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Productivity Slowdown in Japan's Lost Decades

: How Much of It Can Be Attributed to Damaged Balance Sheets?

March 22, 2016
Ichiro Muto*
Nao Sudo**
Shunichi Yoneyama***

Abstract

There are two opposing views on the cause of Japan's lost decades, which started in the early 1990s. One view argues that the lost decades were caused by a slowdown of total factor productivity (TFP) growth. The pioneering work by Hayashi and Prescott (2002) has shown that a standard growth model with the TFP decline accounts for the output slump during the lost decades. The other view emphasizes the role of damaged balance sheets of non-financial firms and financial intermediaries (FIs) due to two financial crises: the bubble burst in the early 1990s, and the banking crisis in the late 1990s. In this paper, we reconcile the two views. We construct a New Keynesian model that consists of balance sheets of non-financial firms and FIs, and estimate the model using Japanese data. We find that adverse shocks to balance sheets, in particular those to FI balance sheets, played a quantitatively significant role in lowering TFP. Based on our estimates, the average annual TFP growth rate during the 1990s would have been about twice as high as the actual TFP growth rate if these shocks had not occurred. We also find that shocks to FI balance sheets affected TFP mostly by exacerbating the inefficient allocation of production inputs in the goods-producing sector rather than by increasing the costs associated with financial intermediation.

JEL Classifications
E20, E51

Keywords
Lost Decades; Total Factor Productivity; Balance Sheet Problem

*Monetary Affairs Department, Bank of Japan
E-mail : ichirou.mutou@boj.or.jp
**Financial System and Bank Examination Department, Bank of Japan
E-mail : nao.sudou@boj.or.jp
***Personnel and Corporate Affairs Department, Bank of Japan
E-mail : shunichi.yoneyama@bc.edu

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