Japan's economic crisis and policy options.

In the seven years following the collapse of the asset price bubble in 1990, the Japanese economy grew at an average rate of about 1 1/2 percent a year. And with output contracting by annualized rates of 5 1/4 percent and 3 1/4 percent in the first and second quarters of 1998 respectively, the economy is now in recession. The economic cycle in Japan is thus desynchronized not only from that of the United States, where output has been growing at a solid pace since 1992, but also from those of the European countries, where, in most cases, growth has either been strong for some time or has recently gained strength [ILLUSTRATION FOR FIGURE 4.1 OMITTED], as well as from most of the rest of Asia, where growth was very strong until the onset of the present crisis. Japan's economic performance in the 1990s is particularly disappointing when viewed in the context of its own past performance - GDP growth in the 1980s averaged about 4 percent a year.

Japan's weak economic performance during this decade has so far not resulted in the high unemployment that has characterized many continental European labor markets. The unemployment rate inched up to only 3 1/2 percent by end-1997, although it has increased significantly in recent months, reaching 4.1 percent in July 1998. The manifestation of the economic crisis in Japan has, rather, taken the form of a self-reinforcing mixture of very slow growth, severe banking sector problems, rising fiscal deficits and public debt, the failure of asset prices to recover from their collapse in the early 1990s, and a profound lack of confidence among both consumers and businesses. Mutually reinforcing adverse spillover effects have recently exacerbated the crisis in both Japan and the emerging market economies of Asia.

As discussed below, the evidence indicates that the protracted slowdown of growth in Japan during the 1990s can be linked to the effects of the collapse of the asset price and investment bubbles in the early years of the decade, the persistent difficulties of the banking system, and strong upsurges in the foreign exchange value of the yen in 1993 and 1995, which undermined incipient recoveries. But this still leaves open many questions about economic developments in Japan. A number of other advanced economies also experienced collapses in asset prices in the early 1990s, and in several of the Nordic countries a severe banking crisis followed the collapse in asset prices, as in Japan. But the aftermath of the asset price collapse in these countries was characterized by a deep recession that was followed by a robust recovery in output. Why has Japan been subject to a protracted slowing of growth, instead of experiencing the sharp decline and quick recovery observed elsewhere? Have the effects of the asset price collapse on domestic demand in Japan been different from those experienced by other countries during this period? Or has Japan's experience in the 1990s been a consequence of the failure of macroeconomic policies to respond adequately to its economic problems? Has the failure to solve the problems in the banking sector prolonged the economic difficulties? Are structural rigidities in the Japanese economy impeding economic revival? What policy options are currently available for overcoming the crisis? This chapter attempts to address these questions.