1. March 26, 2007Japanese Economy1 The Japanese Economy: Macroeconomic Overview Presentation prepared for International Finance course at GSIS, Ewha Women’s University Takeo Hoshi Graduate School of International Relations and Pacific Studies University of California, San Diego, NBER, and TCER

2. March 26, 2007Japanese Economy2 Outline 1. Trouble in the 1990s to the early 2000s 2. Recovery from 2003 3. Remaining problems?

3. March 26, 2007Japanese Economy3 GDP Growth (68SNA): 1956-2000

4. March 26, 2007Japanese Economy4 GDP Growth:1995-2006 (93SNA, SA, Chained)

5. March 26, 2007Japanese Economy5 Unemployment Rate (%, SA)

6. March 26, 2007Japanese Economy6 Industrial Production (SA, 2000=100)

7. March 26, 2007Japanese Economy7 Aggregate demand or aggregate supply Economic growth can slow down or economy can get into recession when: 1. Aggregate demand stops growing or falls 2. Productive capacity does not grow or falls Demand factor was more important for Japanese recession Deflation suggests there was not enough demand

8. March 26, 2007Japanese Economy8 Inflation Rate (GDP Deflator, Chained)

9. March 26, 2007Japanese Economy9 Inflation Rate (CPI)

10. March 26, 2007Japanese Economy10 Non-Performing Loans (Risk Management Loans): 1996-2006 (100 million yen)

11. March 26, 2007Japanese Economy11 Trouble originally started with the collapse of asset prices Stock prices peaked at the end of 1989 Land prices peaked in 1991 Looking back, people refer to the late 1980s as the bubble economy

12. March 26, 2007Japanese Economy12 Nikkei 225: 1980-2007 (yen)

13. March 26, 2007Japanese Economy13 Land Price Index:1980-2006 (March 2000 = 100)

14. March 26, 2007Japanese Economy14 Recovery 2002 1st quarter 2003 4th quarter 2006 4th quarter GDP growth-3.3%3.6%2.5% Inflation rate (GDP)-1.2%-1.5%-0.5% CPI Inflation-1.2%-0.4%0.3% Unemployment rate5.3%4.9%4.0%

15. March 26, 2007Japanese Economy15 Economic Recovery Started in 2003 Growing economy, lower unemployment, deflation ending? Stock market has been recovering Land prices have started to rise in large cities

16. March 26, 2007Japanese Economy16 Recovery in Land Prices

17. March 26, 2007Japanese Economy17 But, we saw recovery before … (GDP growth figure again)

18. March 26, 2007Japanese Economy18 Fiscal policy mistake in 1997

19. March 26, 2007Japanese Economy19 Monetary policy mistake in 2000

20. March 26, 2007Japanese Economy20 Will a policy mistake happen again? Budget deficits cut in FY2005-2007 FY2003¥36.4 trillion (7.3% of GDP) FY2004¥36.6 trillion (7.3% of GDP) FY2005¥34.4 trillion (6.8% of GDP) FY2006¥30.0 trillion (6.0% of GDP) FY2007¥25.4 trillion (5.0% of GDP) Is this expansionary enough?

21. March 26, 2007Japanese Economy21 Monetary Policy: End of ZIRP 3/9/2006End of quantitative easing: change the target from CAB (current account balance) to call rate. Target call rate stays at 0%. 7/14/2006End of ZIRP: raise the target call rate to 0.25%. 2/21/2007Raised the target call rate to 0.50%. Another premature tightening?

22. March 26, 2007Japanese Economy22 Supply side constraint Even if the BOJ can get away with the mistake this time, the supply side can become a serious constraint on the economic growth End of deflation suggests the increasing importance of the supply side factors

23. March 26, 2007Japanese Economy23 Improving TFP will be more important for the sustained growth TFP growth estimated by Hayashi and Prescott (2002) “The 1990s in Japan: A Lost Decade,” Review of Economic Dynamics 5, 206-235. PeriodTFP growth 1960-19736.5% 1973-19830.8% 1983-19913.7% 1991-20000.5%

24. March 26, 2007Japanese Economy24 Why has TFP growth been low in Japan? May be related to the bad loans problem Rather than writing off non-performing loans, Japanese banks tend to “ever-green” many of them (political pressure? To avoid intervention by FSA? Costly side of the main bank system?) Peek and Rosengren (2005, AER) report some statistical evidence for “ever-greening” (the main banks are more likely to lend to firms with deteriorating health) Banks also extend interest concession and other helps to troubled borrowers

25. March 26, 2007Japanese Economy25 Ever-greening creates zombie firms

26. March 26, 2007Japanese Economy26 Example of a “zombie firm”: Shikisai Shikisai: Hot spring resort at Nikko Planned in 1980s and opened in 1996 One of the largest borrowers of Ashikaga Bank (failed in late 2003) Revenue a half of what was initially planned Restructuring under Ashikaga’s help since 1999 Restructuring plans continue to be too optimistic (Shikisai ’ s manager) “ concedes that the last one was too optimistic, since it was based on occupancy estimates of 2.7 guests per suite per night, even though each suite has only two single beds ” (Phred Dvorak “Many ailing banks in Japan lean on old friends for help” Wall Street Journal, 12/5/02)

27. March 26, 2007Japanese Economy27 Zombie firms and (lack of) restructuring Ever-greening of non-performing loans hurts the process of “creative destruction” (important driver of productivity growth) in a couple of ways 1. Keeps the resources in zombie firms and reduces the amount of resources available for potential new entrants 2. Zombie firms distort the competition (by charging low prices and paying high wages), which reduces the expected profits for new entrants

28. March 26, 2007Japanese Economy28 Ever-greening may be finally declining

29. March 26, 2007Japanese Economy29 Non-Performing Loans at major banks declined drastically

30. March 26, 2007Japanese Economy30 Factors of Changes in NPLs (Definition based on the Financial Revitalization Act): 2003-2006 (trillion yen) March 2003 March 2004 March 2005 March 2006 Total Changes in NPL (FRA definition) -7.9-8.7 -4.6-29.9 New NPL+8.7+6.3+5.2+3.4+23.6 Improved to “Normal” -2.3-3.8-3.4-1.5-11.0 Repayment, etc.-0.7-1.7-1.9-0.7-5.0 Write-offs (including sales) -13.6-9.5-8.7-5.9-37.7

31. March 26, 2007Japanese Economy31 Corporate Restructuring by IRCJ Buys NPLs from non-main banks (Had ¥10 trillion to buy NPLs by the end of March 2005) Works with the main bank to reorganize the poorly performing customer to restore its health Sell the non-main bank debt to new sponsors, who are involved in the reorganization process IRCJ selected 41 troubled companies to work on (Spent only ¥1 trillion) Successfully finished its mission and is disbanding at the end of March, 2007, one year earlier than the original plan

32. March 26, 2007Japanese Economy32 Conclusions Japanese economy is recovering Bank of Japan may be getting away with premature tightening this time If the demand side recovers, the supply side constraint becomes binding Ever-greening may be finally declining