The Economics of Japan’s Lost Decade

Here’s an excellent piece of research from Tanweer Akram of ING discussing the economics of Japan over the course of their continuing balance sheet recession.

I pulled some of the highlights from the report that I thought might look familiar.  Notably, Japan’s sectoral balances and the lack of impact of monetary policy and increasing central bank balance sheets:

“As shown in Figure 28, the Bank of Japan’s balance sheet had been bloated even before the 2008 global recession forced central banks the world over to expand theirs. However, despite years of an expanding monetary base — and contrary to monetarist mantras — Japan remains mired in deflation (see Figures 29 and 30). Japan’s experience since the turn of the century validates the contemporary understanding of monetary policy and central banking, which holds that the expansion of central bank’s balance sheet does
not necessarily lead to higher inflation. Increases in reserves are merely outcomes of the expansion of the central bank’s balance sheet; they do not directly affect bank lending or credit growth, and inflationary pressures may not arise unless credit growth fuels economic activity. This is particularly true when an economy is characterized by excess slack and spare capacity, as Japan’s is.”


“Understanding sector balances in Japan (as shown in Figure 31 and the accompanying text box) can provide useful insights about the evolution of the Japanese economy. Japan’s domestic sector balance had been weakening in the late 1980s, preceding the bursting of its real estate and equity asset bubbles. Japan has been fairly consistently running current account surpluses over the past three decades, contributing to the surplus of its domestic private balance. However, its general government deficits declined from 1988 to 1991, going from nearly 5% of nominal GDP to a surplus. The decline in the government deficit resulted in the weakening of the surplus in the country’s domestic private balance. In response to slower growth and fiscal stimulus, the surplus in domestic private balances rose in the mid-1990s as the government deficit rose, helping to partly — but slowly — repair the balance sheets of the private sector. Since the mid-1990s, current account balances stayed in the range of around 1.5% to 5.0% of nominal GDP while general government deficits have varied from 2.0% to 10.0% of nominal GDP. Clearly the change in general government deficits has been the main driver in the variation of domestic private balances. As the domestic private sector deleveraged and spurned debt to repair their balance sheets after the bursting of asset bubbles, the government had to run deficits in order to prevent the economy from failing into a tailspin.

Japan’s current account surplus could decline in the coming years, particularly as the country’s export growth slows due to stiff competition from various Asian countries and the strength of the Japanese yen, and as Japan’s energy import bill rises going forward. Remarkably, the Japanese yen had appreciated through the lost decades, thereby limiting the international competitiveness of Japanese exports, while creating deflationary pressures domestically. If in the coming years Japan’s current account surplus diminishes, its government deficits must get larger to retain the domestic private sector’s surplus at its
current ratio.”

Source: ING


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • El Viejo

    …”deficits declined from 1988 to 1991, going from nearly 5% of nominal GDP to a surplus.”

    And Clinton had a surplus in what 1998 ??

    Does this mean that less vertical money causes less opportunity, stagnates wages and forces people more into debt and we pay for it down the road?? Add the repeal of Glass Steagall and presto-changeo the greatest transfer of wealth in the history of the world.

    Great post Cullen.

  • Cullen Roche

    So, the kicker to understand is private investment. That’s why we focus on S=I+(S-I). For instance, the private balance in the USA was negative from 1995-2008. And what happened? The economy actually boomed. GDP rose 75% and household net worth doubled. Why? Because private investment was through the roof. This is why (S-I)=(G-T) is insufficient to understand the full picture. The govt can help bolster the economy, but it doesn’t steer it. The private sector does.

    I also don’t use vertical vs horizontal money. I think it’s too confusing. Better to understand how inside money (bank money) can expand in an investment boom helping sustain private growth regardless of the net private saving position as is perceived through the lens of the sector financial balances.

  • El Viejo
  • scharfy

    Our demographics aren’t quite as detrimental to growth as Japan’s, and Bernanke-son well aware of potential deflation making his policy much more aggressive.

    2.0 core CPI for life…..

  • Johnny Evers

    Another way of looking at this is that while private borrowing in the U.S. spurred growth, it then led to a crash when the loans had to be paid back.
    And wouldn’t it be ironic if the hyperinflationists are wrong — that the massive increase in debt will lead to hyper-deflation!

  • Lukey

    I think the difference between a QE flood causing or not causing inflation, as Cullen alludes to above, lies in the conditions in the private sector. Are the conditions conducive to business, wage and wealth expansion or are they not? When they are you will get hyper inflation, due to the money velocity effects of private credit expansion from people taking out loans to start businesses and buy or build stuff. When they aren’t you get stagnation. And since big government is probably the biggest impediment to private sector expansion, a constant QE program that is used to fund an ever bigger government is going to give you lost decades (as it has the Japanese). The question is, will we wise up before it happens to us?