Over the past 20 years, asset-inflated bubbles have emerged in Japan, the United States and Europe--only to burst and throw those economies into recession.
The United States and Europe are now trying to avoid the "lost two decades" experienced by Japan after its bubble economy collapsed.
What is occurring in advanced economies and why have central banks been unable to fulfill their key role of providing economic stability?
Kiyohiko Nishimura, a deputy governor of the Bank of Japan, sat down with The Asahi Shimbun to answer these and other questions.
Excerpts of the interview follow:
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Question: Why did bubble economies arise in Japan, the United States and Europe one after another?
Nishimura: In Japan, real estate prices began rising sharply from around 1990, while in the United States housing prices shot up after 2000. That happened because everyone thought, "Prices will never fall. Someone will definitely buy at a higher price than what I paid."
Even prices that in hindsight were outrageous were considered as "standards for a new age of prosperity." The essence of bubble economies is excessive optimism about the future.
The same thing can be said about Europe, which is now suffering from a government debt crisis. The economies continue to grow and government bonds can be issued at low interest rates because the nations are members of the euro currency. Everyone thinks that the present prosperity will continue and begin to feel that they can take out loans forever.
Those nations piled up debt and engaged in reckless fiscal management.
Q: Does excessive optimism suddenly occur?
A: Looked at in the long term, economic growth is influenced by how large the working population is as well as how high the productivity of those workers is.
In Japan, the United States and Europe, when the bubble economies arose, the ratio of the working population was increasing. Because many people purchase land and housing when they are young, when there is a large ratio of working people, it becomes easier for asset prices to increase.
When this gift of population composition pushed up the economy, people came under the illusion that a new age had arrived.
For example, in Japan in about 1990, the population in active service, 15 years of age or older and under 60, was more than double the combined population of those under 15 and 60 or older. As a result, the bubble economy hit its peak around 1991.
In the United States, the ratio of the working population to the non-working population reached its peak in the period between 2005 and 2010 and the so-called subprime loan bubble peaked in 2007.
While the circumstances behind the collapse of the three bubble economies are different, the bursting of the bubble all occurred when the population gift converted into a burden on society. The bubble economies burst when population aging proceeds and the ratio of the working population falls, leaving behind a burden.
Q: Were the central banks also caught up in an illusion?
A: When everyone is very excited about the coming of a new age, it is extremely difficult to burst such bubbles by raising interest rates.
In 1989, when I was an associate professor at the University of Tokyo, I gave a speech at a gathering in which I said, "Japan's land prices are being pushed up by a bubble." However, I came under siege because there were a large number of counterarguments saying I was wrong and that there would be a need to look at price movements over a bit longer period.
Even if the central bank could not burst the bubble, it should not have helped in the effort to inflate that bubble. That is one point on which the BOJ should reflect.
As a result of a long period with low interest rates despite the economic circumstances, many people came to feel, "Now is the time to purchase real estate even if loans have to be taken out."
Even if a bubble economy had arisen, the central bank should have been able to minimize the damage from the collapse of that economy. It should have cast a sharper eye not only on the management situation of individual banks, but also over the entire financial system to ensure that there was no excessive lending in real estate, for example.
Q: How do you view the fact that Japan still suffers from deflation even after 20 years have passed since the collapse of the bubble economy?
A: After the collapse of the bubble economy, the Japanese economy had to shoulder the "three excesses," namely, the excesses of debt, production capacity and employment. In the process of reducing those excesses, the "blood circulation" of the entire economy worsened.
Banks were pressed to clear their books of non-performing loans and were unable to discover new growth companies. Although in the past, banks supported companies such as Sony Corp. and Honda Motor Co., which did not yet have their futures ensured, they lost their ability to take on the risk of making loans to such companies.
As companies rushed to eliminate excessive production capacity, their ability to develop new business sectors through forward-looking investment weakened. As they reduced their workforces, the companies also lost the luxury of providing training opportunities to their workers to allow them to increase their capabilities. As a result, worker productivity decreased.
Q: Has the aging of the population also made it more difficult to deal with the aftereffects of the bubble economy?
A: As people age, it becomes more difficult for them to be transferred at work or move to other locations. Even if one region suffers from a worker shortage, fewer people will move from regions that have a surplus of workers. That creates a mismatch in labor between different regions and that also reduces productivity.
The animal spirits that stimulate entrepreneurs to start new businesses in an uncertain future become weaker so a new supply that responds to a new demand does not emerge. I believe this is what most blunts the vitality of an economy. Because there is insufficient supply, demand does not become visible even if it exists.
Q: Will the United States and Europe also suffer from a long recession as Japan did?
A: The United States and Europe will be unable to avoid "Japanization" in the sense of having to make adjustments after the collapse of their bubble economies while society has lost flexibility due to the aging of the population.
Even in the United States, which is said to have high flexibility, people are not moving around as much. Many are unable to move because even if they want to sell their home and move elsewhere, they are unable to repay their loans because home prices have fallen. There has also been a decrease in rate of birth of establishments. Although the United States has long been known as a nation of immigrants, not only has the inflow of immigrants decreased, but there has also been an increase in cases of immigrant out-migration.
While Japan had fiscal leeway when its bubble economy collapsed, the United States and Europe will have to rebuild their economies while their fiscal conditions are in the worst possible state. Although Japan is falling slowly, it can now see other nations falling much faster all around it.
I believe adjustments to deal with that situation will be prolonged and difficult. It will be especially difficult in the common euro currency sphere. In terms of the pace of the aging of the population, China is similar to Japan. South Korea is aging even more quickly than Japan.
From the standpoint of world history, a gigantic change is now occurring.
Q: You first presented your theory of the Japanization of the United States and Europe at an economics conference in the United States in January 2011.
A: The moderator who invited me to the conference suddenly burst out laughing when I gave my speech, probably due to surprise. At that time, many people never thought that the Japanization of the United States would ever occur. The reaction has changed considerably in the year that has passed since. In particular, Europe has begun to seriously think about Japanization as it faces the double punch of an aging population and the economic crisis.
Q: What do you feel about the view that the BOJ is responsible for Japan's inability to move out of a recession?
A: If you compare the economy to a ball, there are multiple factors at work for why the ball does not bounce. For example, overseas economic circumstances, such as the subprime loan problem in the United States, have a major effect. I do not believe it is a good thing to single out monetary policy and play it up excessively.
A society that has many young people willing to work can be compared to an easily bouncing ball full of air.
Such a society is called a high-pressure economy, where increases in the amount of money in circulation will immediately create demand for products. In such a situation, what is important is to skillfully lower pressure in the ball so that it does not bounce too much. That can be done by tightening or loosening the valve, that is, interest rates.
On the other hand, a society such as Japan, where the aging of the population has progressed, is a low-pressure economy. It is difficult to make a ball that has lost air to bounce simply by operating the valve, that is, interest rates. It is much more difficult to make a ball that does not bounce at all start bouncing again than to make an already bouncing ball less bouncy by loosening a pressure valve.
Q: Are you saying the BOJ was not at fault because there was nothing it could do to prevent the aging of the population?
A: We have to accept the fact that the BOJ's efforts were not successful in moving the Japanese economy out of deflation.
However, at each occasion along the way we made a decision that we considered the best. There were also many learning experiences while we made new challenges to deal with the situation. I believe we were able to implement aggressive policy in our response to the collapse of U.S. investment bank Lehman Brothers in the autumn of 2008.
The pressure inside the ball has to be increased in order to bounce it. That means a structure is needed to support entrepreneurship and allow money to circulate. We have expanded the system to extend low-interest loans to banks that invest in and make loans to companies in 18 growth sectors, such as the environment and medical care.
I also hope that banks will change their traditional way of thinking.
While some say it has become harder to make loans because of reduced profit margins due to the falling interest rates caused by the BOJ's monetary easing measures, I want banks to be more positive in finding new ways by themselves to secure wider profit margins. For example, one possibility could be developing new products that would serve as an effective intermediary between senior citizens who want to invest their assets and young people who want money to start new businesses.
Because everyone knows that the number of senior citizens will increase, there is a need to create an economy that can respond to that change. I hope banks will change.
Q: Was it difficult for you, as you moved from the University of Tokyo to the BOJ, to apply the results of your research at the university to actual monetary policy?
A: That is a difficult question because current monetary policy is not a simply application of the economic theories we learnt in school. We are doing things that are not included in any textbook. In that sense, new monetary theory is now being created. We cannot simply rely on textbooks.
Economics is constantly looking toward the future. Our job is not to focus on what occurred in the past, but to think and explain about what we can do from now.
The past only has significance as information that could be useful for the future.
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Kiyohiko Nishimura is a deputy governor of the Bank of Japan. He became a member of the BOJ Policy Board in 2005 after serving as an economics professor at the University of Tokyo. Nishimura, 59, was named deputy governor in 2008.
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