THE STUDY OF THE JAPANESE

ECONOMY
MACROECONOMICS FOR BUSINESS EXECUTIVES

TEAM 6
Yingying Gu (1155118505)
Bo Li (1155115866)
Jerry Chiang (1155113706)
Freddie Wong (1155123668)
Stella Ni (1155113707)
Utkarsh Jain (1155120904)
Table of Contents
EXECUTIVE SUMMARY.......................................................................................................................... 2

BACKGROUND ....................................................................................................................................... 3

REASONS FOR THE PROLONGING DEFLATION ............................................................................... 5

POLICIES THE JAPANESE GOVERNMENT INTRODUCED TO STIMULATE INFLATION (BEFORE

SHINZO ABE WAS ELECTED)................................................................................................................ 6

ABENOMICS AND ITS EFFECTS ........................................................................................................... 8

CURRENT SITUATION OF JAPAN ........................................................................................................ 9

SOLUTIONS ........................................................................................................................................... 10

CONCLUSION ....................................................................................................................................... 12

REFERENCE ............................................................................................................................................ 13

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EXECUTIVE SUMMARY

Japan is the third-largest economy in the world by nominal GDP and the fourth-
largest by purchasing power parity (PPP), and is the world's second largest developed economy.
The path of Japan’s economic escalation has seen some of the problems still remain where the
government, corporations, and individuals are acting together to push the economy to grow,
globalize, and fight the prolonging periods of deflation and the other problems associated with
it.
This report provides an overview of the Japanese Economy, throws light on the reasons behind
the prolonging state of deflation, and identifies and analyzes the steps taken by the government
(before Shinzo Abe took power) to fight deflation and other issues that arose in Japan such as
the aging problem. The report also identifies and analyzes the economic measures introduced
by Shinzo Abe, popularly known as Abenomics, to fight deflation, evaluates the current state
of the Japanese Economy with Abenomics in play and provides recommendations to tackle
deflation.
The report discusses the reasons for prolonging deflation and the problems associated with it,
and to ensure that Japan tackles these problems efficiently; this report highlights three critical
recommendations that would aid Japan in the process:
(a) Solve the Aging Problem, which is aimed to increase the total labor productivity;
(b) Solution to the Huge Government Debts;
(c) Improve the Declining Net Exports and the Low Consumer Price Index (CPI)

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BACKGROUND

Japan, as we know, was shaped by a historical event that changed everything across the globe
– World War II. After the Japanese surrendered, US led allies started to rebuild Japan. From
the economic perspective, US fixed the value of a Dollar at 360 yen under the Bretton Woods
system in 1949, partly to help stabilize prices in the Japanese economy, and it was convenient
for FDI to move into Japan as it had a USD backing. As Japan gradually recovered, in 1959 -
The US dollar/yen exchange rate liberalized. The margin of fluctuation was set at 0.5 per cent
on either side of its US dollar parity.

From 1959 through to 1980, these 20 years saw Japan’s GDP grow steadily to about $1000Bn
by 1980. Majorly because of the low base value, the GDP growth rate was as high as 12% -13%
in the early days. After 1980 was where things picked up and the GDP growth rate had increased
to 5% annually and, in some years, it reached as high as 10%. To put things in context, the
actual GDP increased from $1000bn USD in 1980 to about $4000bn USD in 1990. All that was
a result of the manufacturing boom of items such as cars, electronic goods, which was a major
contributor to Japan’s exports, and the housing boom also contributed significantly to Japan’s
GDP growth.

In 1985, The U.S., Japan, West Germany, The U.K and France signed the “Plaza Accord” to
fix the huge amount of trade deficit, which was due to the high exchange rate of U.S dollars.
After the deal, exchange rate of U.S. dollars fell from 240 yen for a dollar to 120 yen for a
dollar. This volatile market situation resulted in a serious loss for the U.S bond holders, lots of
capital flew into Japan, leading to a significant drop in Japan’s exports. This is when The Bank
of Japan started quantitative easing, lowering the interest rates which would result in excessive
capital in the market. Besides, the commercial banks in Japan also began lending more to real
estate, retail and wholesale industries which added low value. Many Japanese bought houses at
high interest rates of around 8-10%, but when the economy experienced a downturn, a part of
the population could not repay the loan and needed to surrender their houses.
Furthermore, this deflation in one of the most developed countries also led to more capital flow
into the stock market. The surge in the real estate market and stock market also attracted
additional capital, and the banks continued lending money to the investors. Owing to the raising
value of collateral, this money was reinvested in the markets.

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Beginning 1988, Japan saw rising exchange rates and the industries experienced diminishing
growth. Although, profits within the Japanese industries had shown signs of decline, people
were still optimistic about the market. However, the increasing discrepancy between the
development of industries and the asset prices caused the breakdown of the real estate and stock
markets by the end of 1989.

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REASONS FOR THE PROLONGING DEFLATION

As the price of real estate became too high for Japanese office workers, the pressure to tighten
the fiscal policy become larger. After Ministry of Finance of Japan announced the new policy
to tighten the lending for real estates, the value of real estate plumped and the stock market
index dropped from 38,957 to 14,000 in just 15 months (Hiroshi, 2001). Most individual,
institutional investors suffered huge losses, and the slump in the value of collateral also
contributed to a huge amount of bad debts. This led to a simultaneous fall in consumption,
which at that time account for around 60 percent of Japan’s GDP, that severely harmed the
economy of Japan. The prices of asset persistently declined, resulting in the decline profits of
enterprises, and the expectation of the falling prices and salaries unintuitively made the people
of Japan hoard Cash, which deteriorated the situation even further (Charles, 2012).

During that period, a lot of Japanese had diversified their investment off shore. As for
individuals, a lot of them had invested in property in Gold Coast and Cairns, and as for the
Corporates, they had not only set up manufacture facilities in other countries such as China,
USA, and Australia but also purchased the Chateau, and its distillery in Scotland. During the
Japanese asset pricing bubble, revenues were high due to prosperous conditions, Japanese
stocks profited, and the number of national bonds issued was small (Lyn, 2019). When the
bubble burst, the annual income decreased. As a result of which, the number of bonds issued
had increased rapidly. Because the interest rates of most treasury bonds were fixed, Japan
experienced an increase in the ratio of debt to GDP, as deflation reduces nominal GDP growth.

Japan’s problems did not stop at deflation, as the country faced other issues such as
development imbalance between industries, huge amount of public debt, falling net export, and
aging population structure. The whole economy fell into a liquidity trap while The Bank of
Japan announced discount rates as low as 0.3%. People still believed that the future price would
be even a lower number, because of which the consumers won’t be willing to spend more,
instead they would wait until prices fell again. That’s why, other than the lack of stimulation,
it was the national behavior that was encouraging deflation (Ryan & Aaron, 2018).

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POLICIES THE JAPANESE GOVERNMENT INTRODUCED TO
STIMULATE INFLATION (before Shinzo Abe was elected)

Japan has long been mired into deflation since the beginning of the 1990s. In order to get rid of
the deflation, the Bank of Japan has adopted several large-scale stimulus policies. Although the
CPI has increased over a period of time, it remained low, in general, for most of the time. The
monetary policy by the BOJ can roughly be divided into the following stages.

The first stage was from 1991 to 2000. In July 1991, the Bank of Japan changed the monetary
base by buying and selling government bonds and changed the money supply through money
multiplier. From 1991 to 1995, the BOJ decreased the discount rate nine times, from 6% to
0.5%. In response to the Asian Financial Crisis, from 1998 to 2000, the BOJ injected funds into
the interbank lending market by purchasing Japanese Government Bonds and Commercial
Paper which are held by commercial banks. In 1998, the purchase of monthly Treasury Bonds
increased from 400 Billion Yen to 600 Billion Yen. The unsecured overnight lending rate first
dropped from 0.25% in 1997 to 0% in September 1999, and then rose back to 0.25% in August
2000 (Takatoshi, 2004).

Overall, the CPI in this time period showed a downward trend. Firstly, it dropped from 4.2%
in November 1990 to -0.7% in November 1995 and then rebounded, rising from -0.7% in
November 1995 to 2.5% in October 1997. However, influenced by the Asian financial crisis
and the rise in consumption tax rates, prices began to fall again, from 2.1% in November 1997
to -0.2% at the end of 2000 (Takatoshi, 2004).

The second stage was the quantitative easing monetary policy from 2001 to 2007. In March
2001, the Bank of Japan pledged to continue providing liquidity to the market until CPI
stabilized above zero, setting a target range of 0% to 2% for medium and long-term prices for
the first time. In order to further provide sufficient liquidity, the Bank of Japan changed its
monetary policy operation target from unsecured overnight lending rate to money supply for
commerce when interest rates dropped to extremely low levels. The bank's current account
balance in the central bank was the target of operation. In addition, it provided a lot of liquidity
to the market by purchasing government long-term treasury bonds, so as to depress the real

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interest rate of long-term treasury bonds, thereby increasing the public's inflation expectations
(Takatoshi, 2004).

Prices during that period had been in a state of negative growth for most of the time. CPI
dropped from -0.3% in January 2001 to -1.6% in February 2002. Prices began to rise but still
remained in a negative state of growth. By September 2004, CPI returned to 0%, then stayed
above 0 for a short time. After January 2005, CPI began to grow negatively. It did not return to
0.1% until May 2006 and maintained positive growth until the end of 2006 (Takatoshi, 2004).

The third stage was to restart quantitative easing monetary policy in 2008-2011. It included
reducing the unsecured overnight lending rate from 0.3% to 0.1% in October 2008,
implementing the expected target value of medium-term and long-term price stability, and
quantifying CPI as positive growth below 2% year-on-year, the target then was 1%. Restarting
the asset purchase plan and expanding the scale of asset purchase, the Bank of Japan's asset
purchase scale reached 101 trillion yen by the end of 2012 (Takatoshi, 2004).
Prices in that period dropped from 2.3% in July 2008 to -2.5% in October 2009. Prices have
risen since then, but they still have not got rid of deflation. CPI increased positively only for a
few months, but was still in a negative state for most of the time (Takatoshi, 2004).

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ABENOMICS AND ITS EFFECTS

In the reason of prolonged battle against deflation, the BOJ became more and more clear that
more powerful monetary easing policies were needed. Therefore, in December 2012, the newly
elected Japanese Prime Minister Shinzo Abe launched Abenomics, which was mainly about
releasing more liquidity into the market, using methods including quantitative and qualitative
monetary easing, seeking to raise inflation expectations, massive JGB purchases by the bank,
and QQE with negative interest rate since 2016 (Haruhiko, 2016).

The most direct effect was on the GDP growth, as according to the Keynesian cross more
spending by the government would boost the economy. After the stimulus to the economy,
Japan’s GDP rose for 7 consecutive quarters, after a long weakening since 2006. With increased
money supply, Japan’s exchange rate against USD increased by 30% at the end of 2017. In
2017, exports increased along with increased private investment. Employment also improved
due to GDP growth. While inflation rate maintained at low level (CPI increased less than 1%
five years after the execution of Abenomics). The reasons for this are as follows:
Firstly, Japanese culture did not encourage job transfer and employers tended to pay stable
salary to employees, no matter how fast the company grew. Secondly, labor force increased
during this period with more women, elderly men and foreigners involved. Lastly, with
increased labor cost, companies were raising productivity rather than prices, trying to reduce
the labor used (Andrea & Matteo, 2016).
Abenomics achieved two main aims: unemployment fallen to a historical low and the GDP
grew (Anthony, 2015). Stock market also soared under Abe. The Nikkei 225 index stood at
10,395 yen when he took office, but nearly twice of that number in 2017-year end.

Even with such results, Japan could not see off a couple of problems. Inflation rate was 1% at
the end of 2017, still far below the target of 2% set in 2013. The growth had also slowed down
with annualized rate of only 0.5% in the 4th quarter of 2017. Consumer spending was still low,
and fertility rate was also low. QQE also brought large deficit, for which Abe planned to raise
taxes to mitigate the deficit, while it is believed that the raise in taxes this will further harm the
consumer expending. Negative rates are said to harm to the financial system, and also lead to
deflation pressures. Government spending pulled the gross debt to GDP ratio to 240% at the
end of 2017, which stood at warning level (Scott, 2019).

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CURRENT SITUATION OF JAPAN

Following Abenomics stimulus, Japan’s economy is becoming moderate but the recovery is
slow. Japan’s GDP only grew 2.2 per cent compared to the period when Abe first came to power.
From the Thomson Reuters Datastream, Japan GDP growth in Q1 2019 grew 0.5% (QoQ).
Aiming to banish deflation, the Bank of Japan already issued strong stimulus packages, which
resulted the consumer inflation to be 0.9% this year, thus putting more pressure on their further
policy making and implementations.

Aging population and huge government debt are two biggest challenges to Japan’s recover from
‘last few decades’. In 2016, IMF predicted that Japan’s work force between 15-64 will reach
150 million, which is showing signs of improvement but is not significant enough. Japan’s
national debts till 2018 are above 246% of the GDP, highest in the world.

On the other side of the story, since Japan does not have a lot of raw materials to fuel its country
growth, whether it’s for the manufacturing industry or domestic consumption, it has to increase
its imports. Japan had maintained a trade surplus for 20 years which ended after Fukushima
Disaster in 2010. Japan has had to import a lot of more fossil fuels to meet the national demands
and started recording a trade deficit. With currency depreciation, capital outflow also increased
by a tremendous amount. (Robin Harding, n.d.)

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SOLUTIONS

The causations of deflation discussed in the aforementioned paragraph indicate the initial steps
that need to be taken to overcome Japan’s deflation. Broadly, we would be providing
recommendations to the following problems:
(a) solve the aging problem;
(b) find solution for the huge government debts;
(c) fix the trade deficit that the country has been facing and improve the CPI

Solution to aging problem (Improve the TFP-Enhance profit of Enterprises-Raise Salary)

As a country with 120 million population, consumption accounts for GDP of Japan over 50%
for decades. However, both the growth rate of population and the overall population has
declined. The aging population structure and declining population not only increases the burden
of social welfare system, but also decreases the consumption. The growth rate of population is
difficult to twist, and even the government implement policies that encourage childbirth, it
would take least two decades bring an impact. To solve this problem, Japan should introduce
the foreign labor force, by easing immigration policies for skilled labour force, and extend the
maximum retirement age.
However, the unit input of labor force would diminish as the input increases. To tackle this,
The Japanese government can encourage investment in research and acquisition of cutting-
edged technologies and industries. For example, Japan is a major exporter in the global vehicle
markets. With self-driving cars seen as the future of this industry, Japanese government can
encourage R&D, combine the resources of academicians and industry experts to develop its
productivity. On the other hand, the AI industry and advanced automatic production line would
be a good solution to the declining labor force. In short, raising the Total Factor Productivity
(TFP) will be the fundamental solution as it can boost each unit input of capital and labor.
Besides, the products with the latest technology could help the companies charge higher price
thereby improving profit of the enterprises. Once the profit of the entreprises improves, it is
more likely that the corporations raise the salaries of employees. The increase of disposable
income would be the catalyst of boosting consumption and investment.

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Solution to huge public debt (Increasing consumption tax and Reducing corporate tax)

After many years of implementation of quantitative easing, the public debt has reached an
unprecedented level. As the overall economic environment has gradually recovered, Bank of
Japan has reduced its balance sheet and asset purchasing scale recently. To reduce the burden
and increase the revenue of government, raising consumption tax in the mild path would be a
proper solution. In 2015, Japan lifted its sales tax from 5% to 8%, which brought pain to their
retail industry, but from 2017, data started to become moderate again.
While an increase in consumption tax would inevitability restrain the consumption, the
implementation of scale and time should be carefully considered. Considering Japanese
corporate tax is relatively high, reducing corporate tax and encourage enterprises to transfer the
benefit generated from the tax cutting to its employees and the customers. Again, the raise of
disposable income can mitigate the shock caused by increasing consumption tax.

Solution to declining export and low CPI (Devaluation)

Japan relies heavily on import since it lacks natural resources such as petroleum and scarce
mineral which are necessary for production industries. On the other hand, export of Japan has
been experiencing stagnation off late. In addition to improving the quality of product, the
exchange rate of Yen is also a critical factor in determining the exports. Although the exchange
rate of Yen compared with that of 2012 has fallen significantly, the volatile geopolitical
environment increases the pressure of Yen appreciation and reduce the aggregate demand from
its export markets. Devaluation might not be an effective tool since the declining export
recently is mainly caused by protectionism and turmoil. However, the devaluation would also
increase the cost of import. Food and natural resource account for large portion of Japanese
import, which also have significant effect on the price level. As price level raised by the
increasing cost of import, it also strengthens the momentum to boosting the price level toward
its target.

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CONCLUSION

This report reviewed the most severe economic challenge that Japan has been facing for around
30 years, which is the deflation, and based on our researches provided some advice to the
Japanese government to defeat the "deflation monster". The long period of suffering from
deflation started in the early 1990s when the Japanese asset pricing bubble burst. The Bank of
Japan implemented monetary policies to stimulate inflation, such as multiple rounds of more
and more excessive quantitative easing monetary policy, but Japan failed to escape the liquidity
trap until the newly elected Japanese Prime Minister Shinzo Abe launched Abenomics in 2012.
In the current stage, Japan's economy grew slowly in 2018, but the accelerating inflation hasn't
met the Bank of Japan's target of 2.0 percent yet. Therefore, to overcome the deflation, the
Japanese government and the Bank of Japan have to act as one and implement strong and
comprehensive measures. Firstly, the enhancement profit of enterprise-raise salary is the way
to solve the aging problem which to be specific is to increase labor productivity. Then, to
decrease the huge public debt, the Japanese government need to increase consumption tax and
reduce corporate tax. Finally, the Japanese government has to fix the net export gap and bring
up price level of national goods by devaluation.

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REFERENCE

1) Hiroshi Nakaso. 2001. The financial crisis in Japan during the 1990s: how the
Bank of Japan responded and the lessons learnt. Retrieved from
https://www.bis.org/publ/bppdf/bispap06.pdf
2) Charles. 2012. AS-AD Model and Its Application. Retrieved from
https://www.edb.gov.hk/attachment/en/curriculum-
development/kla/pshe/references-and-
resources/economics/Topic%20G%20National%20Income%20Determination
%20and%20Price%20Level_revi.ppt
3) Lyn Alden Schwartzer. 2019. Japan’s Central Bank Bubble Is Truly Remarkable.
Retrieved from https://seekingalpha.com/article/4246218-japans-central-bank-
bubble-truly-remarkable
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https://www.nber.org/papers/w10878
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df
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Japanese Experience with Abenomics. Retrieved from
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situation-in-italy-worse-than-in-japan/

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