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Distortions in Resource Allocation and Bank Lending:

The Malfunction of Financial Intermediation

March 2007
Akira Otani*1
Shigenori Shiratsuka*2
Takeshi Yamada*3

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Abstract

In this paper, we empirically analyze the interaction between the distortions in the real side of the economy (real distortion) and those in the financial side of the economy (financial distortion) in Japan after the 1990s. We focus on protracted economic stagnation after the bursting of the asset price bubble, and the subsequent recovery in economic activity and restoration of financial system stability. We use the intersectoral differences in relative factor prices as an indicator for the real distortion, and use the gap between the actual and benchmark loan portfolios, based on the mean-variance approach to maximize risk adjusted returns from loan portfolios, as an indicator for financial distortion. We show that both distortions sharply deteriorated in the late 1990s and improved in the 2000s. In addition, we conduct panel data analyses using data at individual bank level as well as at industry level to examine the interaction between the two distortions: the interaction was negative in the late 1990s, but reversed to positive in the 2000s.

Key Words:
Efficiency in Resource Allocation, Interaction between Real and Financial Distortions, Mean-Variance Approach

JEL Classification Code: G21, G28, O47

The authors thank Kazuhito Ikeo, Kunio Okina, Masaaki Shirakawa, and staff of the Financial Systems and Bank Examination Department, Monetary Affairs Department, Research and Statistics Department, and Institute for Monetary and Economic Studies, Bank of Japan, for their helpful comments, and Mitsuru Katagiri, Yuko Suda, and Ryoko Tsurui for their helpful assistance. The views expressed in this paper are those of the authors and do not necessarily reflect the official views of the Bank of Japan or the Financial Systems and Bank Examination Department.

  • *1 Financial Analysis and Research, Financial Systems and Bank Examination Department, Bank of Japan (e-mail:akira.ootani@boj.or.jp)
  • *2 Financial Analysis and Research, Financial Systems and Bank Examination Department, Bank of Japan (e-mail:shigenori.shiratsuka@boj.or.jp)
  • *3 Financial Analysis and Research, Financial Systems and Bank Examination Department, Bank of Japan (e-mail:takeshi.yamada@boj.or.jp)

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