Glossary

11.1 Economic bubble burst and "Lost Decades"

3 min read•july 24, 2024

Japan's economic bubble burst in the late 1980s, causing decades of stagnation. Overvalued assets, risky lending, and speculative investments led to a crash that shook the nation's financial foundation. The Plaza Accord and government policies also played a role.

The aftermath, known as the "," brought low growth, , and employment issues. Japan's government tried various strategies to stimulate the economy, including fiscal packages and "," but struggled to achieve sustained growth.

Economic Bubble and Its Collapse

Factors behind Japan's economic bubble burst

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  • Overvaluation of assets drove real estate prices to skyrocket and stock market reached unsustainable levels (Tokyo's Imperial Palace worth more than all of California)
  • Excessive lending by banks implemented easy credit policies and inadequate risk assessment led to risky loans
  • Speculative investments encouraged companies to invest heavily in non-core businesses and individuals engaged in risky financial behavior (zaitech)
  • Plaza Accord of 1985 led to rapid appreciation of the yen and encouraged monetary easing by the Bank of Japan
  • Government policies deregulated financial markets and implemented tax policies favoring land transactions
  • Global economic factors caused slowdown in major economies and increased competition from other Asian countries (China, South Korea)

Consequences and Government Response

Consequences of Japan's "Lost Decades"

  • resulted in low GDP growth and persistent deflation (average annual growth rate of 1%)
  • created non-performing loans and bankruptcies of major financial institutions (Yamaichi Securities)
  • Employment issues led to rise in unemployment and shift towards non-regular employment (part-time, contract work)
  • Demographic challenges exacerbated by and declining birth rates (fertility rate dropped to 1.26 in 2005)
  • Social impacts increased income inequality and rise of the "freeter" and "NEET" phenomena (young adults without full-time employment)
  • Consumer behavior changes reduced spending and increased preference for saving over investment
  • Corporate restructuring saw decline of lifetime employment system and increased focus on shareholder value

Government efforts for economic stimulation

  • Fiscal stimulus packages funded public works projects and implemented tax cuts (1992 stimulus package of 10.7 trillion yen)
  • Monetary policy measures introduced zero interest rate policy and
  • Financial system reforms created the Financial Services Agency and injected public funds into banks
  • Structural reforms deregulated various sectors and privatized state-owned enterprises (Japan Post)
  • "Abenomics" (introduced in 2012) implemented three arrows: monetary easing, fiscal stimulus, and structural reforms
  • Effectiveness of measures showed limited success in achieving sustained growth, persistent deflationary pressures, and accumulation of public debt (debt-to-GDP ratio exceeded 200%)

Japan's stagnation vs historical precedents

  • Great Depression (1930s) shared similarities in deflation and high unemployment but differed in global scale and severity of decline
  • Post-war reconstruction in Europe paralleled need for economic revitalization but contrasted with rapid growth in Europe vs stagnation in Japan
  • Latin American debt crisis (1980s) mirrored financial sector issues but diverged with hyperinflation in Latin America vs deflation in Japan
  • Asian Financial Crisis (1997) resembled real estate bubble and banking problems but had shorter duration and more severe immediate impact
  • Global Financial Crisis (2008) echoed asset bubble burst and financial sector instability but differed in global nature and faster recovery in other countries
  • Stagflation in the United States (1970s) shared economic stagnation but contrasted with high in the US vs deflation in Japan

Key Terms to Review (18)

Abenomics: Abenomics refers to the economic policies implemented by Japanese Prime Minister Shinzo Abe starting in 2012, aimed at combating deflation and revitalizing the Japanese economy. The approach combines aggressive monetary easing, fiscal stimulus, and structural reforms to stimulate growth and increase inflation, reflecting an effort to overcome the challenges posed by the economic bubble burst and the prolonged 'Lost Decades'.
Aging population: An aging population refers to a demographic trend where the median age of a population rises due to declining fertility rates and increasing life expectancy. This phenomenon often leads to a higher proportion of elderly individuals compared to younger age groups, impacting economic productivity, social welfare systems, and overall societal dynamics.
Asset price bubble: An asset price bubble is a market phenomenon characterized by the rapid escalation of asset prices, often driven by excessive speculation, which eventually leads to a sharp decline in prices when the bubble bursts. This cycle of rising and falling prices can have devastating effects on the economy, particularly when the bubble involves significant sectors such as real estate or stocks.
Bad Loans: Bad loans refer to loans that are unlikely to be repaid, leading to significant financial losses for lenders. These types of loans often arise during economic downturns when borrowers face insolvency or financial distress, and they are closely tied to the phenomena of economic bubbles and subsequent financial crises, such as the one experienced during the Lost Decades in Japan.
Banking crisis: A banking crisis is a situation where a significant number of banks experience financial instability, leading to a loss of confidence among depositors and investors. This often results in bank runs, where customers withdraw their funds en masse, and can trigger a broader economic downturn. In Japan, the banking crisis was closely tied to the economic bubble burst, causing severe impacts during the 'Lost Decades.'
Consumer confidence: Consumer confidence refers to the degree of optimism that households feel about the overall state of the economy and their personal financial situation. This term is critical in understanding economic behavior, as higher consumer confidence typically leads to increased spending and investment, which in turn stimulates economic growth. Conversely, when consumer confidence is low, spending decreases, potentially leading to economic slowdowns or stagnation.
Deflation: Deflation is an economic condition characterized by a general decline in prices, often associated with a reduction in the supply of money or credit. It leads to decreased consumer spending, as people anticipate further price drops, which can cause businesses to reduce production and lay off workers. This cycle of reduced spending and investment can contribute to prolonged periods of economic stagnation.
Economic stagnation: Economic stagnation refers to a prolonged period of little or no economic growth, often characterized by high unemployment and low consumer spending. It can lead to a decrease in overall productivity and can stem from various factors, including poor government policies, lack of innovation, and external pressures. In Japan's history, this term is especially relevant during the decline of traditional power structures and the subsequent economic challenges faced in the late 20th century.
Heisei Recession: The Heisei Recession refers to a prolonged period of economic stagnation in Japan that began after the asset price bubble burst in the early 1990s and extended into the early 2000s. This era was marked by deflation, high unemployment rates, and a lack of consumer confidence, leading to what is often referred to as the 'Lost Decades' as Japan struggled to recover from the economic fallout of its bubble economy.
Inflation: Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power. This economic phenomenon can lead to a decrease in the value of currency, making it essential to understand in contexts where economic stability is challenged, such as during economic bubbles or wartime economies.
Job insecurity: Job insecurity refers to the uncertainty individuals feel about the continuity and stability of their employment. This concept is particularly relevant in the context of economic downturns, where employees may fear losing their jobs or experiencing reduced job prospects. Job insecurity can have significant psychological and economic impacts on workers, especially during periods of economic turbulence like the burst of the economic bubble and the ensuing 'Lost Decades'.
Keynesian Economics: Keynesian economics is an economic theory based on the ideas of John Maynard Keynes, which argues that government intervention is necessary to stabilize the economy during periods of recession or economic downturns. It emphasizes the role of aggregate demand in influencing economic output and promotes fiscal policy measures, such as increased public spending and lower taxes, to stimulate growth and reduce unemployment.
Labor shortage: A labor shortage occurs when the demand for workers exceeds the available supply of qualified labor. This situation can lead to various economic challenges, particularly in the context of an economy recovering from a significant downturn. In this case, it highlights the struggles of businesses to find skilled workers during periods of economic recovery and growth after a prolonged recession.
Lost Decades: The Lost Decades refer to a prolonged period of economic stagnation in Japan, which began after the burst of the asset price bubble in the early 1990s and lasted throughout the 1990s and into the 2000s. This era was marked by low economic growth, deflation, and a series of financial crises that profoundly impacted Japan's economy and society.
Quantitative easing: Quantitative easing (QE) is a monetary policy used by central banks to stimulate the economy by increasing the money supply through the purchase of government securities and other financial assets. This strategy aims to lower interest rates, boost lending and investment, and ultimately spur economic growth, particularly in times of economic downturns or periods of deflation. Its implementation has been crucial in addressing the fallout from economic events, especially after significant financial crises.
Shinzo Abe: Shinzo Abe was a prominent Japanese politician who served as the Prime Minister of Japan in two non-consecutive terms, first from 2006 to 2007 and then from 2012 to 2020. His leadership is closely associated with efforts to revitalize Japan's economy and tackle the challenges posed by the economic bubble burst and subsequent 'Lost Decades', which profoundly impacted Japan's growth and global standing.
Supply-side economics: Supply-side economics is an economic theory that posits that economic growth can be most effectively fostered by lowering taxes and decreasing regulation, thereby incentivizing individuals and businesses to produce more goods and services. This approach emphasizes the role of supply in driving economic growth, rather than focusing solely on demand-side factors like consumer spending.
Yasuo Fukuda: Yasuo Fukuda is a prominent Japanese politician who served as the Prime Minister of Japan from September 2007 to September 2008. He took office during a challenging time, as Japan was dealing with the aftermath of an economic bubble burst and the ensuing 'Lost Decades,' which were characterized by economic stagnation and deflation.
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