Current Confusion in Japan's Economic Policy

Takahiro MIYAO (Professor, GLOCOM)

This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on October 8, 2002: posted here with the author's permission.

As an economist, I feel obliged to comment on the current confusion in Japan's economic policy. Why should the implementation of the pay-off system be postponed, when the accelerated disposition of bad loans with the injection of public funds is supposed to strengthen the financial system? Why should an additional anti-deflation policy package be adopted, when the elimination of bad loans is expected to increase bank loans.

The answer is that, in my view, there is a fundamental misunderstanding of the cause and the effect of Japan's economic crisis on the part of Prime Minister Junichiro Koizumi and Finance Minister Heizo Takenaka, who mistakenly regard the very existence of bad loans as the cause of economic stagnation and deflation in Japan. The fact is that the cause is the unexpectedly sharp decline in the values of real estate and stocks since the early 1990s, which has destroyed the balance sheets of most corporations and financial institutions and resulted in bad loans in the banking sector. In other words, the cause is asset deflation and the effect is bad loans. Without understanding this fact, Takenaka and his camp are trying to accelerate the direct disposition of bad loans, which would inevitably lead to a sharp increase in corporate bankruptcies and unemployment and acceleration of asset deflation, most likely resulting in an increase, rather than a decrease in the amount of bad loans even with the injection of public funds into the banking sector. Postponement of the pay-off system and adoption of an anti-deflation policy might mitigate the bad effect of this mistaken policy, but could not correct it.

What should be done is quite clear, once we correctly grasp the cause and the effect of Japan's economic problem. Public funds should be used to revitalize the real estate and stock markets, for example, by eliminating most taxes on those key assets, rather than to boost banks' capital without any real effect. At the same time, the government and the Bank of Japan should make it clear that they are determined to stop asset deflation and take all possible measures to turn the prices of real estate and stocks around. In other words, an "asset inflation target," rather than a general inflation target, should be set and observed by all policy makers. Once real estate and stock prices start recovering, corporations, banks, as well as consumers, will regain their vitality and willingly dispose of bad assets and bad loans without government intervention. Then we could implement the pay-off system without delay and do away with wasteful public spending. Just as in the U.S. in the 1990s, we would be able to achieve both structural reform and economic recovery in Japan, given that the real estate and stock markets are back on the right track. I hope that Koizumi and Takenaka are wise enough to catch this important message, at least from the market, if not from me.

For the past discussion on this issue, see the following:

Takahiro Miyao "Debate on Deflation in Japan: Moderator's Summary and Comments"
(http://www.glocom.org/debates/200203_miyao_sum/)

Takahiro Miyao "Japan's Economic Problems: Diagnosis and Prescriptions"
(http://www.glocom.org/debates/20020517_miyao_japan/)