dividends
2.5 10 received/
non-operational
2 8 revenue (RHS)
1.5 6
1 4
0.5 2
0 0
66 98 0 0 02 04 06 08 10 12 14 16
19 19 20 20 20 20 20 20 20 20 20
FY FY FY FY FY FY FY FY FY FY FY
Fig. 6.21 Dividends received from abroad and their share in non-operational
revenue. Note: Dividends received = “Dividends and withdrawals from income of
quasi-corporations” in Ministry of Finance, “Balance of payments statistics.” Non-
operational revenue is for all industries excluding financial and insurance compa-
nies. Source: Ministry of Finance, “Financial Statements Statistics of Corporations
by Industry”
low level since. If the domestic economy is expected to grow at a low

rate, domestic investment is restrained (Fig. 6.22).8
Second, the difference in profitability between foreign and domestic
investment may be making companies wary about domestic investment.
Figure 6.23 indicates that the ratio of current profits to sales of foreign
subsidiaries has been substantially higher than that of domestic companies
(all industries excluding financial and insurance companies) after entering
the 2000s, although it has declined sharply in recent years.
8
The shrinking population or the expectation of the population shrinking is sometimes
cited as a cause of the decline of expected growth rate. However, the number of people of
working age in the population started to decline in the mid-1990s, and the total population
started to decline in the latter half of the 2000s. It is probably since about 2010 that the eco-
nomic effects of the population shrinking started to be widely recognized. Developments in
expected growth rate do not seem to be in line with evolution of the demographic facts. Refer
to the supplement to this chapter for information about the demography and the economy.
246 K. ARAMAKI
(%)
7.0
6.0
5.0
Next
4.0 year
Next
3.0 three
2.0 years
Next
1.0 five
years
0.0
FY1973
FY1975
FY1977
FY1979
FY1981
FY1983
FY1985
FY1987
FY1989
FY1991
FY1993
FY1995
FY1997
FY1999
FY2001
FY2003
FY2005
FY2007
FY2009
FY2011
FY2013
FY2015
-1.0
-2.0
Fig. 6.22 Expected growth rate held by companies. Source: Cabinet Office,
“Survey on company behavior”
(%)
7.0
6.0
Foreign subsidiaries
5.0 (all industries
excluding financial
4.0 and insurance)
3.0 Domestic companies

(all industries
excluding financial
2.0
and insurance)
1.0
0.0
Fig. 6.23 Ratio of current profits to sales (%). Source: Ministry of Economy,
Trade and Industry, “Basic survey on overseas business activities”
The ratio of outstanding balance of outward FDI to domestic physical

assets (excluding land) has been consistently rising since around the end of
the 1990s. Reflecting the depressed growth expectation of the domestic
economy and relatively high profitability of overseas operations, compa-
nies seem to have been gradually shifting their business base to overseas,
by increasing overseas investment and restraining domestic investment as
a rational choice, particularly, since mid-2000s (Fig. 6.24).
Figure 6.25 shows that the overseas production ratio (sales of subsidiar-
ies/[sales of subsidiaries + sales of domestic companies]) of the manufac-
turing sector has been largely rising consistently. For manufacturing
companies with overseas subsidiaries, 38% of the total production was
done abroad in FY 2014. Nominal yen appreciation tends to be followed
by a further rise in overseas production ratio after a lag of a few years.
The foregoing indicates that companies seem to have been strengthening
their position to place a greater emphasis on foreign operations year by year,
and as a result, a gap has emerged between the amount of domestic invest-
ment and the amount of cash flow. In order to examine this situation, we
have added FDI to domestic investment in Fig. 6.26. The combined amount
of domestic and foreign investment comes close to the level of cash flow in
(%)
50
45
40
35
30
25
20
15
10
5
0
Fig. 6.24 Ratio of outstanding Foreign Direct Investment (all sectors) to physical
assets (excluding land) (all industries excluding financial and insurance companies).
Note: Outstanding FDI is obtained by converting the year-end outstanding bal-
ance of outward FDI (all sectors, in US dollars) to yen using the year-end exchange
rate. Physical assets are the sum of “other physical assets (excluding land)” and
changes from the previous year in “expenditure for construction that has not been
completed” (all industries excluding financial and insurance companies). Source:
Ministry of Finance, “Statistics of corporate financial statements,” JETRO)
248 K. ARAMAKI
(%) (dollar per yen)

45 0.014
Companies
40 0.012 with foreign
35 subsidiaries
0.01 (manufacturing)
30
All domestic
25 0.008 companies
20 (manufacturing)
0.006
15 Yen-dollar
0.004 rate (in
10 numbers of
5 0.002 dollars to one
yen) (RHS)
0 0
Fig. 6.25 Overseas production ratio (manufacturing). Source: Ministry of

Economy, Trade and Industry, “Basic survey on overseas business activities”
(trillion yen) (%)

80
70
Private
60 investment
(excluding
50 land)
40 Cash flow
30 Private
investment
20 + outward
FDI
10
0
FY2003
FY2006
FY2009
FY2012
FY2015
FY1961
FY1964
FY1967
FY1970
FY1973
FY1976
FY1979
FY1982
FY1985
FY1988
FY1991
FY1994
FY1997
FY2000
Fig. 6.26 Private investment, outward Foreign Direct Investment, and cash flow.
Source: Ministry of Finance, “Financial Statements Statistics of Corporations by
Industry”; JETRO “Direct Investment Statistics”; IMF, “International Financial
Statistics”
most recent years, indicating that companies are starting to use their cash
flows almost completely, but with a greater emphasis on overseas investment.
Let us summarize the outcome of the examination of investment
restraint in this chapter:
First, the long-lasting investment restraint extended over more than

20 years after the burst of the bubble. The reason for the investment
restraint in the first and second stages of the stagnation from the begin-
ning of the 1990s through the first half of the 2000s, on the one hand,
and the reason for the investment restraint in the third stage of stagna-
tion from the mid-2000s, on the other hand, may be different.
Second, investment restraint (or reduction) in the first and second stages
of stagnation was largely due to the hangover of excessive assets and
liabilities.
Third, in the third stage of stagnation, domestic investment has been
restrained relative to the amount of cash flow, despite the negative legacy
of the bubble and the shocks of the financial crisis having been overcome
and the balance sheets of companies normalized. This could be attributed
to an irrationally defensive attitude of companies, with risk aversion hav-
ing become deeply ingrained into mindsets during the shocks of the col-
lapse of the bubble and the financial crisis.9 However, this behavior could
reflect that companies have become cautious about domestic investment
and have started to place greater importance on overseas business, based
on stagnant growth expectations about the domestic economy and
expectations for relative profitability of overseas business. As is shown in
Fig. 6.22, the settlement of low growth expectation of domestic econ-
omy prompted by the financial crisis provided an important background
for such defensive attitude.
Mechanism of Wage Restraint

Next, taking into account the preceding analysis of investment, let us
examine the mechanism of wage restraint.
9
As Fig. 6.7 in this chapter shows, cash and deposits held by companies sharply increased
from the latter half of 2000s. This is partly due to the shock of the GFC, but the fact that it
continues to increase demonstrates the strength of defensive attitude or risk avoidance.
250 K. ARAMAKI
Developments in Wages
Developments in wages indicate that wages have been restrained for nearly
20 years. Year-on-year rate of changes in wages per worker (nominal index,
2015 average = 100) has been negative in 12 out of 19 years from 1998
to 2016 (a simple average of year-on-year rate of change over 19 years is
−0.7%). The level of nominal wage per worker declined by 12.4% from the
peak of 114.8 in 1997 to 100.6 in 2016 (Fig. 6.27).
Developments in real terms are almost the same. Real wages per worker
(yearly average, deflated by CPI, 2015 = 100) have declined by 13.1%
from the peak of 115.8 in 1996 to 100.6 in 2017 (a simple average over
the first to third quarters) (Fig. 6.28).
ow Did the Wage Restraint Start? Problems Brought about by

H
Corporate Behaviors in the First Stage of Stagnation
As we have seen, wage reduction occurred after the financial crisis in
1997–1998. In the preceding period, after the collapse of the bubble, the
total sales of companies (all industries excluding financial and insurance
companies) suddenly stopped growing and followed a declining trend until
the beginning of 2000s, yet the total amount of wages paid by companies
continued to increase for the first half of 1990s. In consequence, the
(%)
5.0
4.0
3.0
2.0
1.0
0.0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
-1.0
-2.0
-3.0
-4.0
-5.0
Fig. 6.27 Monthly nominal cash earnings per worker (in establishments with
five employees or more, year-on-year change). Source: Ministry of Health, Labor
and Welfare, “Monthly labor survey”
120.0
115.0
110.0
105.0
100.0
95.0
90.0
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
1990
1991
1992
1993
1994
1995
1996
1997
Fig. 6.28 Monthly real cash earnings per worker (in establishments with five
employees or more [2015 = 100]). Source: Ministry of Health, Labor and Welfare,
“Monthly labor survey”
ratio of total wages to total sales significantly increased after entering the
1990s, and the operating profits substantially declined and stagnated (see
Figs. 6.1 and 6.2).
As previously mentioned, response by companies in the period after the
collapse of the bubble but before the financial crisis was passive. During
this period of passive response, companies maintained employment and
wages, and accordingly, a rise in labor costs and reduction in operating
profits resulted.
Figure 6.29 shows developments in real wages and labor productivity
since the 1990s. It shows that the rise in real wages from 1990 exceeded
the rise in labor productivity over the same period throughout the 1990s.
Reflecting such developments, as Fig. 6.30 indicates, the share of labor
income (the labor share) in national income sharply increased in the
1990s.10
10
Labor income share = (labor income in real GDP)/(real GDP) = (real wage per worker
[w]) × (total number of workers [N]) / (real GDP [y]) = w/(y/N). Therefore, the rate of
change in labor income share = the rate of change in real wages − the rate of change in labor
productivity. So, if an increase in real wages exceeds an increase in labor productivity, as is the
case shown in Fig. 6.29, the labor income share rises.
252 K. ARAMAKI
115
110
105 Real wages

(1990 = 100)
100 Labor
productivity
95 (1990 = 100)
90
85
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
1990
1991
1992
1993
1994
1995
1996
1997
1998
Fig. 6.29 Real wages and labor productivity (1990 = 100). Note: Real wages =
real wages in Monthly Labor Survey, labor productivity = real GDP (all indus-
tries)/No. of employees in Labor Force Survey. Source: Ministry of Health, Labor,
and Welfare, “Monthly labor survey”; Cabinet Office, Statistics Bureau, Ministry
of Internal Affairs and Communications, “Labor force survey”
The rise in real wages and labor income share depressed return on assets
(ROA) of companies. As we saw in Fig. 4.2, ROA continuously declined
after entering the 1990s until near the end of the 1990s.11
In this way, in the first stage of stagnation until before the financial crisis,
companies not only continued to hold excess (unprofitable) assets, as previ-
ously explained, but also accepted increases in labor costs, and as a result,
incurred a further decline in ROA. However, the situation drastically changed
with the breakout of the financial crisis in the late 1990s. The lending stance
of financial institutions was sharply tightened. With the deterioration of fund-
ing environments, companies started to rapidly strengthen their net asset
positions, as explained before. The “period of crisis response” previously
mentioned then started. With little expectation for sales increase, companies
aimed to strengthen their net asset positions by creating profits through labor
cost reduction, in addition to repayment of debts (interest payment reduc-
tion), and sales of assets (realization of unrealized capital gains).
11
The decline in ROA may have been another factor that contributed to the restraint on
investment.
(%)
76.0
74.0
72.0 GDP
statistics
70.0 with base
year = 2000
68.0
GDP
66.0 statistics
with base
64.0 year = 2011
62.0
60.0
2010
1984
1994
1996
1998
2000
2002
2004
2006
2008
2012
2014
1980
1982
1986
1988
1990
1992
Fig. 6.30 Labor income share. Note: Labor income share = labor income/
national income (in factor price base). Source: Cabinet Office, GDP statistics
Labor cost reduction after the financial crisis was pursued basically
through a reduction in wages of regular workers and a reduction in the
number of regular workers and their replacement with non-regular work-
ers. As we saw in Fig. 4.15, the number of regular workers declined by
4.8 million in eight years from 1997 to 2005. It tended to decline beyond
that, but it hit a bottom in 2014 and recovered an upward trend recently.
Also, as we saw in Fig. 4.14, the share of non-regular workers sharply
increased from 20.2% in 1990 and 20.9% in 1995 to 37.9% in 2014, sub-
sequently declined somewhat thereafter.12
12
Expanded use of non-regular workers has been in progress in almost all sectors from
2003 to 2015 (Ministry of Internal Affairs and Communications, “Labour Force Survey,
Detailed Tabulation”). The share of non-regular workers is high in restaurants, hotels,
wholesale and retail, real estate, and services, including medical and welfare. Also, the share
of non-regular workers substantially increased in such sectors as transportation, restaurants,
and hotels. At the same time, employment in manufacturing sector has been declining, and
employment has been rising in such sectors as medical care and welfare and restaurants and
hotels, showing a shift in industrial structure toward domestic demand-type services indus-
tries. Among the sectors in which increased employment has been provided, the wage levels
in those sectors, such as medical care, welfare, and wholesale and retail are relatively low and
the wage levels in information and communication are high. The wage levels in regulated
sectors, such as railways and electricity, gas and water supply are high (Ministry of Health,
Labor, and Welfare, “Basic Survey on Wage Structure”).
254 K. ARAMAKI
104
102
100
Normal
98
workers
Part-time
96
workers
94
92
90
Fig. 6.31 Monthly cash earnings per worker for normal workers and for part-
time workers (2015 = 100). Source: Ministry of Health, Labor, and Welfare,
“Monthly labor survey”
Figure 6.31 shows developments in nominal wages (total cash earn-

ings) for normal workers and part-time workers. The nominal wages of
normal workers increased up to the financial crisis, but thereafter started
to rapidly decline. By contrast, the nominal wages of part-time workers
almost continuously followed a rising trend. Labor cost reduction by com-
panies was conducted through cutting back the number and wages of
regular workers and by their replacement with non-regular workers.
Demand for non-regular workers consequently increased, and their wages
followed an upward trend.
The ratio of wages of non-regular workers to those of regular workers
has been rising from the level around 60% in the mid-2000s, but it
remained at 63.9% in 2015. A reduction in the number of regular workers
and their replacement with non-regular workers has produced substantial
labor cost reduction effects for companies in the short run (Fig. 6.32).13
13
If we include social security contribution borne by companies, costs of hiring a regular
worker become further high as compared with hiring a non-regular worker.
(%)
65.0
64.0
63.0
62.0
61.0
60.0
59.0
58.0
57.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Fig. 6.32 Ratio of wages of non-regular workers to those of regular workers.

Source: Ministry of Health, Labor, and Welfare, “Basic survey of wage structure”
It seems that the reduction in nominal wages and replacement of regu-

lar workers with non-regular workers on such a large scale was conducted
only after the financial crisis. Behaviors of companies, which once consid-
ered the provision of stable employment as their social responsibilities, was
dramatically altered upon the outbreak of the financial crisis.
hy Does Wage Restraint Still Continue?

W
The mechanism of wage restraint explained in the preceding subsection
may not continue once the unsustainable situation created by a hike in
labor costs and labor income share has been corrected through downward
adjustments of labor costs (resolution of excess employment and wage
reduction). However, the reality is different.
As a result of labor cost restraint, the labor share in Japan, which was
internationally at a high level in the 1990s, significantly declined by mid-
2000s, as shown in Fig. 6.33, and although it rose somewhat due to the
GFC and is high to some extent in most recent years, it is broadly at a
comparable level to those in other major advanced countries.
On the other hand, the share of labor costs to the value added dropped
sharply after the financial crisis. Due to the sudden shrinking of the value
added after the GFC, the share of labor costs went back to a high level but
subsequently started to decline sharply, and there does not seem to be a
fundamental change to the trend of labor cost restraint (Fig. 6.34).
(%)
78
76
74
72
70 Japan
68 US
66 UK
64 Germany
62 France
60
58
56
Fig. 6.33 Compensation of employees/net national income (at factor price).

Note: Net national income (at factor price) = net national income (at market price)
− taxes less subsidies on productions and imports. Compensation of employees is
made up of two components, namely, wages and salaries, and the value of social
contributions payable by employers, and does not include mixed income. Source:
Organisation for Economic Co-operation and Development [OECD], data down-
loaded from OECD. Stat on May 28, 2016
(%)
66
64
62
60
58
56
54
52
FY1999
FY2000
FY2001
FY2002
FY2003
FY2004
FY2005
FY2006
FY2007
FY2008
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
FY2015
FY2016
FY1990
FY1991
FY1992
FY1993
FY1994
FY1995
FY1996
FY1997
FY1998
Fig. 6.34 Labor cost/value added. Note: Labor cost = wages + bonuses +
expense for fringe benefits. Source: Ministry of Finance, “Financial Statements
In this way, despite companies having overcome the negative legacy of

the bubble (excess assets and liabilities), with substantially reduced labor
costs and greatly strengthened net asset positions after the financial crisis,
they continue to restrain wages. While employment conditions in the
labor market continue to improve, wage increases have been weak. The
unemployment rate, which recorded a high of 5.5% in July 2009, declined
to a yearly average of 3.6% in 2014, and then to 2.8% in October 2017.
However, the average rate of increase (year-on-year) in the nominal wage
per worker (total monthly cash earnings per worker in establishments with
five or more workers from the “Monthly Labor Survey”) for three years,
from 2014 to 2016, was as low as 0.3%. As shown in the next chapter, the
hourly wages of non-regular workers have been showing a rate of increase
higher than that of regular workers for the last few years. Tightening of
labor market conditions is reflected more clearly in wages of non-regular
workers than in wages of regular workers.
Figure 6.35 shows developments in the amount of value added and the
ratios to value added of three values: the amount of increase in wages from
the previous year, the amount of increase in net assets from the previous
year, and the amount of dividends paid out. After the amount of value
(trillion yen) (%)

350 20.0 Value added
Ratio to value
300 15.0 added of increase in
wages from previous
250 10.0
year (RHS)
200 5.0 Ratio of dividends
to value added
150 0.0 (RHS)
100 (5.0) Ratio to value

added of increases in
50 (10.0) net assets from
previous year
0 (15.0) (RHS)
FY1961
FY1965
FY1969
FY1973
FY1977
FY1981
FY1985
FY1989
FY1993
FY1997
FY2001
FY2005
FY2009
FY2013
Fig. 6.35 Value added and ratio of wage increase, dividends, and increase in net
assets to value added. Source: Ministry of Finance, “Financial Statements Statistics
258 K. ARAMAKI
added stopped growing following the collapse of the bubble, and, particu-
larly, after the financial crisis, the amount of value added was allocated
differently from the previous pattern—strengthening the net asset position
and dividend payments, and curtailing increases in wages. Companies’ pri-
orities for the allocation of value added changed greatly with the outbreak
of the financial crisis, and the change may have become irreversible.
Are Effects of External Factors Relevant to the Continuation of a

Defensive Attitude Concerning Labor Cost Restraint?
What is the reason for the stance of companies toward restraining labor
costs, which appears to be almost unceasing? Is it because of an irrational
excessively defensive mindset? Or is it the outcome of rational choice? As
with investment restraint, let us look at the effects of external factors.
redisposition to Low Inflation of the Japanese Economy

P
Figure 6.36 shows developments in average nominal wage (1990 = 100)
for five advanced countries. It is only Japan, among these advanced coun-
tries, which has experienced stagnation and decline in nominal wages. The
rate of increase in hourly earnings (manufacturing) for Japan, as shown in
250.0
200.0
US
150.0 UK
Germany
100.0 France
Japan
50.0
0.0
Fig. 6.36 Annual average wage (1991 = 100). Source: OECD Economic
Outlook Database
Fig. 6.37, has been significantly low, as compared with other countries.

This may be the result of companies’ responses to excessive employment,
but whether there were other factors causing decline in wages needs to be
examined.
Figure 6.38 shows the annual rate of change in CPI (excluding food and
energy) for the OECD average and Japan. The rate of change in CPI
(excluding food and energy) in Japan has been lower than the OECD aver-
age by more than four percentage points, on average, since the latter half of
the 1970s. To reiterate, Japan had a significantly lower inflation rate, as
compared with other advanced countries, for the last few decades, and its
inflation rate was declining almost consistently and approaching zero.
ackground of the Predisposition to Low Inflation of the Japanese

B
Economy—International Competition with Cost Restraint
What is the background of such a predisposition to low inflation of the
Japanese economy? It may be due to the long-lasting yen appreciation (that
reduces prices of imports) and the increase in low-priced imports from
emerging market economies (import penetration). In addition to these fac-
tors, evolution of export price may have been relevant. Figure 6.39 shows
300.0
250.0
200.0
Japan
150.0 US
Germany
100.0 UK
France
50.0
0.0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Fig. 6.37 Hourly earnings (manufacturing) (1990 = 100). Source: OECD

0
20
40
60
80
100
120
140
160
180
200
260
01/01/1970
01/12/1971
01/11/1973
10
15
20
25
0
5
-5
01/10/1975
(%)
01/09/1977 1971
K. ARAMAKI
01/08/1979 1974
01/07/1981
1977
01/06/1983
01/05/1985 1980
01/04/1987 1983
01/03/1989 1986
01/02/1991
1989
01/01/1993
01/12/1994 1992
01/11/1996 1995
01/10/1998 1998
01/09/2000
2001
01/08/2002
Export price index (yen base)

01/07/2004 2004
01/06/2006 2007
OECD
Japan
01/05/2008 2010
average
01/04/2010
01/03/2012
01/02/2014
Fig. 6.39 Export price index (yen base) (2015 = 100). Source: Bank of Japan
01/01/2016
Fig. 6.38 Annual rate of increase in CPI (excluding food, energy). Source: OECD
developments in the export price index (yen base, 2015 = 100). Export price
has been largely on the decline since the 1980s.14
Such a continuous decline in export price (yen base) suggests that, in
addition to the effects of technological progress, the pricing behavior of
export industries focused on restraint of export prices in the situation of
intensifying competitive pressure from emerging market economies and
continuous yen appreciation. Restraint on export prices by export indus-
tries, which are leading industries in Japan, depressed prices of intermedi-
ate inputs and wages.
As we have seen, wage restraint has continued even after excess employ-
ment was eliminated by the mid-2000s. The continuing restraint may
reflect the long-held company goal of maintaining international competi-
tiveness through cost reduction, with labor cost reduction through wage
restraint and replacement of regular with non-regular workers offering a
very effective tool to accomplish this aim.
However, competition through such cost reduction seems to have
placed Japanese economy in a more difficult position. The terms of trade
on domestic production of manufacturers (output deflator / input defla-
tor) has been deteriorating since the 2000s, and this development has
made it more difficult to make profits, further depressing wages (Fig. 6.40).
Such a tendency is most articulated in electric machinery industries, which
suffered significant decline in the output deflator. These developments in
terms of trade were the outcome of companies’ behavior in internationally
competitive environments, but at the same time, worked as an impetus to
expand low cost production abroad and to reduce domestic production. For
the production of goods that can be easily standardized, international com-
petition through cost restraint may have ceased to be an effective strategy, as
Japan is a high-wage economy (Fig. 6.41).
Despite such efforts for exports price restraint, Japan’s export share in
world exports has declined significantly since the 1990s. This reflects
decline in competitiveness and/or a shift of production bases abroad
through foreign direct investment.
However, other industrial countries have also lost their share in world
exports, with the rise of emerging market economies, particularly China,
14
In terms of the rate of change, the average rate of change vis-à-vis previous year of
Japan’s export price index (yen base, monthly) over the period from January 1976 to
December 2013 was −1.2%.
262 K. ARAMAKI
140.0
120.0
100.0
Output
80.0 deflator
60.0 Input
deflator
40.0
20.0
0.0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
1994
1995
1996
1997
1998
1999
2000
2001
Fig. 6.40 Developments in terms of trade (output deflator and input deflator):
manufacturing (2005 = 100). Source: Cabinet Office, GDP Statistics
250.0
200.0
150.0 Output
deflator
Input
100.0 deflator
50.0
0.0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
1994
1995
1996
1997
1998
1999
2000
2001
2002
Fig. 6.41 Developments in terms of trade (output deflator and input deflator):
electric machinery (2005 = 100). Source: Cabinet Office GDP Statistics
and therefore, the declining export share is not a phenomenon unique to

Japan. Deterioration in Japan’s export performance has been brought about
partly by the rapid industrialization of the Chinese economy (Fig. 6.42).
(%)
20
18
16
14
Japan
12
US
10
Germany
8
UK
6 France
4 China
2
0
1950
1953
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
2016
Fig. 6.42 Share of G5 and China in world exports. Source: IMF, “Direction of
Trade”
Wage Restraint Coupled with Low Interest Rate and Consumption

In this subsection, we examine how wage restraints have affected con-
sumption. Reduction in nominal wages, decline in the number of regular
workers, and their replacement with non-regular workers have brought
about a decline in employment income beginning in the 1990s. Although
increasing in recent years, the total amount of employment income has
declined by 13.1 trillion yen (equivalent to 4.9% of the total employment
income in FY 1994 (i.e., the earliest year that GDP statistics with base
year=2011 covers)) from FY 1994 to FY 2014. When compared to FY
1997, which was before the effects of the financial crisis had arisen, the
reduction in the total employment income from FY 1997 to FY 2014
amounts to 26.5 trillion yen (equivalent to 4.7% of the total employment
income in FY 1997) (Fig. 6.43).
Let us further look at interest income as an income source for house-
holds other than employment income. Due to the low-interest rate policy
after the burst of the bubble, net interest received (interest received −
interest paid) by households significantly declined. It declined by 12.9
trillion yen from 14.1 trillion yen in FY 1994 to 1.2 trillion yen in FY
2013, that is, a 91.4% decline from the level in FY 1994 (Fig. 6.44).
264 K. ARAMAKI
(trillion yen)
300.0
250.0
200.0 Base
year = 2000
150.0
Base
100.0 year = 2011
50.0
0.0
FY1980
FY1982
FY1984
FY1986
FY1988
FY1990
FY1992
FY1994
FY1996
FY1998
FY2000
FY2002
FY2004
FY2006
FY2010
FY2014
FY2008
FY2012
Fig. 6.43 Employment income. Source: Cabinet Office, GDP statistics
(trillion yen)
20.0000
15.0000
10.0000
Base
5.0000
year = 2000
Base
0.0000
year = 2011
FY1980
FY1982
FY1984
FY1986
FY1988
FY1990
FY1992
FY1994
FY1996
FY1998
FY2000
FY2002
FY2004
FY2006
FY2008
FY2010
FY2012
FY2014
-5.0000
-10.0000
-15.0000
Fig. 6.44 Net interest received by households. Source: Cabinet Office, GDP
statistics
The combined amount of employment income and net interest received

by households declined by 31.1 trillion yen (25.4 trillion yen of employ-
ment income + 5.6 trillion yen of net interest received), or by 10.8% from
the peak in FY 1997 to the bottom in FY 2012 (Fig. 6.45).
(trillion yen)
350.0000
300.0000
250.0000
Base
200.0000 year = 2000
150.0000 Base
year = 2011
100.0000
50.0000
0.0000 FY1996
FY1998
FY2000
FY2002
FY2004
FY2006
FY2008
FY2010
FY2012
FY2014
FY1980
FY1982
FY1984
FY1986
FY1988
FY1990
FY1992
FY1994
Fig. 6.45 Employment income + net interest received by household. Source:

Cabinet Office, GDP
Let us look at developments in consumption. The ratio of household

consumption to household income15 was in the lower 70% range from the
1980s to the beginning of 1990s. It started to rise from the mid-1990s,
exceeded 80% at the end of the 1990s, rose over 90% in the 2010s, and
reached a peak of 91.5% in 2013 (Fig. 6.46).
At the same time, as we saw in Fig. 4.32, the household savings ratio,
which was approximately 12–13% until mid-1990s, sharply declined there-
after, dropping below 10% at the end of the 1990s, and falling to −0.7%
in 2013 (it has recovered somewhat since, but it is still at a low level, 5.1%
in 2015).
Effects of Terms of Trade Deterioration

In this way, the decline in both employment income and interest received
has made it difficult for consumption to increase. In addition to these fac-
tors, deterioration in terms of trade may have contributed to the erosion of
real income. As shown in Fig. 6.47, Japan’s export price index (yen base)
15
The ratio of household consumption to household income is defined as the ratio of final
consumption expenditure of households to the combined amount of nominal income of
households, including employment income, property income such as net interest received,
and operating surplus and mixed income (that is, personal business income).
266 K. ARAMAKI
(％)
100
90
80
70
60 Base
year = 2000
50
Base
40 year = 2011
30
20
10
0
1994
1996
1998
2000
2004
2006
2008
2010
2012
2014
1980
1982
1984
1986
1988
1990
1992
2002
Fig. 6.46 Ratio of nominal household consumption to household income

(including personal business income). Source: Cabinet Office, GDP statistics
300
250 Export price

index (yen base)
200 Import price
index (yen base)
150 Export price
index (yen
100 base)/import
price index (yen
50 base)
0
01/01/1960
01/04/1963
01/07/1966
01/10/1969
01/01/1973
01/04/1976
01/07/1979
01/10/1982
01/01/1986
01/04/1989
01/07/1992
01/10/1995
01/01/1999
01/04/2002
01/07/2005
01/10/2008
01/01/2012
01/04/2015
Fig. 6.47 Export price, import price, and terms of trade (2015 = 100). Source:
Bank of Japan
has been declining since the mid-1980s. By contrast, Japan’s import price
index (yen base) had been stable from mid-1980s but increased substan-
tially from the mid-2000s. Reflecting such developments in export and
import prices, the terms of trade (export price index/import price index)
followed a declining trend from the beginning of the 1970s. It tended to
be stable from the 1980s but very rapidly deteriorated from the latter half
of 1990s.
A deterioration of the terms of trade may bring about a decline in real
wages, as indicated in the equation here, which is derived from the defini-
tion of the real wages:
W / CPI ( real wages ) = ( WN / Y )( y / N )( d / CPI )

= ( labor share ) ´ ( labor productivity ) ´ ( the ratio of GDP deflator to CPI )

Where
W = nominal wage per worker

CPI = consumer price index
N = total number of workers
Y = nominal GDP
y = real GDP
d = GDP deflator
Even if the labor share (WN/Y) and the labor productivity (y/N) are
kept unchanged, real wages decline if the GDP deflator declines more than
the CPI. A deterioration in terms of trade (export price/import price) low-
ers the GDP deflator/CPI ratio, because a rise in import prices is reflected
in the CPI but not in GDP deflator, and a decline in export prices is
reflected not in the CPI but in the GDP deflator. A decline in the GDP
deflator/CPI ratio makes an increase in nominal GDP (and, therefore,
nominal wages) smaller than an increase in CPI, thereby reducing real
wages. A stagnation in real wages in the 2000s could have been brought
about by the deterioration in the terms of trade. We saw in Chap. 4 that
the growth contribution of private consumption has been declining since
the 2000s. The consistent decline in real wages due to factors including
deterioration in the terms of trade seems to be among the causes of such
decline.
268 K. ARAMAKI
3 Summary of the Causes of Deflation and

Long Stagnation
This chapter tried to find a mechanism of long stagnation and deflation,
drawing on corporate behaviors indicated in the examination of combined
financial statements of the corporate sector as a whole. What we have
found are as follows.
After the collapse of the bubble at the beginning of the 1990s, the total
amount of the sales of the corporate sector stopped growing suddenly and
subsequently started to decline. However, the amount of wages paid in
total continued to increase for some time before flattening around the
mid-1990s, which depressed the operating profits. The non-operational
profits started to improve from the beginning of the 1990s, and reflecting
this improvement, the current profits that include non-operational profits
recovered into a rising trend at the end of the 1990s. However, different
from the pattern up to the 1980s, improvements in current profits ceased
to be reflected in an increase in wages. This new pattern has been main-
tained in and after the 2000s.
On the assets and liability side, the corporate sector expanded the size
of its assets and liabilities from the mid-1980s at a pace far faster than the
trend at that time indicated. Growth of assets and liabilities decelerated
beginning in the 1990s, and the assets and liabilities started to shrink from
the mid-1990s. Liabilities stopped declining at the beginning of the 2000s
and stayed flat thereafter. By contrast, assets began a rising trend in the
2000s. However, physical assets, such as structures and machinery, consis-
tently followed a declining trend from the latter half of the 1990s. The
increase in assets was supported by an increase in securities held for invest-
ment purposes, and a substantial part of the increase of the latter was
accounted for by outward FDI.
Developments in the net asset position indicate that the corporate sec-
tor started to rapidly strengthen its net asset position mainly through
earned surplus from around the time of the financial crisis.
Drawing on these observations, this book contended that the stagnant
period after the burst of the bubble may be divided into three stages: the
first stage of stagnation preceding the financial crisis (called the “Period of
passive response” based on corporate behavior), the second stage of stag-
nation after the financial crisis (“Period of crisis response”), and the third
stage of stagnation since the mid-2000s (“Period of continued defensive-
ness”). The mechanism of stagnation in each of these three stages is

explained here.16
In the first stage of stagnation after the burst of the bubble and before the
financial crisis, stock adjustment conducted by the corporate sector that tried
to address excessive investment in the bubble period brought about invest-
ment restraint. However, disposition of excessive assets did not progress in
this period. On the contrary, as the period of low growth lengthened, the
expected growth rate was adjusted downward, which further lowered the
level of necessary (optimum) asset size. In other words, the size of excess
assets increased, and this resulted in the lengthening of time of investment
restraint.
Furthermore, in this period, even as sales stopped growing, the amount
of wages continued to increase for some time, resulting in a rapid increase
in the share of labor costs in value added. On both fronts—removal of
excess assets and restraint on labor costs—response of the corporate sector
was passive or inactive in this period.
In the second stage of stagnation (called the “Period of crisis response,”
based on corporate behavior) that started with the financial crisis, the corpo-
rate sector, faced with the outbreak of the crisis and the sharp tightening of
lending by financial institutions, started to forcefully remove excessive assets
and liabilities, reduce labor costs and other expenses such as interest pay-
ments, and strongly strengthen their financial positions through earned sur-
plus. The corporate sector completed elimination of excess assets, excess
liabilities, and excess employment by the mid-2000s. Through this process in
the second stage, the economy continued to stagnate.
What is unique about Japan’s long stagnation is the fact that, despite the
corporate sector strengthening its balance sheets and proceeding with
removal of excess employment after the financial crisis, as well as eliminating
excess assets, excess liabilities, and excess employment, thereby removing the
negative legacy of the bubble by the mid-2000s, the defensive attitude of
companies to restrain investment and wages continued and led the economy
to the third stage of stagnation (“Period of continued defensiveness”).
Results of the examination in this chapter that sought to capture the mecha-
nism of this third period are summarized here:
16
Images of the stagnation mechanism in each of the first, second, and third stages are
given in the supplement to this chapter.
270 K. ARAMAKI
There are two views on the motivation for the continuation of investment
restraint. In one view, it is construed that the investment restraint was
brought about by an irrationally defensive mindset of companies, which had
been deeply ingrained as a result of the long-lasting low growth. From the
other perspective, the investment restraint was viewed as the result of a ratio-
nal choice made by companies to shift the production base to overseas,
reflecting, one, low growth of the domestic economy over an extended
period of time, and, two, a difference in profitability between domestic and
foreign operations.
As for wages, the labor income share rose to an unprecedented high
level in the first stage of stagnation. After the financial crisis, the corpo-
rate sector drastically changed its stance and rapidly proceeded with labor
cost reduction through reduction of nominal wages of regular workers
and their replacement with non-regular workers. As a result, excess
employment was eliminated by the mid-2000s. However, wage restraint
continued. This may have occurred because the labor cost reduction,
through reduction of nominal wages of regular workers and their replace-
ment with non-regular workers who were paid lower wages, could be
utilized as an effective tool in competition through further cost reduc-
tion, even after the excess employment had been eliminated. This corpo-
rate behavior may have been influenced by pricing behavior that is,
long-term restraint on export prices, which has been long employed by
companies during the yen appreciation and faced with international
competition.
With the continued wage restraint and the reduction in interest received
by households under the low-interest policy, the ratio of household con-
sumption to household income continued to rise and the savings ratio of
households became negative. Due to deterioration in the terms of trade
from the 2000s, the real wages further declined, making it difficult to
expect a greater growth contribution from consumption.
The Japanese economy returned to a normal situation from the mid-
2000s, after overcoming the negative legacy of the bubble and shocks of
the financial crisis. Under these circumstances, the corporate sector still
continued to restrain investment and wages. These defensive behaviors,
together with the effects of the resultant decline in nominal wages and
structuralized shortage of domestic demand, seem to have brought about
continued deflation. Deflation itself in turn had depressing effects on the
economy, by lowering sales expectations held by companies for the future
and by rewarding defensive behavior of risk avoidance (for example, hold-

ing cash rather than investing). A vicious cycle might have been at work in
which competition through cost reduction by companies could lead to
restraint on wages, to stagnant consumption, and in turn to a stagnant
domestic economy, depressing sales growth expectations, and then lead-
ing to restraint on domestic investment and further competition through
cost reduction.
Cost reduction that is rational at a micro level may have been produc-
ing stagnation of the whole economy and imposing negative impacts on
the companies.
No matter whether such continued restraint on investment and wages
by companies is due to an excessively defensive mindset or the outcome of
rational choice, it has been bringing about continuous shortage of domes-
tic demand (with increase in trade dependence and rising external vulner-
ability) and restraint on domestic investment (with resultant decline in
potential growth rate17). Structuralized domestic demand shortage and
investment restraint may be the two most important problems that the
Japanese economy developed after excesses were removed and impacts of
the financial crisis were overcome.
Considering the current situation seems to be governed by the struc-
turalized defensive attitude that has a certain degree of self-fulfilling
nature, what should be done? In the next chapter, we will examine policies
of the current administration (Abenomics) and assess what has been done
and what needs to be done.
17
Particularly due to restraint on investment in physical assets over an extended period of
time, it is possible that supply capacity of companies may have been significantly reduced,
leading to a decline of potential growth rate. The potential growth rate of Japanese economy
estimated by the Cabinet Office declined from 4.4% in the 1980s, to 1.9% in the 1990s, and
further, to 0.7% in the 2000s. Thereafter, it has risen somewhat, and it was estimated to be
1.0% as of second quarter of 2017.
272 K. ARAMAKI
SUPPLEMENT
Mechanism of the Three Stages
of Stagnation Collapse of the bubble
(1) Mechanism of the first stage Cessation of sale
of stagnation (from the collapse Formation of increase and
excess assets subsequent
of the bubble until just before decline of sales
the financial crisis: 1991–1997)
Passive response by companies
Lengthening of
Initial acceptance
disposition of
of wage increase
excess assets
Japanese–US
trade disputes
Investment Profit Sharp increase

restraint decline in labor share
Yen Increase in
appreciation excess
assets
Lengthening of
Drag on exports investment
restraint
Lengthening of
stagnation
Decline in
debt service
capacity
Decline in profitability of
land, decline in land
prices, decline in
collateral value of land
Shift of cost of excess
assets to financial sector
(worsening of NPL
problems)
(2) Mechanism of the second stage

Increase in NPL
of stagnation (from the financial
crisis to the elimination of excess
assets: 1998–first half of the
Financial crisis 2000s)
Deterioration of
economic Tightening of lending
conditions stance
Crisis response of companies

(strengthening of net asset position through profit
increase)
Reduction of Debt repayment Labor cost reduction

physical assets
Wage Replacement
reduction by non-regular
workers
Investment
restraint Decline in
growth
contribution of
consumption
Decline in Structuralized domestic

potential demand shortage
growth
rate
Deflation
and low
growth
274 K. ARAMAKI
(3) Mechanism of the third stage of stagnation (from the elimination

of excess assets to present: mid-2000s–present)
Continued low
growth
Low growth
expectations
Population decline
Continued defensive
attitude of companies
High Competition
profitability Investment Labor cost through cost
of overseas restraint restraint reduction
business
Replacement
Wage
Decline in growth by non-regular
restraint workers
potential and
export
competitiveness
Decline
Decline in in
growth Future
Deterioration concern of marriage
in terms Decline in contribution of and
consumption households
of trade, interest received birth
decline in rates
real wages
Monetary
policy
relaxation
Structuralized
Continuation
domestic demand
of deflation
Fiscal shortage
and low
stimulus growth
Deterioration
in fiscal
position
GDP Gap, Nominal Wages, and CPI

As shown in Fig. 6.48, nominal wages (year-on-year change) appear to
move with the GDP gap (in percent of potential GDP). It seems most
probable that efforts by companies to reduce cost under stagnant eco-
nomic conditions have brought about decline in wages (Fig. 6.48).
Developments in nominal wages also appear to be correlated with
developments in the CPI. It seems possible that economic stagnation has
brought about reduction in nominal wages, which led to reduction in the
CPI (Fig. 6.49).
Demographic Interpretation
Another interpretation of stagnation relates to demography. In 2010, a
small book entitled The True Origin of Deflation (Motani 2010) became
a bestseller. Motani’s contention is that the demographic change, in
particular, the absolute decrease in the working age population, which
(％)
6
4 GDP gap (in

percent of
2 potential
GDP)
0 Monthly
1991 I
1992 I
1993 I
1994 I
1995 I
1996 I
1997 I
1998 I
1999 I
2000 I
2001 I
2002 I
2003 I
2004 I
2005 I
2006 I
2007 I
2008 I
2009 I
2010 I
2011 I
2012 I
2013 I
2014 I
2015 I
2016 I
2017 I
cash
-2 earnings per
worker
(change from
-4 previous
year)
-6
-8
Fig. 6.48 GDP gap and changes of monthly cash earnings per worker from pre-
vious year. Source: Cabinet Office, Ministry of Health, Labor, and Welfare,
“Monthly Employment Survey”
276 K. ARAMAKI
(%)
6
CPI (excluding
4 fresh food)
(change
from
2 previous
year)
0 Monthly
cash
Jan-91
Jan-94
Jan-97
Jan-00
Jan-03
Jan-06
Jan-09
Jan-12
Jan-15
Jul-92
Jul-95
Jul-98
Jul-01
Jul-04
Jul-07
Jul-10
Jul-13
Jul-16
earnings
-2 (change from
previous
year [five-year
-4 moving
average])
-6
Fig. 6.49 Nominal wage and Consumer Price Index (excluding fresh food)
(changes from previous year). Note: Nominal wage = total cash earning per
employee (in the establishments with five or more employees). Source: Statistics
Bureau of Japan, Ministry of Health, Labor, and Welfare, “Monthly labor survey”
began in 1996, reduces domestic demand, making business conditions

for domestic demand-type industries more difficult.18
While Motani does not analyze deflation (fall in the general price levels),
his simple message, “demography matters,” seems to have had significant
influence. For example, Bank of Japan (BOJ) Governor Shirakawa said,
“Delayed responses to structural changes such as these [the declining birth
18
Motani (2010, 140) wrote, “As the working age population continues to decline, the
domestic demand-type industries, which account for a large part of employment, constantly
suffer from excess supply and their business performance will never improve.” Examples of
demand stagnation in terms of quantity that Motani indicated include the following:
–– The number of new cars sold domestically hit a peak in 2000, decreasing thereafter.
–– The number of books and magazines sold domestically hit a peak in 1997.
–– The quantity of goods transported domestically (weight × distance) hit a peak in fiscal
year 2000.
–– The quantity of alcoholic beverages sold domestically started to decrease from fiscal year
2002.
–– The quantity of tap water used per one person hit a peak in 1997.
(%)
15 2.5
2
10
1.5 Real GDP

5 growth rate
5-year moving
1
average
0 growth rate
0.5 Population
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
growth (RHS)
-5
0
-10 -0.5
Fig. 6.50 Real GDP growth and population growth (Japan). Source: IMF, OECD
rate and the aging population] and to globalization ... are the fundamental
causes of low growth and deflation” (Shirakawa 2012b).19
We look next at Fig. 6.50. The GDP growth rate may look like this,
generally, following population developments in Japan. Does demography
determine our future?
However, such a pattern does not seem to be universal. A similar but
less clear pattern has been observed in France and the United States
(Figs. 6.51 and 6.52), but not in the United Kingdom or in Germany
(Figs. 6.53 and 6.54).
A fundamental rebuttal of Motani’s argument, or any other arguments
that relates demography to the two decade-long stagnation, is that demo-
graphic changes proceed only gradually and, therefore, would not be able
to produce such an abrupt change as shown by the nominal GDP
developments since 1990s in Fig. 6.55. Structural headwinds may be with
us, but demographic changes do not wholly explain the long stagnation
over two decades from the 1990s. Although it is an issue that warrants
thorough examination—how long- term and structural factors such as
demography were related to the long stagnation and the current condi-
19
Shirakawa (2012a) further states, “In the 1990s, low growth was mainly brought about
by the deleveraging associated with the unprecedented bursting of the bubble. In the 2000s
and thereafter, the major causes of low growth in Japan have been rapid population aging
and population decline.”
278 K. ARAMAKI
(%)
10 1.6
8 1.4
1.2
6 Real GDP
growth rate
1
4 5-year moving
average
0.8
growth rate
2
0.6 Population
growth rate
0 (RHS)
0.4
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
-2 0.2
-4 0
Fig. 6.51 Real GDP growth and population growth (France). Source: IMF, OECD
(%)
10 2
1.8
8
1.6
6 1.4
Growth rate
1.2
4 5-year moving
1 average
growth rate
2
0.8
Population
0.6 growth rate
0 (RHS)
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
0.4
-2
0.2
-4 0
Fig. 6.52 Real GDP growth and population growth (US). Source: IMF, OECD
(%)
8 0.8
6 0.7
Real
0.6 GDP
4
growth
0.5 5-year
2 moving
0.4 average
0 growth
0.3 rate
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
-2 Population
0.2 growth
-4 0.1
-6 0
Fig. 6.53 Real GDP growth and population growth (United Kingdom). Source:
IMF, OECD
(%)
15 1.2
1
10
0.8 Real GDP
growth
0.6 rate
5
5-year moving
0.4 average
growth
0 0.2 rate
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
Population
0 growth
-5 rate (RHS)
-0.2
-10 -0.4
Fig. 6.54 Real GDP growth and population growth (Germany). Source: IMF,
OECD
280 K. ARAMAKI
600.0 14000
12000 Nominal
500.0
GDP (base
10000 year = 1990)
400.0 Nominal
8000 GDP (base
300.0 year = 2000)
6000
Nominal
200.0 GDP (base
4000
year = 2011)
100.0 2000 Population
(RHS)
0.0 0
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
Fig. 6.55 Nominal GDP and population. Source: Ministry of Health, Labor,
and Welfare, “Vital Statistics Report”; Cabinet Office, GDP statistics
tions of the economy—resorting to such factors does not seem to contrib-

ute to the understanding of the mechanism of the stagnation, which
started abruptly and subsequently eternalized (Fig. 6.55).
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CHAPTER 7
Abenomics and Challenges
for the Japanese Economy
As we have seen in the preceding chapters, the corporate sector, which is

the central player in the Japanese economy, assumed a very defensive atti-
tude during the long stagnation and deflation. Such a defensive attitude
started in the early 1990s under pressure from the persistence of unprofit-
able excess assets after the burst of the bubble, and it was drastically
strengthened and structuralized in the shock of the financial crisis in the
late 1990s. Such structuralized defensiveness has a self-reinforcing nature,
whether due to an excessively defensive mindset or to rational choice.
Restraint on investment tends to lower growth rate, and therefore, further
restraint on investment may be justified. Restraint on labor costs tends to
lower consumption, and therefore, resultant stagnation in sales and profits
may well justify further restraint on wages. Furthermore, restraint on
investment and labor costs could lead to deflation, rewarding risk avoidance
(cash holding brings return). Repeated use of fiscal stimuli to support weak
growth resulting from the defensive attitude of companies aggravated fiscal
position, and may have raised anxiety for the future of households, thus
strengthening defensive behavior of households. Expectation of population
decline exists as an additional source of concern for both companies and
households. Through all these channels, the Japanese economy has been
led to an equilibrium governed by low-growth expectation and wariness
about the future.
In late 2012, the Liberal Democratic Party (LDP) came back to the
power, and Mr. Shinzo Abe, President of the LDP, started his second pre-

286 K. ARAMAKI
miership. He initiated a comprehensive package of economic policies,

which was soon dubbed “Abenomics.” Initial responses in the markets
were quite significant.
We will see in this chapter, first, what the Abenomics is; second, what
impacts it has brought about; and, third, whether the core problem of the
Japanese economy has been addressed and improved.
1 Abenomics
Start of Abenomics
On November 14, 2012, then Prime Minister (PM) Noda of the Democratic
Party (DP) declared in the Parliamentary discussion with Mr. Abe, presi-
dent of the LDP, that he would dissolve the House of Representatives in
two days, that is, on November 16. In the election on December 16, the
LDP had won a landslide victory, gaining 294 seats from the pre-election
level of 119, out of the total 480 seats, while the DP suffered a crushing
defeat of reducing its seats by three-fourths from 230 to 57.
On December 26, 2012, the second Abe administration started and
adopted its “Basic Policy” in the first cabinet meeting, in which it was
stated about the economy:
A strong economy is the source of Japan’s strength. Without its revival,
there is no restoration of fiscal soundness nor Japan’s future.
Through “three arrows” of bold monetary policy, flexible fiscal policy,
and growth strategy that promote private investment, we overcome pro-
longed deflation, and aim to increase employment.
This is the declaration of the start of Abenomics.
Thoughts behind “three Arrows” are explained as follows:1
In order to eliminate a deflationary mindset, bold monetary policy is indis-

pensable (bold monetary policy).
At the same time, the government needs to take a lead in creating demand
and ignite the dampened economy (flexible fiscal policy).
However, as the government cannot continue to create demand for an
indefinite time, therefore, it is necessary to restore the confidence of
1
Refer to materials on Abenomics published on the home page of the Prime Minister’s
office including the manuscript of the press conference by Prime Minister Abe on January
11, 2013 (https://www.kantei.go.jp/).
ABENOMICS AND CHALLENGES FOR THE JAPANESE ECONOMY 287
companies and people for the future and raise private investment
(growth strategy).
Following these thoughts, measures have been taken.
First Arrow: Bold Monetary Policy: Kuroda Bazooka

(Initial QQE)
On March 20, 2013, Mr. Kuroda, former president of the Asian
Development Bank (ADB), took the office of Bank of Japan (BOJ) gover-
nor.2 On April 4, 2013, the BOJ introduced Quantitative and Qualitative
Monetary Easing (QQE), which was composed of the following:
“Price Stability Target” of 2%
The BOJ introduced the price stability target of 2% in terms of the year-
on-year rate of change in the Consumer Price Index (CPI) (excluding
fresh food) and committed to achieve the target in the earliest possible
time, with a time horizon of about two years.3
“Quantitative and Qualitative Monetary Easing”
To that end, BOJ introduced the QQE, consisting of the following:
he Adoption of the “Monetary Base Control”

T
Under the QQE, the main operating target for money market operations
was changed from the uncollateralized overnight call rate to the monetary
base. The BOJ would double the monetary base in two years. The BOJ
would conduct money market operations, so that the monetary base will
increase at an annual pace of about 60–70 trillion yen.
2
Governor Kuroda is reported to have said in his inaugural speech to BOJ staff that the
BOJ is the only central bank in the world that does not achieve its mission to realize price
stability. Governor Kuroda is also reported to have said in his first meeting with BOJ execu-
tive staff, “First, you have to believe that you can do it.”
3
The BOJ under the former Governor Shirakawa had already introduced a price stability
target of 2% in January 2013. The difference is that the QQE under Governor Kuroda set a
time limit for its realization.
288 K. ARAMAKI
n Increase in Japanese Government Bonds Purchasing and Their

A
Maturity Extension
With a view to encouraging a further decline in interest rates across the
yield curve, the BOJ will purchase Japanese Government Bonds (JGBs),
so that their outstanding amounts will increase at an annual pace of about
50 trillion yen. The BOJ will more than double the average remaining
maturity of JGB purchases.
n Increase in Exchange Traded Funds and Japanese Real Estate

A
Investment Trust Purchases
With a view to lowering the risk premium of asset prices, the BOJ will
purchase exchange traded funds (ETFs) and Japanese real estate invest-
ment trusts (J-REITs), so that their outstanding amounts will increase at
an annual pace of 1 trillion yen and 30 billion yen, respectively.
he Continuation of the QQE
T
The bank will continue with the QQE, as long as it is necessary to achieve
the price stability target of 2% and maintain that target in a stable manner.
Strengthening of the QQE
The QQE has been strengthened as follows:
On October 31, 2014, the BOJ announced an expansion of the QQE,
which included an increase of the targeted annual increase in base money
from the previous amount of 60–70 trillion to 80 trillion yen.
Adoption of Supplementary Measures

On December 18, 2015, the BOJ introduced supplementary measures for
the QQE, including lengthening of average remaining maturity of the
Bank’s JGB purchases (about 7–10 years in 2015 to about 7–12 years
from 2016).
Introduction of a Negative Interest Rate

On January 29, 2016, the BOJ decided to introduce a negative interest
rate of −0.1% to be applied to a part of the increase in the outstanding
balance held by financial institutions in the current account with the BOJ
(“QQE with a negative interest rate,” effective on February 16, 2016).4
4
The BOJ adopted a three-tier system: (1) an interest rate of +0.1% is applied to the aver-
age balance of the current account (less required reserves) during 2015, as before; (2) an
Introduction of Yield Curve Control

On September 21, 2016, the BOJ conducted a comprehensive assessment
of the developments in economic activity and prices under “Quantitative
and Qualitative Monetary Easing (QQE)” and “QQE with a Negative
Interest Rate,” as well as their policy effects, and based on the assessment,
the BOJ decided to greatly change its policy and introduced “QQE with
yield curve control.” Under the new policy, the policy target was changed
from a previous increase in base money to the short-term interest rate (a
negative interest rate of −0.1% applied to a part of the outstanding balance
held by financial institutions in the current account with the BOJ) and the
long-term interest rate (the BOJ will purchase JGBs, so that ten-year JGB
yields will remain more or less at the current level of around 0%).
Deletion of the Outlook on the Timing of Achievement of the 2%

Price Stability Target
On April 27, 2018, the BOJ deleted, from its “Outlook for Economic
Activity and Prices,” submitted to the Monetary Policy Meeting held on
the same day, the wording on the timing as to when the 2% price stability
target was expected to be achieved, which the BOJ had maintained from
the initiation of the QQE in April 2013.5
Second Arrow: Flexible Fiscal Policy
doption of Fiscal Stimulus

A
Over the five years since the start of Abenomics, the size of initial budget
increased by 7.1 trillion yen or 7.9% from 90.3 trillion yen in fiscal 2012,
before Abenomics, to 97.5 trillion yen in fiscal 2017. The rate of increase
interest rate of 0% is applied to the sum of the amount of reserves required and the outstand-
ing amount of certain credit from the BOJ; and (3) a negative interest rate of −0.1% is
applied to the outstanding balance in excess of the outstanding balance on (1) and (2) com-
bined. The BOJ estimated that, as of the start of the new system, (1) would be about 210
trillion yen, (2) would be about 40 trillion yen, and if the outstanding balance of the current
account increased to 260 trillion yen in February, then the negative interest rate of −0.1%
would be applied to 10 trillion yen.
5
At the start of the QQE, the BOJ stated in the “Outlook for Economic Activity and
Prices” (April 26, 2013) that the 2% price stability target would be reached toward the latter
half of the projection period (FY 2013–FY2015). Its outlook for the timing of the achieve-
ment of the target had been postponed six times before the wording itself was deleted in
April 2018. In the monetary policy statement released on September 21, 2016, which intro-
duced the yield curve control, objectives were stated as achieving the price stability target of
2% at the earliest possible time, with no mention of the specific timing of the achievement.
The only occasion where the time limit for the achievement of 2% target was mentioned in
the policy statement was when the original QQE was introduced on April 4, 2013.
290 K. ARAMAKI
vis-à-vis the previous year was 2.5% and 3.5% for fiscal years 2013 and
2014, respectively, but it has been contained to a level less than 1% for
subsequent years. By contrast, during the period of less than five years,
economic stimulus packages were compiled four times. Outlines of the
packages are described here.6
On January 11, 2013, the government decided on “the Emergency
Economic Measures for the Revival of Japan’s Economy,” with the central
government expenditure amounting to 10.3 trillion yen and the expected
impact on real GDP at about 2%. The focus is placed on the quickness of
effects and demand creating impacts such as public work, including recov-
ery from the Great Earthquake.
On December 5, 2013, the government decided on “The Economic
Measures for Realization of Virtuous Cycles,” with the central govern-
ment expenditure amounting to 5.5 trillion yen and the expected impact
on real GDP at around 1%.
On December 27, 2014, the government adopted “the Immediate
Economic Measures for Extending Virtuous Cycles to Local Economies,”
with additional central government expenditure amounting to 3.5 trillion
yen and expected contribution to real GDP growth at about 0.7%.
On August 2, 2016, the government adopted “Economic Measures for
Realizing Investment for the Future,” with additional central government
expenditure of 13.5 trillion yen and expected short-term contribution to
real GDP growth at about 1.3%.
I ncrease in Consumption Tax Rate and Treatment of Fiscal

Consolidation
On January 22, 2013, the Cabinet Office, Ministry of Finance, and the Bank
of Japan released the “Joint Statement of the Government and the Bank of
Japan on Overcoming Deflation and Achieving Sustainable Economic
Growth,” to strengthen coordination between the government and the
Bank of Japan. In the joint statement, it was clearly stated, “the Government
will steadily promote measures aimed at establishing a sustainable fiscal
structure with a view to ensuring the credibility of fiscal management.”
On June 14, 2013, the government decided on “Basic Policy on
Economic and Fiscal Management and Reform 2017—Overcoming
Deflation and Revitalizing the Economy,” which set it as a goal “to halve
6
On the settlement basis, which includes supplementary budgets, after the size increased
by 3.2% from 97.1 trillion yen in fiscal 2012 to 100.0 trillion yen in fiscal 2013, it declined
somewhat. It was 97.5 trillion yen in fiscal 2016, slightly greater by 0.5% from fiscal 2012.
the size of primary balance7 deficit (in GDP) of the central and local gov-
ernments by fiscal 2015, as compared with fiscal 2010, to make the primary
balance in surplus by fiscal 2020, and to aim at reducing steadily the size of
outstanding debt (in GDP) thereafter.” The primary balance deficit of cen-
tral and local governments (in GDP) declined to −3.0%, achieving the tar-
get of halving the deficits from the level of fiscal 2010 (−6.6%).
Furthermore, Japan included the aforementioned fiscal consolidation
goals in the “St. Petersburg Action Plan,” adopted at the G20 summit
meeting held in St. Petersburg, Russia, in September 2013.
On October 1, 2013, the government decided to raise the consumption tax
rate from current 5% to 8% from April 1, 2014, as scheduled, which was the first
increase of the rate in last 17 years. At the same time, the government decided
to compile an economic package (“The Economic Measures for Realization of
Virtuous Cycles”) to cope with the risk of economic downturn caused by a
reactionary fall in demand after the last minute surge before the rate increase.
On April 1, 2014, the consumption tax rate was increased from 5% to
8%. Then, the economy recorded negative growth in the second and third
quarters consecutively, due to factors including reactionary demand fall
after the last minute surge.
In November 2014, Prime Minister Abe announced that the consump-
tion tax rate hike from 8% to 10% scheduled for October 2015 would be
postponed by 18 months to April 2017, and that he would dissolve the
lower house to ask for the people’s judgment on Abenomics.
In “Basic Policy on Economic and Fiscal Management and Reform
2015” adopted by the Cabinet on June 30, 2015, previous goals were
maintained that the government is to achieve surplus in the primary balance
in fiscal 2020, and to this end, reduce the size of the primary balance deficit
and that the government is to steadily reduce the level of outstanding debt
(in GDP) in the medium and long term.
However, on June 1, 2016, Prime Minister Abe announced another
postponement of the planned increase in consumption tax rate from 8% to
10% by 2 years and a half from April 1, 2017, to October 1, 2019.
7
Primary balance is the balance between, on the one hand, revenues arising from taxes and
other means of revenue, excluding assumption of debts through, for example, issuing gov-
ernment bonds, and; on the other hand, expenditures excluding interest and principal repay-
ments for the debts such as government bonds that were issued in the past. Primary balance
is a criterion to measure whether expenditures necessary to implement policies for the year
are financed by taxes and other means of revenue, excluding debt assumption. We should
note that, even if primary balance is in balance, the outstanding balance of government debt
will increase by the amount of interest payable to the debts assumed in the past.
292 K. ARAMAKI
Furthermore, Prime Minister Abe announced that the use of additional

revenue, to be obtained by the rate increase from 8% to 10% for the con-
sumption tax, would be changed. Previously, it was decided that one-fifth of
the additional revenue, amounting in total to more than 5 trillion yen from
the tax increase, would be used for improving social security and the remain-
ing four-fifths (that is, more than 4 trillion yen), for repayment of debt. Prime
Minister Abe made it clear that the remaining four-fifths would be used in
order to transform the social security system to the one for all generations by,
for example, making early childhood education free of charge. Prime Minister
Abe also declared that, because he was changing previous policy, he would
dissolve the lower house to ask for the people’s judgment. In the election
conducted on October 22, 2017, the ruling LDP had an overwhelming vic-
tory, by gaining 284 seats, far exceeding the majority of total 465 seats.
Third Arrow: Growth Strategy

As part of its growth strategy, the administration has placed into force a
wide range of measures; the major ones are described here:
2013
June The government decided on the “Japan Revitalization Strategy—
Japan is Back” and for “A New Decade of Revival,” after the 20 years of
stagnation; the strategy set as its goal to aim at achieving around 3% nomi-
nal and 2% real GDP growth, on average, over the coming 10 years (there-
after, the growth strategy is revised in June of each year up to 2016).8
September “The Trilateral Forum for Realization of Virtuous Cycles
among the Government, Companies, and Employees” was established, so
as to form a common understanding on such issues as wage increases and
to pass through the increase in cost of inputs onto the prices paid to sub-
contractors through participation by relevant ministers and representatives
from business and labor.
8
The growth strategy, revised in June 2014, included the following reforms: ① Aiming to
reduce the effective corporate tax rate to a level below 30% (the effective corporate tax rate was
reduced to a level below 30% beginning April 2016); ② Revising the basic asset allocation
policy of the Government Pension Investment Fund (GPIF), the world largest pension fund
(the basic asset allocation policy was revised on October 2014, as described in the text, and the
share of risk assets has been increased); ③ Strengthening corporate governance (as described in
the text, the amendment to the Company Act placed into force on May 1, 2015, held account-
able certain companies, including listed companies, if they did not hire directors of their
boards from the outside); ④ Other reforms including deregulation in vital areas such as agri-
culture, healthcare, energy, and the introduction of national strategic zone, where further
deregulation will be applied in such areas as medical care, employment, education, redevelop-
ment of cities, agriculture, and utilization of historic buildings.
2013
June Japan revitalization strategy—Japan is back and a new decade of revival: aim
of 2% GDP growth over coming 10 years.
September “Trilateral forum for realization of virtuous cycles among the government,
companies, and employees” formed.
2014
February The Financial Services Agency formulated a stewardship code, under which
institutional investors are required, on a “comply or explain” basis, for
example, to have clear guidelines on such issues as execution of the voting
rights they have and publication of their voting decisions.
June The Company Act was amended (implemented in May 2015) to make certain
companies, including listed companies, accountable for non-hiring of directors
on their board from the outside, on a “comply or explain” basis.
October The basic asset allocation policy of GPIF (the world largest pension fund) was
changed as below:
Domestic bond 60%→35%
Domestic equity 12%→25%
Foreign bond 11%→15%
Foreign equity 12%→25%
2015
June The Tokyo Stock Exchange formulated and put into force a corporate
governance code by revising listing rules, under which listed companies are
required to hire more than one independent director on their board on a
“comply or explain” basis.
September Prime Minister Abe proposed “Three new arrows,” composed of “Robust
economy (nominal GDP to be 600 trillion yen in 2020),” “Childcare
supports (desirable birth rate of 1.8 targeted),” and “Social care that provides
reassurance (no one forced to leave their job for nursing care of elderlies),”
and also set a policy goal to maintain population of 100 million even 50 years
later.
October Basic agreement reached for the Trans-Pacific Partnership (TPP)
A forum between government and the private sector for investment for the
future was established (meetings were held for five times from October 2015
to April 2016 with participation by the Prime Minister, relevant ministers,
chairman of Keidanren (Japan Business Federation), and others to discuss
challenges to address in order for the expansion of private investment)
November Outline of comprehensive TPP-related policy measures adopted
December Outline of tax reform approved by cabinet (effective corporate tax rate to be
reduced to a level below 30% (29.27%) from fiscal 2016)
294 K. ARAMAKI
2016
June Plan for dynamic engagement of all citizens adopted, incorporating
work-style reform (a principle of “equal pay for equal work,” correcting long
working hours, promotion of employment of the aged) and provision of
favorable environments for child care and nursing
September The implementation meeting for work-style reform established to discuss an
implementation plan for work-style reform, with participation by Prime
Minister, relevant ministers, representatives from business and labor, and
experts
2017
March The implementation meeting for work-style reform adopted an
implementation plan for work-style reform (incorporating guidelines for
“equal pay for equal work” prepared by the government, and the
introduction of a regulation with a penalty for violation to impose an upper
limit on overtime work)
July A framework agreement reached for Japan–European Union economic
partnership agreement
November Basic agreement reached for TPP 119
2 Reactions of Foreign Exchange and Stock

Markets Under Abenomics
Dramatic Initial Reactions and Subsequent Changes
Initial reactions to Abenomics in foreign exchange and stock markets from
late 2012 to 2013 were dramatic. The Nikkei stock index (Nikkei 225)
rose by 88.0% from November 14, 2012 (when then Prime Minister Noda
declared the dissolution of the House) to end 2013. The yen–dollar rate
9
In addition to these measures, the administration has been continuing its efforts to
reform and strengthen the economy through such actions as below:
Adoption of an enforcement plan of regulation reform (June 2014, June 2015, June 2016,
and June 2017)
Adoption of an enforcement plan for the strengthening of industrial competitiveness
(February 2013 and February 2016)
Adoption of five commitments for the encouragement of inward foreign direct investment
(March 2015)
started to depreciate sharply from the end of 2012 and fell by 20.6% from
79.91 yen to the dollar on November 14, 2012, to 100.63 yen at the end
of May 2013. However, subsequent developments were not one-sided or
dramatic as in the initial period, but mixed, consisting of positive develop-
ments and stagnation.
While it is a very rough grouping, we may be able to classify develop-
ments in stock and foreign exchange markets under the Abenomics into
five periods: ① dramatic change, ② deceleration, ③ re-acceleration, ④
adverse developments, and ⑤ stabilization.
To explain Fig. 7.1, making use of Table 7.1, in about half a year from
November 2012 when dissolution of the House was declared to May
2013, the most dramatic changes occurred; the yen rate (monthly aver-
age) depreciated by 19.2%, and the stock price index (end of month) rose
by 45.8%. In the following year and a half, while depreciation of the yen
and stock price increase continued, the pace significantly decelerated and
became somewhat stagnant. After the BOJ introduced the QQE expan-
sion measures at the end of October 2014, the yen rate depreciated fur-
(yen) (yen)
140 QQE 25,000
QQE strengthened Yield curve control (2016.9.21)
(2013.4.4) (2014．10.31)
120
20,000
100
Supplementary 15,000
80
measure (2015.12.28)
60 Negative interest
rate (2016.1.29) 10,000
40
Yen = dollar exchange rate (monthly
average) 5,000
20 Nikkei225 (end of month[RHS])
0 0
May-12
May-13
May-14
May-15
May-16
May-17
Sep-12
Sep-13
Sep-14
Sep-15
Sep-16
Sep-17
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Fig. 7.1 Developments in the stock and foreign exchange market: Five subperi-
ods under Abenomics. Source: Bank of Japan, Yahoo Finance. https://stocks.
finance.yahoo.co.jp/stocks/history/?code=998407.O DL accessed on November
18, 2017
296 K. ARAMAKI
Table 7.1 Five periods in relation to developments in stock price and the yen
rate under Abenomics
Periods Events Changes in foreign Changes in
exchange rate stock price
November 2012~May House dissolved (November −19.2% 45.8%

2013 2012) (80.9 yen/ (9,446
(6 months) Introduction of QQE (April dollar→101.0 yen→13,775
[Period of dramatic 2013) yen/dollar) yen)
change]
May 2013~October Sharp drop of crude oil price −8.5% 19.2%
2014 (from August 2014) (101.0 yen/ (13,775
(17 months) dollar→108.0 yen→16,414
[Period of deceleration] yen/dollar) yen)
October Expansion of QQE (October −11.3% 16.0%
2014~December 2015 2014) (108.0 yen/ (16,414
(14 months) dollar→121.8 yen→19,034
[Period of yen/dollar) yen)
re-acceleration]
December Supplementary measures 19.4% −13.6%
2015~September 2016 (December 2015) (121.8 yen/ (19,034
(9 months) Another sharp drop in crude dollar→102.0 yen→16,450
[Period of adverse oil prices (from end-2015) yen/dollar) yen)
developments] Introduction of a negative
interest rate (January 2016)
September Introduction of yield curve −9.7% 33.9%
2016~October 2017 control (September 2016) (102.0 yen/ (16,450
(13 months) Victory by Mr. Trump in US dollar→112.9 yen→22,012
[Period of stabilization] presidential election yen/dollar) yen)
(November 2016)
Note: Yen/dollar rate is the monthly average of the rate at 5 p.m. in the Tokyo market, and the stock price
is end-month Nikkei 225
Source: BOJ, Yahoo Finance
ther to around 120 yen to the dollar. The stock price, which had been on a
rising trend from around the summer of that year, continued to rise further.
However, from end-2015, together with a recurrence of the sharp fall in
crude oil prices, the yen rate substantially appreciated close to 100 yen to
the dollar and the stock price also fell. Subsequently, after the BOJ changed
its policy from the base money targeting to the yield curve control, based
on the comprehensive assessment of the QQE, the yen depreciated and the
stock price rose, partly helped by the US stock price surge and dollar appre-
ciation after the victory of Mr. Trump in the US presidential election.
Background of the Dramatic Initial Change

It appears that the dramatic initial change was brought about mainly by
foreign investors in financial markets.
Figure 7.2 shows trading amounts by investor type in the Tokyo Stock
Exchange, 1st section. Investors that recorded a substantial amount of net
purchases in 2013 were foreign investors, and domestic investors were net
sellers in that year.
Fukuda (2015) examined daily price changes in stock and foreign
exchange markets for different time zones (the article divided a day into
two time zones, that is, Japan daytime and Japan nighttime) from January
2012 to October 2014. He found that both the rise in stock price and the
exchange rate depreciation took place in the Japan nighttime.
For example, Nikkei 225 futures are traded not only in Osaka but in
other places including Chicago. Figure 7.3 shows accumulated price
changes of Nikkei 225 futures for Japan daytime (9:00–15:15) and for
Japan night time (15:15–6:15) from October 30, 2012 (= 0). Nikkei 225
futures significantly rose during the Japan nighttime, particularly, through
May 2013, but declined during the Japan daytime. Fukuda (2015) con-
(billion yen)
20000
15000
10000 Trading accounts

Corporations
5000 Individuals
Foreign investors
0 Securities companies
-5000
-10000
Fig. 7.2 Trading amounts by investor type in Tokyo, 1st section. Source: Japan
Exchange Group, “Trading amounts by investor type in Tokyo Stock Exchange,
1st section”
298 K. ARAMAKI
Fig. 7.3 Accumulated change of Nikkei 225 (October 31, 2012 = 100). Source:
Fukuda (2015)
tended that the dramatic stock market boom under Abenomics happened
only in time zones when foreign investors were active and concluded that
foreign investors’ responses to the new regime played a leading role in
improving the market sentiments.
Figure 7.4 shows, as in the previous figure, accumulated yen–dollar
exchange rate changes for Japan daytime (9:00–17:00) and Japan night-
time (I = 17:00–9:00, II = 17:00–7:00) from October 31, 2018 (= 0).10
In the same way as the stock price, yen depreciation took place in the
Japan nighttime when foreign investors were active.11
Abenomics and the Real Economy
en Depreciation and Stock Price Rise and the Real Economy

Y
Let us look at how real GDP developed under yen depreciation and the
rise in stock prices. Figure 7.5 shows evolution of the yen–dollar exchange
10
Depreciation of the yen rate is indicated by a vertical upward movement.
11
Japan nighttime II excludes Japan’s morning hours when the Sydney market starts trad-
ing from the definition of Japan nighttime. While, under this alternative nighttime definition
(from 5 p.m. in Tokyo to 7 a.m. in Tokyo in the following business day), the yen’s deprecia-
tion in nighttime was less dramatic, the basic feature is maintained.
(yen/dollar)
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
2013/9/6
2014/5/7
2014/6/3
2013/8/12
2013/10/3
2014/1/21
2014/2/17
2014/3/14
2014/4/10
2014/6/30
2014/7/25
2014/8/21
2014/9/17
2012/10/31
2012/11/28
2012/12/26
2013/01/29
2013/02/26
2013/03/26
2013/04/22
2013/05/22
2013/06/18
2013/07/16
2013/10/31
2013/11/27
2013/12/24
2014/10/15
-5.0
-10.0
Japan daytime Japan nighttime I Japan nighttime II
Fig. 7.4 Accumulated change of yen = dollar exchange rate (October 31,
2012 = 0). Source: Fukuda (2015)
(yen) (%)
140 6
120 4
100 2
80 0
60 -2
Yen = dollar exchange rate
40 -4
Real GDP growth rate
20 -6
0 -8
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
2013Q4
2014.Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
2013Q3
Fig. 7.5 Yen = dollar exchange rate and real GDP growth rate. Source: Bank of
Japan, Cabinet Office, GDP statistics
300 K. ARAMAKI
rate (period average) and the development in real GDP growth rate (quar-
ter-to-quarter rate of change, annualized). While the yen–dollar exchange
rate substantially changed, there has not been a significant change in real
GDP growth rate.
Figure 7.6 shows developments in stock prices and the real GDP. Here,
again, the rise in stock prices has not been accompanied by any significant
changes in the real GDP growth rate.
ontributions to Real GDP Growth by Demand Components

C
Figure 7.7 shows the real growth rate and growth contribution by demand
components in two periods, that is, the three-year period preceding the
Abenomics in the 2010s (2010Q1–2012Q4) and about a five-year period
of Abenomics (2013Q1–2018Q1).12
(yen) (%)
25000 6
4
20000
2
15000 0
10000 -2
Nikkei 225
-4
5000
-6
0 -8
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
2013Q3
2013Q4
2014.Q1
2014Q2
2014Q3
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
2016Q2
2016Q3
2016Q4
2017Q1
2017Q2
2017Q3
Fig. 7.6 Nikkei 225 and real GDP growth rate. Source: Yahoo Finance, Cabinet
Office GDP statistics
12
As the outcome of the two-period comparison significantly changes depending on how
we define the preceding period, we need to cautiously assess analysis in this part. In the text,
we excluded the year of 2009 that includes the period of sharp contraction of the economy
immediately after the Lehman shock (−18.2% annualized quarter-to-quarter rate of change
in 2009Q1) and subsequent substantial recovery (8.7% annualized quarter-to-quarter rate of
change in 2009Q3) and accordingly, defined the preceding period as starting from 2010Q1.
(%)
2
Net export
1.5
Government expenditure
1 Inventory
0.5 Private investment
Housing investment
0
10Q1-12Q4 13Q1-18Q1 Consumption
-0.5
(quarter-to-quarter,
-1 annualized)
Fig. 7.7 Real growth rate and growth contribution by demand components:
Preceding period (2010Q1–2012Q4) and Abenomics period (2013Q1–2018Q1).
Note: The figures show a simple average of quarter-to-quarter growth rates (annual-
ized) and the average growth contribution by each demand component, and the line
shows real GDP growth rate. Source: Cabinet Office, GDP statistics, Bank of Japan
The average real GDP growth rate stayed the same from 1.3% in the
preceding period to 1.3% in the Abenomics period. If we define the pre-
ceding period as covering 2009Q2 or 2009Q3 to 2012Q4, the average
growth rate in the Abenomics period was marginally lower than that in the
preceding period. Therefore, it may be duly said that there has not been a
significant change in GDP growth under Abenomics.
By contrast, there has been a significant change in the composition of
growth contribution by demand components. Growth contribution of net
exports increased by 0.8 point from −0.5 point to 0.3 point. Government
expenditure nearly doubled its growth contribution from 0.1 point (more
precisely, 0.14 point) to 0.3 point (more precisely, 0.25 point), but con-
sumption reduced its growth contribution to a level smaller than half of
the level in the preceding period from 0.7 point to 0.2 point. There has
not been a big change in growth contribution of private investment.
What is characteristic of the Abenomics period is that, as the impedi-
ments to exports, arising from sharp appreciation of the yen in the preced-
302 K. ARAMAKI
ing period, were removed, net export recovered its growth contribution
and government expenditure supported growth, while private investment
did not increase significantly and consumption substantially reduced its
growth contribution.
Developments in Major Demand Components
Investment
As we saw in the preceding subsection, private investment has not shown
a large increase. Is it that the very eased monetary policy under Abenomics
has not been effective? Figure 7.8 shows developments in the interest rate
on Japanese government bonds by maturity. The interest rate on the gov-
ernment bonds has declined since Abenomics started across the maturi-
ties. Bold monetary policy has been effective in this respect.13
Both the interest rate on government bonds and the lending rate were
on a declining trend from 2006 and from 2008, respectively. As Figs. 7.8
(%)
2.5
1.5 13-Nov-12
2-Apr-13
10-Oct-14
1
17-Dec-15
28-Jan-16
0.5 20-Sep-16
22-Nov-17
0
1 year
2 year
3 year
4 year
5 year
6 year
7 year
8 year
9 year
10 year
15 year
20 year
25 year
30 year
40 year
-0.5
Fig. 7.8 Interest rate on government bonds by maturity. Source: Ministry of

Finance HP
13
Fig. 7.8 shows interest rates across maturity one day before the day when major policy
action was taken mainly in the field of monetary policy.
and 7.9 show, the rates continued to decline further from 2013, and bank
lending continued to increase after bottoming out in 2010.
The amount of real private investment dropped with the Lehman shock,
hit the bottom of 65.4 trillion yen in 2009Q4, then started to increase and
became 85.2 trillion yen in 2017Q4, exceeding the peak that had been
reached before the Lehman shock. However, the pace of increase has not
shown a big difference between before and after Abenomics started.
Furthermore, as we saw previously, private investment has not increased
much relative to the amount of cash flow (see Fig. 6.20 in Chap. 6).
While companies are in possession of a large amount of cash and deposits,
as we see in the next subsection (Fig. 7.21), private investment by compa-
nies has not shown a large increase and its growth contribution has not
significantly increased either (Figs. 7.7 and 7.10).
(trillion yen) (%)

600 4.50
4.00
500
3.50
3.00 Outstanding
400 balance of
2.50 bank lending
Interest rate
300 2.00
on
government
1.50
bond (RHS)
200
1.00 Lending rate
0.50
100
0.00
0 -0.50
Fig. 7.9 Interest rate on government bonds, lending rate, and outstanding bal-
ance of bank lending. Source: Bank of Japan; IMF, IFS
304 K. ARAMAKI
(trillion yen)
90.00
80.00
70.00
60.00
50.00
40.00
30.00
20.00
10.00
0.00
Fig. 7.10 Real private investment. Source: Cabinet Office, GDP statistics
Consumption
Consumption has reduced its growth contribution, as we have seen.
Developments in the amount of real private consumption since 2007, that
is, the peak year before the Lehman shock, shows that, after it dropped
with the Lehman shock, it began a recovery. Then, due to factors including
a reactionary fall, after a last minute surge in demand preceding the increase
in consumption tax rate in April 2014, private consumption significantly
declined. Thereafter, it started to recover, but the pace of recovery is slow.
This is what the figure may indicate. However, if we look at the develop-
ments in real consumption more closely, we can see that the amount of real
consumption became almost flat from 2013Q2, two quarters before
2014Q1, when the last minute surge in demand before the consumption tax
increase was observed (Fig. 7.11). Behind this stagnation of consumption
lies a fact that, as we saw in the preceding chapter, consumer prices started
to increase from mid-2013 and the pace of the decline in real wages acceler-
ated (for example, real wage index [2015 = 100] declined by 2.9% in half a
year from 105.2 in June 2013 to 102.2 in December 2013) (Fig. 6.28).
Exports
Exports were flat after recovering from the fall following the Lehman
shock, and even under Abenomics, the recovery was relatively slow and
stagnant on a real-term basis, despite sharp depreciation of the yen–dollar
exchange rate. From around the latter half of 2016, exports started to
show a mild increase. By contrast, imports have been stagnant (Fig. 7.12).
(trillion yen)
310.00
305.00
300.00
295.00
290.00
285.00
280.00
275.00
270.00
265.00
260.00
2011/ 1- 3.
7- 9.
2012/ 1- 3.
7- 9.
2013/ 1- 3.
7- 9.
2014/ 1- 3.
7- 9.
2015/ 1- 3.
7- 9.
2016/ 1- 3.
7- 9.
2017/ 1- 3.
7- 9.
2007/ 1- 3.
7- 9.
2008/ 1- 3.
7- 9.
2009/ 1- 3.
7- 9.
2010/ 1- 3.
7- 9.
Fig. 7.11 Real private consumption. Source: Cabinet Office, GDP statistics
(trillion yen)
100.00
80.00
60.00
40.00 Real exports

Real imports
20.00 Real net exports
0.00
2000/ 1- 3.
2001/ 1- 3.
2002/ 1- 3.
2003/ 1- 3.
2004/ 1- 3.
2005/ 1- 3.
2006/ 1- 3.
2007/ 1- 3.
2008/ 1- 3.
2009/ 1- 3.
2010/ 1- 3.
2011/ 1- 3.
2012/ 1- 3.
2013/ 1- 3.
2014/ 1- 3.
2015/ 1- 3.
2016/ 1- 3.
2017/ 1- 3.
-20.00
-40.00
Fig. 7.12 Real exports, real imports, and real net exports. Source: Cabinet
Office, GDP statistics
306 K. ARAMAKI
Government Expenditure
Real government expenditure mostly declined in the 2000s. However,
due to the fiscal stimulus adopted after the Lehman shock, it turned to
follow a rising trend. Thereafter, real government expenditure continued
rising, even after the real GDP became 508.4 trillion yen in 2013Q2,
exceeding the peak of 507.3 trillion yen in 2008Q1 before the Lehman
shock. Injection of public demand seems to have become a normal aspect
of the economy (Fig. 7.13).
evelopments in Prices
D
In January 2013, the government and the BOJ issued a joint statement, in
which the BOJ stated that it set a price stability target of 2% and aimed to
achieve the target at the earliest possible time. Under the QQE in April
2013, the BOJ committed to achieve 2% price stability target at the earliest
time, with a time horizon of about two years (inflation targeting with time
limit). The price stability target of 2% was defined in terms of the year-on-
year rate of change in the CPI (excluding fresh food). While this indicator
tended to become negative from 2012 to the beginning of 2013, it started
to show a clear positive trend from May 2013. However, it then fell into a
negative territory again from August 2015. It became positive from
January 2017. While the pace of increase is constantly positive, it stays at
0.8% year-on-year, that is, less than 1%, as of July 2018 (Fig. 7.14).
Meantime, while the BOJ stated in the initial period after the introduction
(trillion yen)
135
130
125
120
115
110
105
2009/ 1- 3.
4- 6.
2000/ 1- 3.
10-12.
2012/ 1- 3.
10-12.
2015/ 1- 3.
10-12.
7- 9.
10-12.
2003/ 1- 3.
10-12.
2006/ 1- 3.
10-12.
7- 9.
4- 6.
7- 9.
7- 9.
4- 6.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
Fig. 7.13 Real government expenditure. Source: Cabinet Office, GDP statistics
(%)
4
0
01/01/2012
01/05/2012
01/09/2012
01/01/2013
01/05/2013
01/09/2013
01/01/2014
01/05/2014
01/09/2014
01/01/2015
01/05/2015
01/09/2015
01/01/2016
01/05/2016
01/09/2016
01/01/2017
01/05/2017
01/09/2017
-1
-2
Fig. 7.14 Consumer Price Index (excluding fresh food) (year-on-year change).
Source: Statistics Bureau, Ministry of Internal Affairs and Communications
of the QQE that the price stability target of 2% would likely be reached
toward the latter half of the three-year period from FY 2013 to FY 2015,
that their projection covered. However, the projected timing of achieving
the price target has been postponed six times. In the Monetary Policy
Meeting held on April 27, 2018, the Bank of Japan deleted the wording
on the timing when the 2% target is reached from “The outlook of eco-
nomic activities and price (April 2018).”
Under the initial QQE, it was considered an important policy transmis-
sion channel to raise inflation expectation through measures, including
expansion of base money, reducing the real interest rate (nominal interest
rate – expected rate of inflation), and thereby, stimulating real economy.14
The expected inflation rate (average) held by private sector economists
substantially rose from 2012 to 2013, became flat in mid-2014, started to
decline from the end of 2015, and recently, has stayed around 1%. Expected
inflation rate held by companies, which the Tankan survey of the BOJ
began to collect in April 2014, also started to decline from mid-2014 and
became flat at around 1% since the latter half of 2016 (Figs. 7.15 and 7.16).
14
See Iwata (2013).
308 K. ARAMAKI
(%)
1.6
1.4
1.2
0.8 2 to 6 fiscal years

ahead
0.6 7 to 11 fiscal years
ahead
0.4
0.2
0
2014.06
2014.12
2015.06
2015.12
2016.06
2016.12
2017.06
2017.12
2009.06
2009.12
2010.06
2010.12
2011.06
2011.12
2012.06
2012.12
2013.06
2013.12
Fig. 7.15 Expected inflation rate held by private sector economists (average).
Source: Tabulated drawing on data provided on website of the Japan Center for
Economic Research
(%)
1.8
1.6
1.4
1.2
In 1 year
1
In 3 years
0.8
In 5 years
0.6
0.4
0.2
0
Mar-16
Jun-16
Sep-16
Dec-16
Mar-17
Jun-17
Sep-17
Dec-17
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
Dec-15
Fig. 7.16 Expected inflation rate held by companies (all industries). Source:
Bank of Japan, “Tankan survey”
Figure 7.17 shows the year-on-year rate of change in CPI (excluding

fresh food, excluding effects of increase in consumption tax rate), the
yen–dollar exchange rate, and the crude oil price since 2012. The rate of
change in CPI (excluding fresh food, excluding effects of increase in con-
sumption tax rate) was continuously positive for longer than two years,
from May 2013. Behind this development was the fact that, as we saw
previously, the yen rate depreciated vis-à-vis the dollar by 19.2% from
November 2012 to May 2013, and this pushed the CPI upward through
higher import prices. Then, as the crude oil price fell sharply to a level
below 100 US dollars per barrel beginning in September 2014, the rate
of increase of the CPI (excluding fresh food) from the previous year fell
sharply close to zero. After that, as the crude oil price became flat in the
range of 50 to 60 dollars per barrel and the yen rate further depreciated
to 120 yen to the dollar, the rate of increase in the CPI (excluding fresh
food) from the previous year also became flat. Then, as the crude oil price
further dropped below 30 dollars from the end of 2015, and the yen rate
appreciated to around 100 yen to the dollar, the rate of increase in CPI
(excluding fresh food) fell into the negative range again.
(%) (yen, dollar per barrel）

2 140
1.5 120
Consumer price index
(excluding fresh food)
100 year-on-year change
1
(excluding effects of
80 consumption tax
0.5 increase)
60 Yen–dollar exchange
rate (RHS)
0
40 Crude oil price (in
01/01/2012
01/07/2012
01/01/2013
01/07/2013
01/01/2014
01/07/2014
01/01/2015
01/07/2015
01/01/2016
01/07/2016
01/01/2017
01/07/2017
dollars per barrel) (RHS)

-0.5 20
-1 0
Fig. 7.17 Consumer Price Index (excluding fresh food) (year-on-year change,
excluding effects of consumption tax increase), yen–dollar rate, and crude oil
price. Source: Cabinet Office, Bank of Japan, IMF
310 K. ARAMAKI
Figure 7.18 shows developments in the rate of change in the CPI, which
excludes, in addition to fresh food, oil products, and other special factors
(also excluding effects of increase in consumption tax rate). Different from
the previous figure, the rate of change in the CPI (excluding fresh food, oil
products, and other special factors) continued to be positive even after the
crude oil price fell sharply from autumn 2014. When the appreciation of
the yen rate proceeded in 2016, the CPI turned steeply downward. As the
CPI excludes oil products, effects of the sharp fall of crude oil price do not
seem to be reflected in the CPI. We can see that developments in the CPI
are significantly influenced by the changes in yen–dollar rate.
On the whole, the CPI (excluding fresh food) seems to have been
strongly influenced by the yen rate and crude oil price, and the increase in
the CPI (excluding fresh food) for more than two years from mid-2013
does not seem to be the outcome of tightening of demand-supply condi-
tions under economic recovery. From around the end of 2016, the rate of
increase in the CPI (excluding fresh food) is almost constantly positive.
ompany Profits and Investment

C
We have looked thus far at reactions in the financial markets and develop-
ments in the real economy and prices. Now, let us look at what sort of
changes are observed in the corporate sector.
(%) (yen, dollar per barrel）

1.5 140
Consumer price index

1 120
(excluding fresh food,
oil products,
100 and other special
0.5 factors) (excluding effects
of consumption tax
80
increase)
0
Yen–dollar exchange rate
01/01/2012
01/07/2012
01/01/2013
01/07/2013
01/01/2014
01/07/2014
01/01/2015
01/07/2015
01/01/2016
01/07/2016
01/01/2017
01/07/2017
60 (RHS)
-0.5 Crude oil price (in dollars
40 per barrel) (RHS)
-1
20
-1.5 0
Fig. 7.18 Consumer Price Index (excluding fresh food, oil products and other
special factors), yen–dollar exchange rate, and crude oil price. Source: Cabinet
Office, Bank of Japan, IMF
Figures 7.19 and 7.20 indicate that combined current profits of all the
profit-making companies have been increasing as the yen rate depreciated
and the stock prices rose.
Figure 7.21 shows developments in current profits, investment, and
cash and deposit holding. Current profits have been recording a historic
high. Under these circumstances, while investment has increased, cash and
deposits that companies hold has increased more sharply. Although com-
panies are making large amounts of profits, they have not increased invest-
ment significantly, but have substantially increased cash and deposit
holdings.
ontinued Restraint on Labor Cost and Difference Observed in Labor

C
Markets of Regular and Non-regular Workers
Not only with investment, but also restraint continues with labor cost.
Figure 7.22 shows developments in the labor share that is the share of labor
income in the national income. The labor share, after a sharp increase under
the Global Financial Crisis (GFC), has been declining consistently since 2010.
Looking at the current labor market conditions, the unemployment
rate has been declining, and it is 2.5% as of July 2018, which is the lowest
(yen) (trillion yen)

140 25
120
20
100
Yen–dollar
15 rate (period
80
average)
60 10 Current
profits (RHS)
40
5
20
0 0
Fig. 7.19 Yen–dollar exchange rate, and current profits. Source: Ministry of
Finance, “Statistics of financial statement of companies,” Bank of Japan
312 K. ARAMAKI
(yen) (trillion yen)

25000 25
20000 20
15000 15 Nikkei 225

Current
profits
10000 10 (RHS)
5000 5
0 0
Fig. 7.20 Nikkei 225 and current profits. Source: Ministry of Finance, “Statistics
of financial statement of companies,” Yahoo Finance
(trillion yen) (trillion yen)

80 250
70
200 Current
60
profits
50 150 Private
40 investment
(excluding
30 100
software)
20 Cash and
50 deposits
10 (RHS)
0 0
FY1960
FY1964
FY1968
FY1972
FY1976
FY1980
FY1984
FY1988
FY1992
FY1996
FY2000
FY2004
FY2008
FY2012
FY2016
Fig. 7.21 Current profits, investment, cash, and deposits. Source: Ministry of
Finance, “Statistics of financial statement of companies”
(%)
76.0
74.0
72.0 GDP
statistics
70.0 with base
year = 2000
68.0
GDP
66.0 statistics
with base
64.0 year = 2011
62.0
60.0
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
1980
1982
1984
1986
1988
1990
1992
1994
Fig. 7.22 Labor income share. Note: Labor income share = compensation for
employee/national income (factor price base). Source: Cabinet Office, GDP statistics
in the last 25 years since August 1993. However, as Fig. 7.23 shows, the
improvement started in 2010, and the improvement in the Abenomics
period is the continuation of this trend.
Despite such a tightening in the labor markets, the rate of increase in
wages per worker has been low, as we have seen before. This partly reflects
the fact that the tightening of labor market is not so strong for regular
workers who have by far higher wages, compared with non-regular
workers.
The effective ratio of job offers to job seekers indicates that improve-
ments in labor market conditions are more substantial for part-timers, par-
ticularly, those part-time workers who are not permanent, as compared
with regular workers. While the effective ratio of job offers to job seekers
for regular workers has been improving, the ratio is around 1, recording
1.02 in April 2018 (it was 1.70 for part-timers at that time) (Fig. 7.24).
Reflecting difference in the degree of tightening of labor market condi-
tions, the rate of increase in hourly wage of non-regular workers is higher
than that for regular workers in recent years (Fig. 7.25). The labor market
tightening has been influencing non-regular workers more favorably than
regular workers.
314 K. ARAMAKI
(%)
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Apr-94
Nov-95
Jun-97
Jan-99
Aug-00
Mar-02
Oct-03
May-05
Dec-06
Jul-08
Feb-10
Sep-11
Apr-13
Nov-14
Jun-16
Jan-80
Aug-81
Mar-83
Oct-84
May-86
Dec-87
Jul-89
Feb-91
Sep-92
Fig. 7.23 Unemployment rate. Source: Statistics Bureau of Japan, “Labor force
survey”
1.80
1.60
1.40 Permanent
1.20 (regular
worker)
1.00 Permanent
0.80 (part-
timer)
0.60 Part-
0.40 timer
0.20
0.00
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1996
1997
1998
1999
2000
2001
2002
2003
Fig. 7.24 Ratio of jobs offers to job seekers. Source: Ministry of Health, Labor,
and Welfare, “Employment stabilization operation statistics”
(％)
3
2.5
2
1.5
Regular
1 worker
0.5 Non-
regular
0
worker
2011 2012 2013 2014 2015
-0.5
-1
-1.5
-2
Fig. 7.25 Hourly wages for regular and non-regular workers (year-on-year
change). Note: Hourly wage = contractual wage (i.e., excluding overtime payment
and bonuses) paid in June of each surveyed year, divided by the total contractual
hours worked in June of that year. Source: Ministry of Health, Labor, and Welfare,
“Basic wage structure survey”
Assessment of the Abenomics and Challenges

for the Japanese Economy
Assessment of the Abenomics
Let us make an assessment of Abenomics, drawing on the examination we
have made so far.
First, Abenomics has brought about a substantial depreciation of the yen

rate and a surge in stock prices, particularly, in its initial period. It seems
most probable that the bold monetary easing changed expectations held
by foreign investors about the Japanese economy or stock prices and
exchange rate, and these changes in expectation substantially influenced
stock prices and exchange rate.
Second, neither the substantial depreciation of the yen rate nor the stock
price surge has affected very much real GDP growth trend yet. However,
the interest rate has declined across maturity, and bank lending has main-
tained an increasing trend that started in the recovery period after the
Lehman shock. So, recovery momentum has been maintained.
316 K. ARAMAKI
Third, the breakdown of the growth rate by demand component in the

Abenomics period shows that, compared with the period preceding the
Abenomics period, growth contribution of net exports significantly
expanded and government expenditure almost doubled its growth contri-
bution, but, in contrast, consumption halved its growth contribution and
the growth contribution of private investment has not changed much.
Fourth, the rate of change in the CPI (excluding fresh food) was kept
positive for more than two years from May 2013. This seems to have
been due to the influence of the effects of exchange rate depreciation.
Fifth, company profits have been recording historic highs in recent years.
However, investment, while increasing, has not shown a substantial
increase, and restraint on labor costs continues, with cash and deposit
holdings by companies reaching record highs.
Sixth, while the unemployment rate is the lowest since the mid-1990s,
tightening of labor market conditions is stronger for non-regular work-
ers than for regular workers, and the rate of increase in wages is higher
for non-regular workers than for regular workers. Companies have not
basically altered their attitude toward restraint of labor costs.
hallenges for the Japanese Economy

C
Abenomics is a comprehensive policy package that encompasses not only
macroeconomic policy but also extensive micro policy, such as governance
reform, TPP promotion, and labor market (work style) reform. It is also a
remarkable undertaking in that the policy package has been strongly
implemented for more than six years under the same administration.
Furthermore, it is a rare policy formation, and evolution in that policy
focus has continuously shifted from monetary and fiscal policy to micro
and social structural policies, such as wage increase, promotion of invest-
ment, governance reform, and work-style reform, the birth rate and popu-
lation target, and productivity enhancement.
However, the current growth structure of the Japanese economy has
important problems. The defensive attitude of the corporate sector has
brought about a stagnant increase in growth contribution of investment,
declining growth contribution of consumption under wage restraint, and
the continued growth dependence on government expenditure. Why has
the behavior of companies not changed? In what follows, we examine
three issues, that is, that investment does not expand fully, that consump-
tion has been losing its growth contribution, and that government expen-
diture continues to hold a substantial share in growth contribution, and
consider what challenges the Japanese economy faces.
Investment Restraint by Companies

As we have seen, companies have not significantly expanded investment in
spite of very favorable environments, including low interest rates and
increasing profits. Why is this? As we examined in Chap. 6, the fundamen-
tal reason is the low-growth expectation of the domestic economy held by
companies.
Figure 7.26 shows developments in expected growth rate of the domes-
tic economy held by companies for the next three years and actual real
economic growth rate (three-year-moving average). Expected growth
rate, which once was around 3% at the beginning of the 1990s, consis-
tently declined to a level below 1% beginning in the 2000s, and beyond
that has stayed around 1%. Decline in expected growth rate proceeded
together with the decline in the actual growth rate, and it became deeply
rooted as the economic stagnation was extended. In other words, the fact
of prolonged low growth strongly constrains future expectations. Most
troublesome is the possibility that low growth expectation works as a
restraining factor on investment and wages (consumption), limiting
growth of domestic demand, and therefore, economic growth in a self-
(％)
7.0
6.0
Expected
5.0 growth rate
held by
4.0 companies
for coming 3
3.0 years
2.0 Real GDP

growth rate
1.0 (3-year
moving
0.0 average)
FY1973
FY1976
FY1979
FY1982
FY1985
FY1988
FY1991
FY1994
FY1997
FY2000
FY2003
FY2006
FY2009
FY2012
FY2015
-1.0
-2.0
Fig. 7.26 Real GDP growth rate and expected growth rate held by companies.
Source: Cabinet Office, “Survey on company behavior”
318 K. ARAMAKI
fulfilling way. Furthermore, due to the need to make up for lack of self-
sustained high growth, the economy cannot lower its dependence on
government expenditure. High dependence on government expenditure,
together with wage restraint, may raise concerns for the future for house-
holds, thus strengthening the mechanism of low growth through its
dampening effects on consumption. The Japanese economy does not
seem to have exited from such a vicious circle yet. Stimulating demand
through the promotion of lending with low interest rates is a policy that
focuses on the cost side of investment activity. It has become clear by the
implementation of bold monetary easing under Abenomics that unless a
sales increase is expected, the effects of cost lowering on investment activ-
ity are limited.
What seems to have started to impose significant effects on growth
expectation of domestic economy, particularly, from around 2010, is
population decline. The total fertility rate, which dropped lower than the
population replacement level of 2.07 in 1974, has been at the 1% level for
more than 40 years. However, it is only recently that population decline
was recognized as a serious problem by the general public. It is probably
since the 2010 publication by Hiroshi Motani of “Defure no Shotai:
Keizai ha jinko no nami de ugoku” (True origin of deflation—The econ-
omy moves by the demographic waves).15,16 To be sure, as Fig. 7.27
shows, the magnitude of expected population decline in Japan is very
15
The Bank of Japan has conducted very extensive research on the effects of the popula-
tion on the economy since the publication of Motani’s book. The executive members of the
BOJ, including then Governor Shirakawa, started to frequently mention effects of popula-
tion decline in their public communication.
16
Motani’s (2010) book is important, as it directed the attention of the public to the issue
of population decline, particularly to its impacts on the demand side of the economy.
Although there are many books on population decline, there are only a handful of books
focusing on the demand side, to the author’s knowledge, examples of which include Nukaga,
Makoto (2005) “Juyo Shukusho no Kiki-Jinko Gensho Shaki no Keizaigaku” (Demand
shrinkage crisis—Economics of population decline) NTT Publication; and Adachi, Makiko
“Shoshi Koreika ga Kakei Bumon ni Ataeru Eikyo” (Impacts of declining birth rate and
aging population on household sector) (Mizuho Soken Ronshu (2004 I), pp. 1–35. Mizuho
Sogo Kenkyujo). Although there were very few reactions from researchers and scholars to
Motani’s arguments, very limited exceptions include Yoshikawa, Hiroshi (2011) “Shoshi
Koreika to Keizai Seicho” (The declining birth rate and aging population and economic
growth), RIETI Discussion Paper Series 11-P-006 January 2011; and Yoshikawa, Hiroshi
(2016) “Jinko to Nihon Keizai” (Population and the Japanese economy), Chu Ko Shinsho.
(thousand)
140,000
120,000
100,000
80,000 75 years old ~
65~74 years old

60,000
20~64 years old
40,000
~19 years old
20,000
0
1920
1940
1950
1960
1970
1980
1990
2000
2010
2020
2030
2040
2050
Fig. 7.27 Population of Japan and its future estimates. Source: National Institute 2060
of Population and Social Security Research, “Population statistics [2017 revision]”
large, and it is considered to act as a strong restraining factor on future

growth expectation.17
Keeping in mind that while population decline may have worked to
depress growth expectation since the 2010s and would continue to function
as a negative factor on the formation of growth expectation in the future,
too, it probably was not significantly relevant to the decline in growth
expectation in the period up to the 2000s. The reason for the decline in
growth expectation and also the reason for the underlying decline in actual
growth performance up to the 2000s were, as we examined in Chap. 6, to
be found in the corporate behavior after the collapse of the bubble.
Persistence of defensive attitudes by companies, even after the excesses of
companies had been finally removed by mid-2000s, seems to have been
brought about by low-growth expectations for the domestic economy held
17
“Population statistics data (2017, revised version)” (Medium fertility assumption
[medium mortality assumption]) by the National Institute of Population and Social Security
Research indicates that Japan’s population is projected to decline by 39.018 million (30.7%)
in 50 years from 127.095 million in 2015 to 88.077 million in 2065. This corresponds to a
decline of 0.780 million per year. It means that one prefectural capital city, such as Niigata
(0.81 million population), Hamamatsu (0.8 million population), or Kumamoto (0.74 mil-
lion population) is projected to disappear each year.
320 K. ARAMAKI
by companies that had been deeply embedded during the prolonged low-
growth performance. It is difficult to judge whether the low-growth expec-
tation of companies at this time is due to an irrational defensive mindset, or
due to rational consideration of factors such as population decline and rela-
tively high profitability of overseas operation. Still, companies seem to be at
least partly constrained by the negative legacy of the 15-year-long low-
growth performance that the corporate sector had brought about.
If the low-growth expectation is due to the defensive mindset, it should
be effective, although seemingly paradoxical, to realize a higher growth
performance than in the past through promotion of economic activities in
such areas where activities were not constrained by low growth in the past
(for example, exports and alteration of foreign demand into domestic
demand through tourism, including medical tourism, promotion of
inward foreign direct investment, and utilization of special economic
zones). Furthermore, it is necessary to encourage more positive behaviors
by companies through, for example, governance reform to promote par-
ticipation of outside people in their management. At the same time, how-
ever, it is necessary to cope with substantive issues for the future. In
particular, it is critically important to mitigate the population decline,
which poses the biggest restraint on growth expectation for the future.
Most importantly to that end is introducing such measures that will enable
women to have and raise children without having their careers interrupted
and negatively affected.
In relation to impacts of population decline on growth, there is a view
that contends that, while Japan’s economy has been behind other advanced
countries in terms of GDP growth, it has not been so in terms of the rate of
growth of GDP per capita or the rate of growth of GDP per working-age
population.18 Figure 7.28 shows the rate of GDP growth of five advanced
countries, including Japan, in every five years. Japan’s growth performance
has been low as compared with other countries since the 1990s.
Figure 7.29 shows the rate of growth of GDP per capita for every five
years. The figure indicates Japan’s performance stagnated in the 1990s,
but it has been neither on the high side nor on the very low side since the
2000s.
For example, see Masaaki Shirakawa (2012a) “Deleveraging and growth: Is the devel-
18
oped world following Japan’s long and winding road?”, a lecture by the then governor of the
London School of Economics and Political Science on January 10, 2012.
(％)
30
25
20
Japan
15
US
10 Germany
France
5 UK
Fig. 7.28 Five-year real GDP growth rate. Source: United Nations, IMF
(％)
30
25
20
Japan
15
US
Germany
10
France
5 UK
-5
Fig. 7.29 Five-year growth rate of real GDP per capita. Source: United Nations,
IMF
322 K. ARAMAKI
Furthermore, Fig. 7.30 shows the rate of growth of GDP per working-

age population for every five years. Japan’s performance has been low but
close to the average level of four advanced countries since the 2000s.
However, we note that, in Japan, the rate of increase of the number of
persons actually employed has been consistently higher than that of the
working-age population (or in the case of decline, the rate of decline is
smaller for the number of persons actually employed than for the working-
age population), and, therefore, the rate of growth in GDP per persons
actually employed will be lower than the figure shows.19
These figures show that, viewed from the supply capacity side, the
growth rate of GDP per working-age population has been on the low side,
as compared with other countries, even after incorporating the positive
effects of a rising labor participation rate. So, in order to raise perfor-
mance, it is essential to enhance productivity through technological prog-
ress or education and training. Furthermore, costs to keep and maintain
the society include such expenses as defense and security or maintenance
(％)
25
20
15 Japan
US
10 Germany
France
5 UK
-5
Fig. 7.30 Five-year growth rate of real GDP per working-age population
(15–64). Source: United Nations, IMF
19
For example, while the rate of increase in the working-age population from 2010 to
2015 is −5.2%, the number of actual employment increased over the same five-year period
by 1.6%, indicating that an increase in the labor force participation ratio has been making up
for the decline in the working-age population.
costs for economic infrastructure that accrue regardless of the size of pop-
ulation. Therefore, it is difficult to maintain the stable management of a
society if the economy grows only in terms of per capita GDP or per
working-age population GDP and not in terms of total GDP. So, it is nec-
essary to aim for a certain growth of total GDP while attempting to trans-
form the society into a compact one, which can economize on overhead
common costs in line with population decline.
However, the working-age population is expected to decline further,
and it is not possible to indefinitely raise the labor force participation rate.
So, given future demographic change that is expected, it is difficult to
expect the growth rate of total GDP to substantially increase in the future,
without technological progress or other factors significantly raising the
growth rate of GDP per working-age population beyond the level experi-
enced in recent years.
Figure 7.31 shows the GDP gap ([actual GDP − potential GDP]/
potential GDP), which was frequently negative after the collapse of the
bubble, narrowed in the Abenomics period, and has been positive recently.
Demand shortages that the Japanese economy has long suffered from the
collapse of the bubble may have been finally resolved.
(%)
6.0
4.0
2.0 GDP Gap

1985-90
0.0 average
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
10-12.
10-12.
10-12.
10-12.
10-12.
10-12.
1980/ 1- 3.
1987/ 1- 3.
1994/ 1- 3.
2001/ 1- 3.
2008/ 1- 3.
2015/ 1- 3.
1991-2012
-2.0 average
2013-17Q2
-4.0 average
-6.0
-8.0
Fig. 7.31 GDP gap. Source: Cabinet Office, GDP statistics

324 K. ARAMAKI
However, there is a cautious view that the elimination of a negative

GDP gap may not be necessarily a positive development. Figure 7.32
shows developments in potential growth rate estimated by the Cabinet
Office. Japan’s potential growth rate, which was at the 4% level at the
beginning of the 1990s, continued to decline after the burst of the bub-
ble, falling to a level just below 1% after the financial crisis in the late
1990s. It fell further to near 0% around the GFC, and subsequently, recov-
ered somewhat but stayed flat at the 1% level up to the present. It is pos-
sible that such a decline in growth potential might have contributed to the
elimination of the negative GDP gap under the expansion of demand.20
Wage Restraint and Consumption Stagnation

As we have seen, restraint on wages and labor costs seems to have brought
about a decline in the growth contribution of consumption. Figure 7.33
shows the growth contribution (period average) of demand components for
(%)
6.0
5.0
4.0
3.0
2.0
1.0
0.0
10-12.
1984/ 1- 3.
10-12.
1989/ 1- 3.
10-12.
1994/ 1- 3.
10-12.
1999/ 1- 3.
10-12.
2014/ 1- 3.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
10-12.
2004/ 1- 3.
10-12.
2009/ 1- 3.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
4- 6.
7- 9.
-1.0
Fig. 7.32 Potential growth rate. Source: Tabulated using data provided from the
Cabinet Office website. (http://www5.cao.go.jp/keizai3/getsurei/getsurei-
index.html)
20
The “2017 White paper on small and medium enterprise in Japan” (pp. 12) notes the
average age of equipment and machinery as of 2016 was 1.5 times older for large companies
and about 2.0 times older for small and medium companies, as compared with 1990, indicat-
ing increased aging of equipment and machinery. Prolonged investment restraint has
imposed negative impacts on competitiveness and growth potential of companies.
(%)
2.5
Net export
2
Government
expenditure
1.5
Inventory
1
Housing investment
0.5
Private investment in
plant and equipment
0
Consumption
-0.5
-1
Fig. 7.33 Growth contribution by demand components. Source: Cabinet Office,

GDP statistics
each of the five subperiods, covering about 24 years since 1994.21 Growth
contribution of consumption has consistently declined from 0.8 point in
1994–1997 to 0.3 point in the Abenomics period. In the background is the
decline in real wages, as we saw previously. There has not been a big change
in the corporate attitudes toward restraining labor costs. Although labor
market conditions has been tightening, it is tighter in the market for non-
regular workers. Duality in the labor market between regular and non-reg-
ular workers, and the existence of differences in wages and other working
conditions between them, provide companies with an opportunity to con-
tain labor costs through increased use of non-regular workers. In other
words, duality in the labor market offers an effective tool for international
competition through cost reduction. However, there is a limit for high-
wage countries in how far they can compete internationally through cost-
cutting. Restraint on wages contains consumption, and contributes to low
growth, creating a vicious cycle of low growth. Also, duality of the labor
market without rational basis seems to have produced external diseconomies
to the society, by, for example, contributing to the falling marriage rate,
21
Twenty-four years are divided into five subperiods, that is, four subperiods that broadly
correspond to subdivision of the period of stagnation described in Chap. 3 plus the
Abenomics period.
326 K. ARAMAKI
accompanied by the decline in birth rate.22 In addition to trying to raise

wages, in order to exit from the vicious cycle of low growth that seems to be
self-fulfilling, it is also important to correct the disparity of treatments
between regular and non-regular workers or that based on age or gender
with no rational basis and to encourage changes in the way companies uti-
lize human resources. However, we cannot entirely deny the possibility that
the defensive attitude of companies is not just due to the mindset but is the
outcome of rational response based upon expected shrinkage of the domes-
tic economy and intensifying international competitive pressure. If there is
rational basis, an increase in wages in excess of productivity growth will
jeopardize international competition, promoting further shift of the pro-
duction base overseas, and increase in domestic investment can result in
accumulation of low-profitability assets. As stated before, in order to respond
to the shrinking population and to have international competitiveness that
is sustainable with high wages, it is necessary to increase wages and enhance
productivity growth at the same time. A fundamental review and improve-
ment of the way our human resources are used and also, how investment in
human resources is conducted is critically important to raising of productiv-
ity.23 We should note that trying to enhance competitiveness by regarding
labor just as costs and simply curtailing it is self-defeating in the longer term.
22
According to The Japan Institute for Labor Policy and Training, “Jakunensha no shugyo
jokyo kyaria shokugyo noryoku kaihatu no genjo ② heisei 24 nen ban ‘shugyou kozo kihon
chosa’ yori (‘Current status of employment, career and work capacity development of young
people ② based on ‘basic survey of employment structure 2012’),” JILP document series
No. 144 September 2014, the share of those having a spouse at ages 30 to 34 is 57.8% for
regular workers, and 23.3% for non-regular workers, such as part-timers. The share at the
ages 35 to 39 is 68.6% for regular workers and 28.1% for non-regular workers. In short, the
share of those having a spouse for non-regular workers is lower than half of that for regular
workers.
23
The Japanese government is currently pressing forward with “work style reform.” This
reform effort has positive elements such as regulation of long work hours and realization of
the principle of “equal pay for equal work.” However, how to achieve productivity increase
that this reform aims at by labor market reform is an issue that needs cautious examination
and thought through formulation of appropriate framework based on scientific and objective
evidence. The most important premise when considering labor market reform is the fact that
workers and companies do not stand on an even ground. Workers enter, and work under, an
employment contract in an overwhelmingly disadvantageous (weak) position. As an indi-
vidual, a worker is normally not in a position to choose the work style. In this sense, what is
needed is not the “work style reform” but a reform of “humane resource development and
utilization” under which the way companies or our society in general develop and utilize our
human resources is examined and reformed where necessary and appropriate.
Continued Dependence of Growth on Government Expenditure

As we have seen, the degree of dependence of growth on government
expenditure has been significantly higher in the Abenomics period, com-
pared to the preceding period. It is worrisome that, when the corporate
sector has been making historically high profits, dependence of growth on
government expenditure is rising.
Figure 7.34 shows developments in the amount of annual issuance of
government bonds. It is not that the amount has increased significantly in the
Abenomics period, but government bonds amounting to 150–170 trillion
yen, which is equivalent to close to one-third of GDP, are issued each year.
The structure of government bond holding is another matter of con-
cern. Figure 7.35 shows shares by holder in the outstanding balance of
government bonds and FILP bonds.24 The deposit-taking financial insti-
tutions held 299.7 trillion yen, accounting for the largest share, 37.9% as
(trillion yen) (%) Refinancing

200 180 bond
180 160 FILP bond

160
140
Reconstruction
140
120 bond
120
100 Exceptional
100 pension bond
80
80 Deficit bond
60
60
40 40 Construction
bond
20 20
Government
0 0 bond/GDP
(RHS)
FY1965
FY1968
FY1971
FY1974
FY1977
FY1980
FY1983
FY1986
FY1989
FY1992
FY1995
FY1998
FY2001
FY2004
FY2007
FY2010
FY2013
FY2016
Fig. 7.34 Annual issuance of government bonds: FY 1965–2017. Source:

Tabulated using data provided on the website of the Ministry of Finance
24
FILP (Fiscal Investment and Loan Program) represents investment and lending operations
by the government. The FILP bond is a type of government bond that the government issues
as a low-interest fundraising tool based on sovereign credit for the operation of the program.
328 K. ARAMAKI
(%)
45.0
40.0
35.0 Deposit taking

institution
30.0
Insurance and
25.0 pension fund
Social security fund
20.0
Household
15.0
Overseas
10.0 Central bank
5.0
0.0
Apr-09
Sep-10
Feb-12
Jul-13
Dec-14
May-16
Dec-97
May-99
Oct-00
Mar-02
Aug-03
Jan-05
Jun-06
Nov-07
Fig. 7.35 Share in outstanding government bonds and FILP bonds held by
major holders. Note: FILP bond is a government bond issued by the government
on account of, and registered with, the FILP account of the government. As a
financial product, it is the same as an ordinary government bond (see Footnote 24).
Source: Tabulated data provided on the website of the Bank of Japan.
of December 2012. However, the amount of holdings and their share

declined to 182.2 trillion yen and 18.7%, respectively, as of June 2017.
By contrast, the amount and share held by the Bank of Japan increased
from 90.9 trillion yen and 11.5% as of December 2012, to 401.9 trillion
yen and 41.3% as of June 2017, respectively. Under the yield curve con-
trol, that is, control by the BOJ of both short-term and long-term inter-
est rates, the government bond yields stay at a very low levels. Because of
the large amount of purchase by the BOJ, government bond holding has
shifted from banks to the BOJ on a large scale, and current account
deposits with the BOJ held by banks have been sharply increasing in
return. The huge amount of current account deposits with the BOJ
bears basically a positive interest of 0.1%. As other profit-making oppor-
tunities for banks are limited, we cannot expect that the rapid increase in
deposits in the current account (in other words, increase in the base
money) could have large impacts on the real economy. Replacement of
government bonds held by banks with deposits in the current account
with the BOJ indicates that the financial position of banks will significantly
depend on the financial soundness not of the government but of the
BOJ. Therefore, in the process of exiting from the current condition of
extremely eased monetary policy, it will become important for the stability
of the financial system to maintain soundness of the BOJ. In other words,
in order for the continued dependence of economic growth on govern-
ment expenditure, coupled with eased monetary policy, not to raise risk to
the financial system, it is becoming increasingly important to accomplish
as soon as possible a private sector-led economic growth structure.
Under the declining strength of consumption, it is sometimes argued
that we need to further strengthen the social security system because con-
sumption has been contained by concern about the future among young
people under the wage restraint and replacement of regular by non-regular
workers. However, judging from the projections of population decline and
further aging in the years to come, it is inevitable for social security expen-
diture, which currently accounts for one-third of expenditures in the gov-
ernment budget, to further increase. Therefore, what is necessary for
maintaining fiscal capability to respond to such policy needs as national
defense and security or maintenance of minimum infrastructure is to raise
taxes and to reduce social security expenditure. In order to alleviate con-
cerns for the future held by young people, it is important to raise the share
of expenditures targeted at young people in such expenditures as social
security. However, if such a shift in focus is accompanied by further deterio-
ration of fiscal position, then it could have negative impacts on the concerns
for the future of young people. Figure 7.36 shows, for each age group of
respondents, the share, among all respondents with concern for the future,
of those who listed deterioration in fiscal, employment, or economic condi-
tions as a factor causing their concern. The share of respondents who listed
any of these three factors is larger for the younger age groups.
Considering the need to alleviate concern for the future, while pressing
forward with restraint on total social security expenditure and also with a
shift of focus toward the younger generation and strengthening education
and job training, it is important to implement such reforms of the social
system that would not raise the fiscal burden. In other words, it is neces-
sary not only for individuals but also for companies and local communities
to move to a society that is based on a principle of “self-help and self-reli-
ance.” We need individuals who do not depend on public support, compa-
nies that do not depend on economic stimulus or subsidies from the
government, and local communities that do not depend on fiscal support
330 K. ARAMAKI
(%)
60
Deterioration in
fiscal position of
50 central and local
government
40
Deterioration in
30 employment
conditions
20 Stagnation and
decline of
10 Japanese
economy
0
(age)
Fig. 7.36 Share of respondents for each age group who listed deterioration in fiscal,
employment, or economic conditions as the cause of their concern for the future.
Note: The figure shows the share of respondents for each age group who listed dete-
rioration in fiscal conditions, employment conditions, or economic stagnation as a
cause of their concern for the future. Respondents are those who had previously
answered that they had concern for the future. Source: Cabinet Office, “Opinion
survey on future image of Japan related to population, economy, and society,” 2012
from the central government such as local distribution tax and subsidies. It
will be inevitable for policies under Abenomics and subsequent policy
developments to shift to the ones that encourage self-reliance of economic
agents and promote their self-help.
resent Status of the Japanese Economy and the Challenges Ahead

P
The Japanese economy has turned into an economy governed by low-
growth expectations and concerns for the future, after the anomaly and
difficulties extending over more than 30 years. In particular, low-growth
expectations held by companies has brought about restraint on domestic
investment and wages with negative impacts on consumption, and also has
produced such by-products as increasing potential financial risks arising
from the policy of extremely low interest rates and the inability to reduce
dependence on government expenditure and concerns for the future of the
younger generation. The low-growth expectation is partly due to the out-
come of a mindset in the sense that it is constrained by actual growth per-
formance in the past, but at the same time, we cannot deny that it has a
rational basis such as expectation of quantitative shrinkage of the domestic
markets due to population decline.
In order to exit from this vicious cycle, companies need an expectation
of sales increase, and households need an expectation of stable increase in
income. As we have already touched on the immediately needed measures
such as transformation of foreign demand to domestic demand and gover-
nance reform, we will briefly list medium- and long-term measures in con-
cluding this book.
First, in order to achieve sales increase, while it may appear to be a
roundabout way, it seems most important to reform the way companies
utilize human resources. Presently, an option is open to companies to con-
duct a price-cut competition through reduction of labor costs by long
work hours by regular workers and a shift to non-regular workers.
However, effectiveness of such price-cut competition is limited for
advanced countries that have relatively higher wages. Also, competition
through labor cost reduction by shifting to non-regular workers has
brought about social costs, including significantly lower marriage rates
among non-regular workers. Therefore, it is necessary to encourage com-
panies to move away from a competition through labor cost-cutting
toward a competition through sales increase, by appropriately regulating
long work hours and correcting irrationally differentiated treatments
between regular and non-regular workers. Together with removing irra-
tionally differentiated treatments between regular and non-regular work-
ers, it seems necessary to separate stability of employment and stability of
wages. No matter whether the worker is regular or non-regular, it is
important to provide stable employment where possible, based on a prin-
ciple of “equal pay for equal work.”25 At the same time, it is necessary to
link wages to performance of the company and also introduce competition
among workers for higher wages. If employment security for regular work-
ers is combined with wage security, it is difficult to expect productivity
increase. A system is in order where both regular and non-regular workers
compete for higher productivity on a level paying field. Although cautious
25
With a view to reducing duality between regular and non-regular workers in the Japanese
labor market, Aoyagi and Ganelli (2013) proposed to introduce a Single Open Ended
Contract (SOEC) for all new hires, in which employment protection, including severance
pay, will increase with tenure. The SOEC would imply lower job security compared to cur-
rent regular employment, but higher job security compared to current non-regular employ-
ment. In this regard, the paper refers to the Danish flexicurity model, which is composed of
332 K. ARAMAKI
analysis is necessary when institutionalizing such system, what is needed is

a system to expose regular workers to external competition.26
Population is the biggest challenge for the Japanese economy and soci-
ety, in light of its negative impacts (its effects on the expectation formation
of sales and growth decline, decline of actual growth rate, and decline of
national power). The biggest barrier to arresting population decline (rais-
ing the birth rate) is the costs accruing to women from career interruption
arising from having and raising children. It is most important to help pro-
vide accommodating working environments where companies accept such
work styles that careers are not interrupted by having and raising children
(e.g., supporting establishment of an intracompany nursery school, and
promoting work styles in harmony with respective stages of life in the form
of working at home or part-time or flexible work hours). For the moment,
until the birth rate is sufficiently raised, it is important to make maximum
use of existing human resources including the aged, women, and non-
regular workers. It is necessary to establish a society where any person can
work and gain stable income based on a principle of self-help and self-
reliance, without irrationally differentiated treatments, so long as the indi-
vidual is healthy and willing to work.27
Utilization of foreign labor has to be examined with a long-term
perspective, taking into account the impacts of settlement of foreign peo-
ple that will inevitably arise (if foreign people settle, then they are immi-
grants). Regarding foreign labor solely as labor force and making use of
them with short-sighted objectives will inevitably create problems for the
future. Bearing in mind that what is at issue is not an economic matter but
(1) flexibility in the labor market (including reduction of protection of regular workers),
combined with (2) social security protection through unemployment benefits, and (3) an
active labor market policy. The main idea of flexicurity is that of protecting workers rather
than jobs. However, the authors pointed out that the most difficult part for Japan is the high
fiscal cost of the flexicurity model.
26
As stated before, how to enhance labor productivity under any given framework is an
issue that needs cautious examination based on scientific evidence.
27
The mandatory age-limit retirement system, while a logical consequence of lifetime long
employment coupled with a seniority-based wage system, is a system that can bring about enor-
mous waste of human resources that is beyond imagination under a productivity-based employ-
ment and wage system. When we hear anecdotally about retired highly skilled workers being
employed by foreign competitor companies and contributing to the strengthening of their
competitiveness, we feel deeply how insensitive our society has been to the social losses that
arise from a system of strong job security coupled with a seniority-based wage system. Intrinsic
to current age-based system are, one, objectives to encourage employees to stay longer with the
a choice to alter the composition of a nation’s people, it is indispensable to

form a national consensus and wholly review and adjust current social insti-
tutions and systems that do not presume a large inflow of foreign people.
Influences of deterioration of fiscal position have already started to sur-
face. For example, deterioration of the financial position of national and
public universities and prolonged non-regular working conditions for
post-doctoral researchers are bound to drive talented human resources
away from research jobs and negatively affect, without fail, Japan’s research
level and technological advancements in the future. Furthermore, aging of
economic infrastructure, such as roads and tunnels, is becoming an imme-
diate problem. In light of population decline, a shift to a geographically
concentrated inhabitation is a must, and restraint on social welfare expen-
diture is inevitable. Individuals, companies, and local communities all
need to act on a principle of self-help and self-reliance, without relying on
fiscal support from the government or short-sighted resort to the use of
foreign laborers.
In particular, the way local government finance is operated poses a seri-
ous problem. Presently, local government finance is managed under a very
centralized system, which incorporates very strong intervention by the cen-
tral government, such as its annual formulation of local governments’ fiscal
programs and legal provision of standard tax rates for local taxes. The basis
of fiscal democracy at the local level is in the approval by local residents of
public expenditure by the local government and collection of local taxes to
finance them. However, we do not often hear about cases where the assem-
blies of local government with relatively abundant revenues cut local taxes
and those with insufficient revenue raise local taxes. Many local taxes have
the nature of national taxes earmarked for local expenditure, in other words,
taxes for specific purposes. Detrimental impacts of earmarked taxes are sig-
nificant, with no need to refer to the case of road-related earmarked reve-
nues. Local governments do not have to raise tax by obtaining approval of
their residents in order to finance public services. They seem to stand in a
company, and, two, difficulty to introduce and operate a wage system that is based on company
performance and assessment of productivity of each employee. As a result, companies continue
to pay wages that may be higher than the productivity of the employees up to the retirement
age and dismiss those employees who can produce more than their wages because they have
reached the retirement age, together with those who cannot. We need to wholly review the
current employment system including the mandatory age-limit retirement system.
334 K. ARAMAKI
position of using revenues that are distributed by the central government.28

In 2018, a new forest environment tax was approved to be introduced as a
national tax, which is predetermined to be transferred to local governments.
This new tax symbolizes the essential nature of the current system of local
government finance, that is, the central government prepares the revenue
and the local government uses it.
Japan’s social system, including its social welfare and economic infra-
structure, seems to have been based on the assumption that the popula-
tion and the economy would continue to expand. It is becoming difficult
for such a basic system of society to operate smoothly with the decline of
the population and low growth of the economy. It is good and appropriate
to aim to mitigate population decline and increase economic growth.
However, policy needs to be prepared for the case when neither popula-
tion nor the economy expands. Now is the time when we have to funda-
mentally review our social system with a presumption that the economy
will not expand and population will decline. The key concept for the
review seems to be, as stated before, “self-help and self-reliance.” We need
to reestablish our society based on a principle of “self-help and self-
reliance” that applies to companies, individuals, and local authorities.
28
This is easily seen by looking at the gigantic and stately building of the Tokyo metropoli-
tan government and the lavish, high-rise local government offices of central wards in Tokyo.
The problem with current local government finance is exemplified by the fact that local
assemblies of these local governments do not examine the balance between such expendi-
tures and tax burden borne by local residents, and do not consider tax cuts.
Supplement
Chronology of Abenomics
2012
November 14 Then Prime Minister Noda of the Democratic Party (DP) declared in
the Parliamentary discussion with Mr. Abe, president of LDP that he
would dissolve the House of Representatives in two days, that is, on
November 16.
November 15 Mr. Abe publicly stated that, once the LDP returned to the power, the
government and the BOJ would set an inflation target of 2~3%, and
implement limitless monetary easing.
December 16 In the election on December 16, the LDP had a landslide victory,
gaining 294 seats from the pre-election level of 119, out of the total 480
seats, while the DP suffered a crushing defeat, reducing its seats by
three-fourths from 230 to 57.
December 18 Governor Shirakawa of BOJ visited President Abe in the LDP
headquarters.
December 26 The second Abe administration started and adopted its “Basic Policy” in
the first cabinet meeting, which listed four focused areas (economy,
foreign and security policy, education, and people’s living) in addition to
the recovery from the Great Earthquake and nuclear plant accident, and,
in the area of the economy, stated:
A strong economy is the source of Japan’s strength. Without its revival,
there is no restoration of fiscal soundness nor of Japan’s future.
Through the “three arrows” of bold monetary policy, flexible fiscal
policy, and growth strategy that promote private investment, we
overcome prolonged deflation, and aim to increase employment.
2013
January 11 The government decided on “the Emergency Economic Measures for
the Revival of Japan’s Economy,” with the central government
expenditure amounting to 10.3 trillion yen and the expected impact on
real GDP of about 2%,
January 22 The Cabinet Office, Ministry of Finance, and the Bank of Japan issued a
joint statement on policy coordination between the government and the
BOJ to get out of deflation and achieve sustainable economic growth, in
which the BOJ committed to the establishment of a price stability target
of 2%, in terms of year-on-year change of the CPI and aimed to achieve
this target as soon as possible.
On the same day, the BOJ made public the changes in monetary policy.
March 20 Mr. Haruhiko Kuroda, former president of ADB, became governor of
the BOJ.
336 K. ARAMAKI
April 4 The BOJ introduced the QQE in its first Monetary Policy Committee
meeting after the change of the governor (from Shirakawa to Kuroda)
and deputy governors (new deputies included Professor Iwata of
Gakushuin University, a long-time outspoken critic of the BOJ).
June 14 The government decided on the “Basic Principles for Economic and
Fiscal Management and Reform,” which presents the directions of
economic and fiscal policy management and the basic strategy for
achieving Japan’s revival, including the promotion of the “three arrows”
in an integrated manner.
June 14 The government decided on the “Japan Revitalization Strategy,” which
is composed of three action plans, that is, plans for the revitalization of
Japanese industry, strategic market creation, and a strategy of global
outreach.
August 8 The government approved the medium-term fiscal program, which
includes the following three goals:
To halve the primary balance deficit of central and local governments
combined from the level in FY 2010 (6.6% of GDP) by FY2015;
To change the combined primary balance of central and local
governments into surplus by FY 2020; and
To reduce steadily the debt-to-GDP ratio thereafter.
September 1 The government decided to set up a forum between relevant ministers
and representatives from both companies and employees, so that they
could exchange views and form common understanding necessary to
cope with challenges for achieving virtuous economic cycles.
October 1 The government decided to raise the consumption tax rate from the
current 5% to 8% from April 1, 2014, which is the first increase of the
rate in the last 17 years.
At the same time, the government decided to compile an economic
package to cope with the risk of economic downturn caused by reactionary
fall in demand after the last minute surge before the rate increase.
December 5 The government decided on “The Economic Measures for Realization of
Virtuous Cycles,” with the central government expenditure amounting
to 5.5 trillion yen and the expected impact on real GDP around 1%.
December 20 The forum of ministers and representatives from companies and
employees issued a statement that, under the policy efforts for the
virtuous cycles by the government, companies and employees will, based
on performances of respective companies, let an increase in profits lead
to an increase in wages.
2014
April 1 Consumption tax rate was raised for the first time in 17 years from 5% to 8%.
April 1 Effective corporate tax rate was reduced by 2.4%.
June 24 The revised “Japan Revitalization Strategy” was released (aimed at
reducing effective corporate tax rate to below 30% in a few years,
enhancing corporate governance, enhancing women’s participation,
enabling flexible working practices, attracting foreign talent, reforming
agricultural policy, etc.).
August 13 Real GDP was estimated to have declined from the previous quarter at
an annualized rate of 6.8% in Q2 2014.
October 31 The BOJ announced an expansion of QQE (increase of the targeted
annual increase in base money from the previous 60–70 to 80 trillion
yen, etc.).
November 17 Real GDP was estimated to have declined from the previous quarter at
an annualized rate of 1.6% in Q3 2014.
November 18 Prime Minister Abe announced that the increase in consumption tax
rate, from 8% to 10% scheduled for October 2015, would be postponed
by 18 months to April 2017, and that he would dissolve the lower house
to ask for the people’s judgment on Abenomics.
November 21 The Lower House dissolved (election on December 14, 2014).
December 14 In the general election on December 14, 2014, the LDP won 291 seats,
just 2 seat less than before the election, and the coalition government
with the Komeito, which obtained 35 seats, maintained the
overwhelming majority of 326, which accounts for more than two-thirds
of the total 475 seats.
December 24 The third Abe cabinet was formed.
December 27 The government decided on “The economic package for the spread of
virtuous cycles to local areas” with additional budget expenditure of 3.5
trillion yen and expected contribution to real GDP growth of about
0.7%.
2015
September 24 Prime Minister Abe declared the Abenomics shift to the second stage
and announced new three arrows (targets), that is, strong economy
(GDP of 600 trillion yen targeted), support for child-rearing (desirable
birth rate of 1.8 targeted), and sound social security (no job departure
due to nursing care of elderlies), and a target of maintaining a
population of 100 million half a century into the future.
December 18 The BOJ adopted supplementary measures for the QQE, including some
lengthening of average remaining maturities of JGB purchased.
2016
January 29 The BOJ decided to introduce a negative interest rate of −0.1% to be
applied to part of the outstanding balance of financial institutions’
current account at BOJ (implemented from February 16) and declared
that it would cut the interest rate further if necessary.
June 1 Prime Minister Abe announced that the increase in consumption tax rate
scheduled for April 1, 2017 would be postponed again by 2 years and a
half to October 1, 2019.
August 2 The government adopted “Economic measures for realizing investment
for the future” with additional central government expenditure of 13.5
trillion yen and expected contribution to real GDP growth of about 1.3%.
338 K. ARAMAKI
September 21 The BOJ released the results of the comprehensive assessment of the
developments under “Quantitative and Qualitative Monetary Easing
(QQE)” and “QQE with a Negative Interest Rate,” and a new policy
called “yield curve control” was announced, in which the policy target
was changed from the previous increase in base money to the control of
both short-term and long-term interest rates (as for the short-term
interest rate, a negative interest rate of −0.1% is applied to a part of the
outstanding balance held by financial institutions in the current account
with the BOJ, and as for the long-term interest rate, the BOJ will
purchase JGBs so that 10-year JGB yields will remain more or less at the
current level around 0%).
October 22 In the election of the Lower House, which was called by Prime Minister
Abe on the grounds that he had changed his policy as to how to use
additional revenue arising from the consumption tax increase, the LDP
had a sweeping victory gaining 284 seats, which is well over half of the
total 465 seats.
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Index1
A Assets, changes in size of (mid-1980s),

Abe, Shinzo, 285, 286, 291–293, 335, 235–238
337, 338 Assets of companies, 225–231
Abe administration, ix, 29, 169–171,
286, 335
Abenomics, ix, 3–5, 11, 15–17, 22, B
29–32, 83, 87n3, 102, 198, 212, Balance sheet, vii, viii, 4, 16, 105, 120,
271, 285–335 133, 139, 141, 142, 162, 163,
chronology of, 335–338 166, 174, 201n10, 211, 225,
foreign exchange and stock markets 232, 243, 249, 269
in, 294–334 damages of, 112–116
Agency of the Ministry of Economy, Bank for International Settlements
Trade and Industry, 143n22 (BIS), 141n20
Ahearne, Alan, 199, 200, 203, Banking Bureau, 145, 147,
205–207 148n32
Annual Economic and Fiscal Report, Bank of Finland (BOF), 151
205n12 Bank of Japan (BOJ), 22, 29,
Aoyagi, Chie, 331n25 85, 136, 138, 139, 146–148,
Asset price inflation, 14, 33–35, 60, 204, 288n4, 295, 318n15
83 monetary policy, 199–207
transformation to bubble, QEP, effects of, 211–214
35–41 Basic Land Law, 84
Note: Page numbers followed by ‘n’ refer to notes.

1

362 INDEX
“Basic Policy on Economic and Fiscal Demand factor arguments, 196–197

Management and Reform 2015,” Demand-side factor views, 14, 89,
286, 291 92–94
BOJ economists’ views, 209–210 Democratic Party (DP), 286
Bretton Woods, 1 Deposit Insurance Corporation (DIC),
Bundesbank, 85 133n3
Bust, 114n19 Deposit Insurance Law, 136–138,
136n9, 137n11
Deposit protection, 140n16
C Diffusion index, development in,
Cabinet Office, 324 97–100
Capital-asset ratio, 138n13 Direct disposition, 141, 141n18
Capital injection, 137, 138, 149 Discount rate, 86
Case of Scandinavia, 149 Disposition types, 140n18
Cash flow, 243 Downward adjustment, 16, 24, 50,
China, vi, 5, 6, 8, 9, 9n3, 90, 192, 183, 255
261, 263 of growth expectation, 109–112
ratio for, 5–6
Chinese economy, 2
Collective decision-making system, 140 E
Commercial Law, 143n21 Early Strengthening Law, 138
Consumer Price Index (CPI), 190, Economic cycles, 98
275, 310 “The Economic Measures for
Consumption, 304–305 Realization of Virtuous Cycles,”
Conventional transmission mechanism 290
of monetary policy, 208 “The Emergency Economic Measures
Corporate bankruptcies, 154 for the Revival of Japan’s
Corporate governance system, 140 Economy,” 290
Corporate sector, 148 Emergency Economic Package, 139
CPI, see Consumer Price Index Employment conditions, 163, 165,
Crisis response, vii, 4, 5 257, 330
Crisis Response period, 26 elimination of, 163
Cumulated Diffusion Index, 97, 99, 104 Employment income, 264
Excessive production capacity, 23,
162
D elimination of, 162–163
Danish flexicurity model, 331n25 Exchange traded funds (ETFs), 288
Deceleration process, 154 Expansion phase, 99n9
Defensive behaviors of companies, 167 Export, 304–305
Deflation, 160 price, 266
causes of, 192–198 price index, 260, 261, 261n14
in Japan, causes of, 268–271 External economic environments,
and monetary policy, 189–215 163–166
INDEX 363
F deflator, 191, 191n1, 193–196

Financial crisis, 17, 24n6, 26, 234 gap, 275–276, 323
bank failures, 130 statistics, 112
breakout of, 129–130 GDP growth, 151, 300–301
comprehensive resolution compare with other countries, 88
framework for, 161 compare with past, 87
fundamental changes in, 153–161 Global Financial Crisis (GFC), 2
and its impacts, 102, 103, 129–161 period IV (2008–2012), 175–178
NPL problem, 131–135, 140–153 “Global financial crisis and after,” 102,
NPL problems addressed, 135–140 103
Financial Function Early Government expenditure, 301, 306
Strengthening Law, 138 dependence of growth on, 327–330
Financial institutions, 141n19 Government Guarantee Fund (GGF),
Financial liberalization, 13, 149 151
Financial Reconstruction Government injected funds, 151
Administration (FRA), 138 Government response, 160–161
The Financial Revival Program, 139, Government’s macroeconomic policy,
169 153
Financial sector, 148 Growth strategy, 292–295, 292n8
problem arguments, 197–198
problem views, 15, 89, 95
Financial Statement Statistics of H
Corporations by Industry, 180 Hashimoto (Prime Minister, LDP),
Financial Supervisory Agency (FSA), 148n33
137n12 Hayami (Governor), 199, 205,
Finland, 151 205n11, 205n12, 206, 206n13,
First Abe Administration (September 206n14, 207n16
2006–August 2007), long Hokkaido Takushoku Bank, 18, 130,
recovery period in, 169–171 137
Fiscal Investment and Loan Program
(FILP), 327n24
Fiscal policy, 116–118, 161, 289–292 I
problem with, 93 Import price, 266
Fiscal stimulus, 289–290 Indirect disposition, 140, 141n18
Fixed assets, 227, 228 Industrial Revitalization Corporation,
Foreign direct investment (FDI), 167, 139
168, 227n3 Initial adjustment period, 101–121
Fukuda, Shin-ichi, 297, 298 Insolvent company, 143
Interbank market participants, 130
Interest rates, 200
G Interest-bearing debt, 163–164
Ganelli, Giovanni, 331n25 International Monetary Fund (IMF),
GDP, 322 114n19
364 INDEX
Investment, company profit and, K

310–312 Keynesian economics, 90
Investment restraint Koizumi administration (April 2001–
by companies, 317–324 September 2006), 139
mechanism of, 239–249 long recovery period under,
Iwata, Kikuo, 192 169–171
Kousai, Yutaka, 32n10
Kuroda Bazooka, 287–289
J Kuroda (Governor), 189, 198
Japan, vi, viii, 2, 4–6, 8–10, 12, 13,
18, 19, 23, 29–33, 38, 39, 41,
43, 46, 48, 50, 51, 54, 55, 57, L
59, 60, 62, 64, 66–69, 76, 88, Labor cost, 169
90, 107, 111n16, 112, 119, 121, restraint, 257–263
130, 138, 149, 152, 160, 162, Labor market, 28, 31, 206n12, 257,
175, 189–191, 200, 207, 222, 311–316, 325, 326n23,
238, 255, 257, 258, 261, 262, 331–332n25
277, 291, 298, 299, 318–320, duality of, 325
322, 330 Land price surge, 84
collapse of bubble economy in, Land prices, 114–116, 133
83–121 tax, 86
deflation in, 190–192 Land use regulation, 84
Financial Big Bang, 148n33 Law Concerning Emergency Measures
import penetration, 193 for the Reconstruction of the
Japan Economy Network (JEN), vi Financial Functions, 137
Japanese economy, v, 1, 4, 10, 19, Law Regarding Emergency Measures
171–174, 189, 190, 221, for Financial Stability, 137
257–260, 270 Liabilities, 16, 24, 107, 108, 119,
assessment of abenomics and 151, 162, 164, 176, 215, 222,
challenges for, 315–334 232, 233, 235–239, 242, 244,
Japanese long-term Government 249, 257, 268, 269
Bonds, 29, 72, 210–212, 288, of companies, 225–231
289, 337, 338 Liberal Democratic Party (LDP),
The Japan Institute for Labor 86n2, 139, 286
Policy and Training, Liquid assets, 182, 225–227, 229, 235
326n22 Liquid liabilities, 229, 230
Japanese real estate investment trusts Long recovery period III (2002–
(J-REITs), 288 2007), 5, 11, 16–21, 98,
Japan Revitalization Strategy, 30 101–103, 115, 161–175
“Japan Revitalization Strategy—Japan fundamental changes in, 166–170
is Back,” 292 under the Koizumi Administration
Jinushi, Toshiki, 203 (April 2001–September 2006)
INDEX 365
and the First Abe Negative interest rate, 288

Administration (September Net assets, 235
2006–August 2007), 169–171 Nikkei 225, 297
Long stagnation, viii, 2–4, 14–17, 21, Nikkei Stock Average, 86
83–121 1956 Economic White Paper, 32n10
in Japan, causes of, 268 Nippon Credit Bank (NCB), 130, 138
Long-Term Credit Bank (LTCB), 18, Nishimura, Kiyohiko, 139n15
130, 137, 138, 145n24 Noda (Prime Minister), 294
Losses of companies, 222 Noguchi, Asahi, 195n3
Lost Decades, 103 Nominal GDP, vi, 1, 7, 14, 15, 90–92,
Low-growth expectation, vii–ix, 10, 95, 96, 267, 277, 280
27, 31, 285, 317, 319, 320, 330 in Japan, 90, 91
Nominal wages, 157, 275
Non-performing loan (NPL) problem,
M 18, 131–135
Macroeconomic policy, 53, 55, 58, 60, addressed, 135–140
120, 153, 161, 174, 196, 316 cost of holding in, 141–144
Medium-sized banks, 136 government solving in, 144–153
Ministry of Finance (MOF), 84, 86, methods of disposition of, 140–141
111n16, 136, 137n12, 144–147, private sector to resolve, 140
147n30, 148n33, 152, 180 Non-regular workers, 157–158
Miyao, Ryuzo, 197 Norway, 150
Miyazawa (Prime Minister), 146 NPL, see Non-performing loan
MOF, see Ministry of Finance
Monetary base control, 287
Monetary policy, 85, 94, 117–119, O
161, 287 Oda, Nobuyuki, 210
assessment of, 198–214 Okina, Kunio, 210
conventional transmission “Outline of Emergency Land
mechanism of, 208 Measures,” 84
deflation and, 189–215 “Outlook for Economic Activity and
Mori, Naruki, 200 Prices,” 289, 289n5
Motani, Kosuke, 275–277, 276n18,
318n16
Motonishi, Taizo, 197 P
Passive response, 4
“Passive response period,” 25
N Payoff cost, 136n9
Nakaso, Hiroshi, 129n1, 135, 135n8, Period before the bubble, 149
136n9, 139n15, 147, 148 “Period of crisis response,” 238
Nakasone administration, 12 “Period of passive response,” 238
Nationalization, 138 Period I, 104–106
366 INDEX
Period IV (2008–2012), 20 S
Physical assets, 227n2 “St. Petersburg Action Plan,” 291
ratio of, 240 Sanyo Securities, 129, 137
Population decline, 332 Savings Bank of Finland
“Population statistics data (2017 (SBF), 151
revised version),” 319n17 Second World War, 130
Postwar history, 130 Shimpo, Seiji, 192
Potential growth rate, 324 Shirakawa, Masaaki, 29, 211, 276,
Price, 306–310 277n19, 287n3
Price stability target, 287, 306 Single Open Ended Contract (SOEC),
Primary balance, 291n7 331n25
Private investment, 105–116, 243 Small and medium enterprises (SMEs),
growth contribution of, 97–98 143, 155
Profits of companies, 222–224 Small-sized banks, 136
Public funds, 139 Stagnation of wages, 143
Stagnation period, 14, 83, 96, 101
characteristics of, 96–97
Q Stagnation, three stages mechanism of,
QQE, see Quantitative and Qualitative 271–274
Monetary Easing Stock adjustments, 16, 106–109, 111,
“QQE with a Negative Interest Rate,” 162, 241, 269
289 Stock price, 30, 34, 39–41, 79, 85,
“QQE with yield curve control,” 289 104, 112, 133, 139n15, 141n20,
Quantitative and Qualitative Monetary 147, 201, 295–298, 300, 311,
Easing (QQE), 29, 189, 288, 289 315
adoption of, 198–199 Supply-side
Quantitative easing policy (QEP), 189 factor, 14
by BOJ, 210–211 views, 89–93
Quantity theory of money, 196n4 “Sustained defensiveness,” 5
“Sustained defensiveness period,” 26
Sweden, 151
R
Reagan administration, 12
Real economy, 211, 317, 3258 T
abenomics and, 298–315 Takenaka Plan, 169
Reconstruction Law, 137, 138 Taxation areas, 84
Resona Bank, 139n15 Taylor rule, 200, 202, 203
Resona Group, 139 Terms of trade, 261, 266, 267
Return on asset (ROA), 27n8, 131, “Three arrows,” 29
132, 252, 252n11 “Three excesses” argument, 162
INDEX 367
Tochi Shinwa, 148 W

Tokuyo City Bank, 130, 137 Wage restraint, 263–267, 324–325
Tokyo, 11 mechanism of, 249–258
Tokyo Kyodo Bank (TKB), 136 “Work style reform,” 326n23
Total asset turnover ratio, 239n6 World War II, 130
Total fertility rate, 318
Trade dependency, 172
The true origin of deflation, 275 Y
Yamaguchi, Yutaka, 207
Yamaichi Securities, 130, 137
U Yen-dollar rate, 294
Unemployment rate, 88–89, 99–100, Yield curve control, 289
155–157, 257 Yoshikawa, Hiroshi, 197, 197n5
USA, 1, 5, 6, 9n3, 12, 43, 44, 46, Yoshimasa Nishimura, 86n2
47n12, 48, 50–52, 55, 56,
60, 62, 64, 69n27, 73, 75,
76, 120, 141n20, 200, Z
277 Zero interest rate, 208–209
economy recovered, 2 Zero interest rate policy (ZIRP), 22
government, 9 Zombie company, 142

Japan's Long Stagnation, Deflation, and Abenomics

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What is the book about?

What is the book about?

What period of the Japanese economy does the book cover?

What period of the Japanese economy does the book cover?

KENJI ARAMAKI

ISBN 978-981-13-2175-7 ISBN 978-981-13-2176-4 (eBook)

Library of Congress Control Number: 2018953058

© The Editor(s) (if applicable) and The Author(s) 2018

Cover Image: © 2nix / Getty Images

Nishikawa (Associate Professor, Yokohama National University) who

Tokyo, Japan Kenji Aramaki

1 Introduction: Objectives and Main Arguments of the Book 1

2 Formation of a Bubble and Its Background 33

3 Collapse of the Bubble and the Start of the Long

4 The Financial Crisis and Its Impacts, Long Recovery, and

5 Deflation and Monetary Policy189

6 Deflation and the Mechanism of Corporate Behavior221

7 Abenomics and Challenges for the Japanese Economy285

Fig. 1.1 Total credit to private nonfinancial sector (in percent of

Fig. 2.12 General government fiscal balance (GDP ratio): Japan

Fig. 3.12 Cumulated Diffusion Index 104

Fig. 4.13 Nominal wages (year-on-year change, three-year moving

Fig. 6.41 Developments in terms of trade (output deflator and input

Fig. 7.17 Consumer Price Index (excluding fresh food) (year-on-year

Table 3.5 Contribution to GDP growth by major demand components

Introduction: Objectives and Main

1 Objectives and Main Arguments of the Book

© The Author(s) 2018 1

• What impacts did the financial crisis have on the economy?

The ultimate objective is to understand the mechanism of long stagnation

abrupt nature to the one with a perpetual or structural nature through

The analyses of company behaviors are mainly conducted in Chap. 6,

c­ompanies, which became conspicuous in the period of crisis response,

2 Chapter 2: Formation of a Bubble and Its

3 Chapter 3: Collapse of the Bubble and the Start

Chapter 3 first provides an overview of the collapse of the bubble and

economic cycles, growth rate, private investment, and unemployment

Period I (1991–1997): “Initial adjustment” period, starting from the col-

Chapter 3 examines Period I (initial adjustment). The growth rate

4 Chapter 4: The Financial Crisis and Its Impacts,

work as had been introduced in 1997–1998 (in the absence of a compre-

dependence on foreign demand, coupled with the increased external

5 Chapter 5: Deflation and Monetary Policy

ply-side factors contributed to the price decline. However, considering

6 Chapter 6: Deflation and the Mechanism of

A very significant change is observed with regard to net assets. While

­ownward pressures on consumption (through wage restraint) and

the defensive mindset (a way of thinking that has become a common

7 Chapter 7: Abenomics and Challenges for the

and deposit holdings by companies have also been recording historic

incomes will steadily grow.10 To realize such expectations, it is necessary to

Formation of a Bubble and Its Background

Japan experienced a formation of a huge bubble in the 1980s, which

1 Formation of a Bubble in the 1980s

Asset Price Inflation and Subsequent Fall

© The Author(s) 2018 33

Transformation of the Asset Price Inflation to a Bubble

 efinition of an Asset Price Bubble

discounted p ­ resent value of future returns to the asset and is expressed as

where R = return (office or housing rent, interest, etc.) to an asset, P =

Tokyo, Japan Kenji Aramaki

1 Introduction: Objectives and Main Arguments of the Book 1

2 Formation of a Bubble and Its Background 33

3 Collapse of the Bubble and the Start of the Long

4 The Financial Crisis and Its Impacts, Long Recovery, and

5 Deflation and Monetary Policy189

6 Deflation and the Mechanism of Corporate Behavior221

7 Abenomics and Challenges for the Japanese Economy285

Fig. 3.12 Cumulated Diffusion Index 104

companies, which became conspicuous in the period of crisis response,

ownward pressures on consumption (through wage restraint) and

efinition of an Asset Price Bubble

discounted p resent value of future returns to the asset and is expressed as

heoretical and Actual Price of Land

S pillovers of Land Price Increase

heoretical and Actual Price of Stocks

implied that real estate-related projects were actively undertaken by non-