Causes of The Japanese Recession 1900s and The Global Financial Crisis 2007

Causes of The Japanese Recession 1990s and Global Financial Crisis 2007

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The Japanese recession of 1990 and the Global Financial Crisis between 2007 to 2012 were considered a pivotal point in economic history. These two economic calamities were considered defining moments in modern economics that changed how economists looked at the modern world economy. Comparing and analysing these two events simultaneously allows us to understand how similar or different the effects and consequences these bore on the world even though they are separated by a decade.

Japan’s economic recession also known as the “Lost Decade” lasted from 1990 to 2001 and saw a significant decline in Japan’s economy. “The most widely cited explanation is the collapse of asset prices in the early 1990s, which has been associated with reduced business and consumer confidence, declines in household wealth, corporate financial weakness, and severe non-performing loan problems at banks.” (Brunner, 1996)

In comparison, The Global Financial Crisis starting in mid-2007 was deemed to be the worst economic disorder the world has witnessed for well over six decades. The debris of this economic collapse spread far beyond where it started. These severe characteristics of the 2007 crisis led economists to name it the ‘Great Recession’. “What started as seemingly isolated turbulence in the sub-prime segment of the US housing market mutated into a fullblown recession by the end of 2007.” (Verick, 2010)

Both economic calamities have played a major role in changing the course of economic study and forcing contemporary economists to study economics from a different perspective. However, this paper will focus on analysing and contrasting the causes that led to these two great economic crises and try to figure out any common ground, if any, that we can find.

Causes of The Japanese Recession 1990

The Japanese Recession of 1990 was a demand-led inflationary distress in Japan’s economy. It is also referred to as the ‘Bubble Economy’ because of the burst in the prices of 3 assets, such as land or real estate in Tokyo. Moreover, the increase in stock prices, with the Nikkei Stock Market reaching record high prices.

The Japanese economy in the 1980s was going through a period of economic growth, approximately at around four percent. “Indeed, the economy was growing at a rate exceeding four per cent, and accel-erating toward the end of the 1980s. The stock prices and land prices started torise sharply at around 1984, and continued their increase toward the 1990s. The consumer price inflation stayed moderate until 1988. Even in 1989, when the prices started to rise, the inflation rate was below three per cent. Accelerating economic growth with moderate inflation, accompanied by rising asset prices, looked great at the time.” (Ito, 2003)

The problem arose when the prices started to increase even further, especially that of real estate and stock shares. These higher returns attracted investors who were more than eager to get a prosperous return. This was also supported by the loose monetary policy held by The Bank of Japan which kept the interest rate low, encouraging borrowing and further attracted the domestic as well as the foreign investors. The prices rose further creating an illusion among investors of their wealth as their asset prices went sky-high. Soon, the government realized this and started tightening up its monetary policy to cool down the overheated economy. This led to a sudden decline in the prices of the assets, causing the illusion to be over and a rapid decrease in stock prices and real estate value, incurring enormous financial economic distress, a severe period of economic stagnation, and severe economic instability.

Now that the main dilemma has been addressed, this essay digs even further down to understand the policies that triggered the economic calamity even further. Firstly, to place all the blame for the “Lost Decade” on the bubble economy would be a bizarre statement. By the late 1990s, the stock prices as well as the land prices were declining compared to the peak.

Moreover, it was more than clear that non-performing loans, a phenomenon adopted by the Japanese government to regard some loans as non-performing, particularly to those people who had difficulty repaying their debt due to the financial strain they incurred, were not working. This phenomenon hit the government when the bank incurred most of the financial burden and ran into a credit crunch and financial instability, some even went to the extent that they no longer had the financial means to sustain the bank hence relying on the central bank. To view it from a different perspective, the blame is placed upon the Japanese government for 1) creating policies that further triggered the economic crisis, for example, the loose monetary policy behavior held by The Bank of Japan led to an increase in the money supply and credit which encouraged massive borrowing by the household and the foreign investors, this increase in money supply also led to further inflation. “During the bubble period, not only bank borrowing but also financing from capital markets substantially increased against the backdrop of the progress of financial deregulation and the increase in stock prices (Figure 8). As a result, the funding of the corporate and household sectors (the sum of bank borrowing, straight corporate bonds, convertible bonds, bonds with warrants, and equity increase) rapidly increased from around 1988 and recorded a rate of growth close to 14 percent on a year-on-year basis in 1989” (Kunio Okina, 2001) and 2) delaying in changing or correcting the policies to gain some sustainability. Blunders were made on the monetarypolicy side of the Japanese government for a decade which led to the continued decline in the economic revival of Japan.

Causes of Global Financial Crisis (GFC) 2007

The main cause of GFC 2007 had to some extent similar economic characteristics to that of The Japanese Recession of 1990. The housing market bubble and the lending of subprime mortgages were considered critical elements of the GFC 2007. Economists put the burden on the loose monetary policy initiative by the US government, 5 which includes low-interest rates, and easing in lending criteria meaning allowing lower credit individuals to qualify for loans. This causes an increase in money supply, and an increase in aggregate expenditure, especially investments in housing and real estate. This again led to the prices of housing reaching record highs and attracting more borrowing and investment. An illusion of wealth was created as the assets were increasing in value and continuing to expand the bubble. When the bubble burst it led to a sharp decline in property values and caused many borrowers to go bankrupt on their mortgages. Another questionable policy was the lending of subprime mortgages. Subprime mortgages are loans issued to borrowers with low credit scores, explaining they have a bad financial history regarding repaying their loans. These mortgages are usually at comparatively higher interest rates. Moreover, securitization of mortgages, which is bundling up mortgages and selling to investors to spread the risk and increase liquidity, also had a significant role in creating the housing bubble. These policy initiatives allowed more individuals to qualify for mortgages and invest in homes, boosting the housing market.. However, when the bubble burst many individuals were unable to pay higher interest rates on their mortgages and defaulted, causing a severe decline in the house market.

Again, to blame the GFC 2007 crisis on the burst of house market bubble would be an unfair statement. There is no doubt in stating that the points mentioned above had a major impact in creating the GFC 2007 but there are factors contributing to the spreading of it.

Firstly, it was the complex nature of the crisis, which never allowed parties involved in transactions to fully understand the nature of the boom. Economists and the US government went on with their loose monetary policy until the collapse took place. Moreover, as the crises initiated by the US housing market, a very broad and interconnected market with other countries deeply invested in the US economy. It was inevitable that the consequences of this financial crisis had to spread far beyond the US geographical territory. The market globalization of US financial markets had to take this crisis to a global level.

Conclusion

This has dug deep down to understand the two phenomena of world economic crisis. However, these two pivotal economic crises were in different timelines of history. The major economic failure to trigger the economic crisis was to some extent similar. We have studied and learned that both crises were due to a bubble burst, one in the US housing markets, while the other in stock and real estate prices in Japan. Both had a similar instance in which the loose monetary policy held by the central bank led to an increase in a sudden boom in the dedicated markets and later the tightening up of the monetary policy to give a sudden shock with a severe decline leading to a collapse in the economy. One adopted the phenomenon of non-performing loans while the other promoted the use of subprime mortgages. Both misunderstanding the true nature of the boom, triggered the crisis even further with their unaware economic policies. It is hence to one knowledge that although these crises had distinct origins, but they do share common ground. One could only understand the fragile nature of the world economy and study these historical events to refine strategies and sustain the future world economy.

References

Brunner, A.D. and Kamin, S.B., 1996. Determinants of the 1991–1993 Japanese recession: Evidence from a structural model of the Japanese economy. Japan and the World Economy, 8(4), pp.363-399.

Verick, S. and Islam, I., 2010. The great recession of 2008-2009: causes, consequences and policy responses.

Ito, T., 2003. Retrospective on the Bubble Period and Its Relationship to Developments in the 1990s. World Economy, 26(3), pp.283-300.

Okina, K., Shirakawa, M. and Shiratsuka, S., 2001. The asset price bubble and monetary policy: Japan’s experience in the late 1980s and the lessons. Monetary and Economic Studies (special edition), 19(2), pp.395-450.