Learning the Lessons of Japan’s Bubble and “Lost Decade” By Vivien Ng, MBA ‘09 The Program on Alternative Investments of the Center on Japanese Economy and Business and the Weatherhead East Asian Institute of Columbia University cosponsored the symposium “Lessons From the Japanese Bubble For the U.S.” on November 19, 2008. Two hundred and sixty people attended to hear from three distinguished speakers on how the United States can learn from Japan’s bubble experience and avoid its own “lost decade.” The speakers were Takeo Hoshi, Pacific Economic Cooperation Professor of International Economic Relations, University of California, San Diego; Paul Sheard, former Global Chief Economist, Lehman Brothers, and now Global Chief Economist and Head of Economic Research, Nomura Securities; and Michael Woodford, John Bates Clark Professor of Political Economy, Columbia University. David Weinstein, Carl S. Shoup Professor of the Japanese Economy, Columbia University, served as the moderator. Professor Hoshi spoke first and addressed the myth that the Japanese government did nothing to respond to the collapse of the asset price bubble and the subsequent financial crisis. He said that, in fact, the Japanese government’s response was quite similar to the current U.S. government's approach—both began by purchasing the bad assets and then injected equity into the banks. The main difference is that the U.S. government has acted much quicker. Professor Hoshi identified several lessons for the U.S. to learn from Japan. First, there was insufficient recapitalization of the banks in Japan. It started out with a “half-hearted recapitalization” in 1998 of 1.8 trillion yen, followed by 8.6 trillion yen in 1999, which was still insufficient. These small and repeated recapitalizations only eased the capital shortage temporarily and a much bigger injection was actually needed. He added that the Japanese government failed to assess the viability of banks receiving government funds. Certain banks that were recapitalized eventually failed. Finally, the Japanese government “went too far” in requiring that recapitalized banks continued to lend to small and medium sized firms that were not viable. Mr. Sheard said Japanese policy makers should have reacted to the crisis aggressively and pursued more coordinated monetary and fiscal policies. He highlighted Japan’s policy of delay and forbearance in the hope the financial crisis would recover on its own. There was “extreme reluctance to commit and then use public funds.” The U.S. government seems to have learned from these mistakes, according to Mr. Sheard. On the other hand, he said Japan did finally attack the underlying problem and there is uncertainty as to whether the United States has accomplished this yet. Finally, he noted that the U.S. government needs a long-term game plan—an exit and correction strategy after the financial system becomes socialized. Professor Woodford discussed the importance of signaling with respect to the future path of interest rates. He argued that when the Bank of Japan (BOJ) first adopted the unconventional Zero Interest Rate Policy (ZIRP) in 1999, it failed to signal a commitment to keep the ZIRP, which hampered the effectiveness of the policy and allowed deflation to persist. In 2001, the BOJ introduced a policy of quantitative easing that dramatically increased the monetary base and committed to ZIRP as long as deflation continued. This led to mild recovery and ZIRP was abandoned in 2006. Professor Woodford emphasized that the BOJ should have made a commitment to reflation as part of the conditions under which the BOJ would end the accommodative policy. An important lesson for the United States is that for monetary policy signaling to be effective, the termination conditions must specify a target amount of reflation to allay fears of ongoing inflation, Mr. Woodford said. If the United States learns from Japan’s lessons, the speakers expressed optimism that the current U.S. crisis would last for a shorter period. The length of the current U.S. crisis will depend on the response to policies, sufficient policy signaling, and aggressive, committed efforts. Mr. Sheard ventured, “One Japanese year is equivalent to one U.S. quarter” due to the intense mark-to-market pressures in the United States that forced markets to deal with the problem sooner. Thus, the question of when the U.S. economy will recover just depends on when the financial crisis actually started – in 2006 or 2008.