ABSTRACT

Just as rampant speculation in assets, excess liquidity and high financial leverage ratios generated the US stock bubble of 1929 so too did similar forces drive up stock and real estate prices in Japan in the mid-1980s. Asset prices became unsustainable and eventually collapsed-suffocating the real economy in its path. The huge fall in the Dow of 89 per cent by 1932 can be compared to the 80 per cent fall in the Nikkei by 2003. Interlocking relationships between Japanese companies only complicated the downward spiral of asset prices and economic activity. Japan experienced serious unemployment problems for the first time since the Second World War. In fact, the implosion of asset and money markets sent shock waves throughout the labour and goods markets albeit with lags. A loss of confidence in the financial sector spread throughout the real economy via lending contraction and an aversion to risk. Japan’s policy response was first one of wait and delay, then astonishment as ‘flagship’ bankruptcies mounted. The intermittent application of traditional monetary and fiscal initiatives failed to offset a prolonged collapse in aggregate demand. Such traditional strategies failed to stimulate economic recovery. Relying on the old strategy of the US locomotive to pull Japan out of recession via export-led growth no longer proved to be effective. This chapter outlines the root causes of Japan’s prolonged recession and why policy responses have failed to date. It also examines why the stock market imploded year after year. And what of the Japanese Model? Is it not relevant anymore? What of Krugman’s ideas-are they that radical? There are also lessons for the rest of Asia.