- Aug. 22, 2019
- Aug. 21, 2019
- Aug. 21, 2019
Home > Research and Studies > Bank of Japan Working Paper Series, Review Series, and Research Laboratory Series > Bank of Japan Working Paper Series 2000 > Understanding Japan's Financial and Economic Developments Since Autumn 1997
Views expressed in Working Paper Series are those of authors and do not necessarily reflect those of the Bank of Japan or Research and Statistics Department.
Questions and opinions on the working paper should be e-mailed to each author whose address is indicated in the document.
Click on cwp00e01.pdf (355KB) to download the full text.
Japan's economy underwent an extremely severe recession. The real GDP recorded negative growth for five consecutive quarters, from the fourth quarter of 1997 on a quarter-to-quarter basis. Currently, Japan's economy is starting to pick up owing to positive effects from monetary and fiscal policies, and the recovery in the global economy, especially in Asia. This recession, however, turned out to be the worst ever experienced by Japan in the postwar era. Even at present, clear signs of a self-sustaining recovery in private demand have not been observed yet. These economic developments may be largely influenced by the disturbance in the financial system that occurred reflecting the failures of large financial institutions from autumn 1997. As a result, several unusual phenomena have been seen in the business cycle.
During the depressed phase of the economy from the end of 1997 for instance, business fixed investment declined substantially, especially in small firms reflecting a decrease in the lending ability of private banks. Paradoxically, however, the growth in money (particularly the monetary base) rather accelerated against the depressed real economy. On the other hand, the growth in money now seems to be slowing down gradually, while improvements are being observed in the economy such as the recovery in industrial production and the improvement in corporate sentiment. Thus, the relationship between the growth in money and the economy in the past two years looks different from what orthodox economic theory tells us. The savings rate of households, which is usually stable, has shown substantial fluctuations due to both mounting and easing of anxieties over the stability of the financial system. This has also been a characteristic of these two years. Furthermore, although this may be a favorable miscalculation, prices are recently starting to stop falling despite a seemingly substantial expansion in the output gap and a decline in wages.
In the financial market, various risk premiums expanded from the autumn of 1997 and remained large throughout 1998. The overnight call rate and the interest rates on term instruments such as the three-month Euro-yen detached substantially. Yield differentials between government bonds and corporate bonds, and yield differentials among corporate bonds across different ratings expanded, as well as the so-called Japan premium. By contrast, these risk premiums have contracted to a certain extent since the spring of 1999. Moreover, an unpredictable phenomenon has occurred within the interbank market: while the Bank of Japan has adopted the exceptional "zero interest rate policy," funds supplied by the Bank are not maintained as bank reserves, but are being accumulated as on-hand funds of tanshi companies (money market broker-cum-dealers).
These financial and economic developments in the past two years indicate that various events have occurred that cannot be easily understood by past experiences or by standard economic theory seen in textbooks. In addition, it seems that there is insufficient understanding of the much stronger interaction between financial and real economic developments in the past two years, thereby confusing discussions regarding monetary policy.
In these circumstances, it is very useful to review the financial and economic developments since the autumn of 1997, and examine the various events through empirical analysis and economic theory. By doing so, it may enhance understanding on how the financial system shock has influenced Japan's economy and what is happening at present. In this paper, we will first review chronologically the financial and economic developments in Japan during the past two years. Then, relying on empirical analyses conducted by staff members of the Research and Statistics Department, we will discuss the following two topics: (i) the relationship between money and the economy; and (ii) the relationship between the output gap and prices.
The outlines of this paper are as follows: