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ESRI International Workshop
"Beginning of the new growth"



Place : Hotel Okura Tokyo
Date and Time : September 3, 2004 9:00-18:15



Session 1: Economic stagnation and policy responses in Japan during 1990s and early 2000s

1. Presentation by presenters

(1) Alan Auerbach "Liquidity Trap and Policy Response"
    Even in a liquidity trap, buying of government bonds through open-market operations improves welfare by reducing taxes needed for the payment of interest on bonds. Furthermore, this policy has the effect of raising prices and increasing production. Therefore, even in a case where a liquidity trap is strong and expected to last for a long period, monetary policy is an important policy instrument. On the other hand, fiscal policy is not so attractive from the viewpoint of welfare and confidence. With sustainable policy action and by gaining the confidence of the public on such policy action, deflationary psychology can be altered.
(Paper: "Monetary and Fiscal Policy In a Liquidity Trap (PDF-Format 124KB)")

(2) Yutaka Harada "What Caused the Great Heisei Stagnation"
    We have examined various hypotheses regarding the reason for the Great Heisei Stagnation using vector autoregression models. The Great Stagnation was not caused by the burst of the bubble, nor is it a structural issue since a drop in labor productivity cannot be observed. The Great Stagnation can be fundamentally explained by the monetary factor. Especially since mid-1990s, the effect of monetary factor has increased. Lending, which is a surrogate for monetary function, has no significant effect on production. Exports and government expenditure are factors for economic fluctuation to some extent, but the effect of government expenditure on production is not significant.
(Paper: "Japan's Great Stagnation: An Interpretation Using Vector Autoregression Models (PDF-Format 337KB)")


2. Comments by discussants

(1) Yasushi Iwamoto(on Auerbach's presentation)
    A case reflecting Japan's actual figures is needed. Since the Bank of Japan will have to shrink money supply at the time of escaping the liquidity trap, it is difficult that increasing future money supply is credible. In addition, if the central bank takes account of the fiscal situation, the central bank's objective becomes too complicated.
(Paper: "Discussion of "monetary and Fiscal Policy in a Liquidity Trap" by Professor Auerbach [1 (PDF-Dormat 438KB)] [2 (PDF-Dormat 442KB)]")

(2) Robert Feldman(on Harada's presentation)
    Because fiscal policy has been adopted in correspondence with economic trends, government expenditure is not exogenous. Since there is change in preferences and such, investment and consumption are not genuinely exogenous. In addition, the number of variables is not sufficient. For example, China, an important variable, is not included. Moreover, it is difficult to believe that an increase in lending necessarily means a good financial system, and besides, lending is not an index for the financial system. Also, since VAR (Vector autoregression model) is an analytic method targeting a massive amount of data, it is not adequate for this small amount of data. Monthly data should be used. Furthermore, if "correlation = cause and effect" does not hold true, the paper's conclusion is not necessarily valid.


3. Q&A

Auerbach
    That the figures are not actual figures of Japan does not influence the essence of the conclusion. That there is no incentive on the part of the central bank to increase welfare may be true, but it is sufficient if the increase of money supply by the central bank is maintained to some extent. However, it would be a problem if the entire policy is reversed.

Speaker
    There is a problem with the model being one of a closed economy. The influence of a weakening exchange rate caused by an increase in money supply is not included. An open economy model is preferred.

Speaker
    Confidence depends on the central bank's statement. The problem is that it is unclear what will happen after overcoming deflation and at what percent the inflation rate would be set. These should be stated specifically.

Speaker
    Confidence can be sufficiently gained with the long-term target greatly exceeding zero.

Speaker
    A rise in land prices in central Tokyo is an important point to consider for monetary policy.

Speaker
    Providing for times like an oil shock, a feedback rule for the central bank is necessary. Is feedback included in the model?

Speaker
    Japanese banks possess government bonds that do not appear on the market. The role of such financial intermediaries should be considered.

Auerbach
    In a liquidity trap, policy different from a conventional one is necessary. I can't say that I have fully analyzed the open economy. I think that the treatment of financial institutions was simple. But the main results should still hold.

Harada
    Including the significance of lending, if variables can be interpreted in various ways, anything can be said. Moreover, that the impact of China on prices is insignificant can be seen from this analysis (Prices in the model represent price factors other than money; specifically, China shock for example. Theses prices do not have a significant effect on production.).
There are other analyses where China's influence is negligible. The remark referring to insufficient degree of freedom (data amount) is true, but that is taken into account in concluding if it is statistically significant or not. Using monthly data is a fine proposal and I would like to try that. On the other hand, since change in monetary base is carried out intentionally, we can say that a cause and effect relationship exists.

Speaker
    Perhaps it would not be a problem if labor productivity did not drop in the 1990s.

Harada
    Labor hours and production fell because real wages rose due to deflation and labor demand decreased. It would be a big problem if employment and production fall.


Session 2: Financial crisis and banking reform in Japan

1. Presentation by presenters

(1) Anil Kashyap    "Solutions to Japan's Banking Problems: What might work and what definitely will fail"
    In order for banks to obtain sufficient profit to accumulate net worth, a profitability miracle along with a continuation of extremely low interest rates for several years is necessary. It appears that the problem of Japanese banks cannot be solved merely by an economic recovery. Further drastic restructuring is needed. A voluntary solution by the private sector is preferable for this rather than government measures.
(Paper: "Solutions to Japan's Banking Problems: What might work and what definitely will fail (PDF-Format 343KB)")

(2) Joe Peek    "The Japanese Banking Crisis: It's Not Over Until the Fat Lady Sings"
    The misallocation of bank credit in Japan, as banks have attempted to protect their own balance sheets, has allowed zombie firms to continue to operate, delaying the restructuring that is necessary to return Japan to an era of robust growth. While progress has been made in reducing the volume of nonperforming bank loans recently, substantial risks remain. For example, banks face risks of substantial capital losses on their massive holdings of Japanese government bonds as interest rates rise as the economy recovers, and banks still have not yet developed a competitive advantage that can ensure consistent profitability, although they are upgrading information technology capabilities and trying to expand activities into new services. Still, one can be somewhat optimistic that the end of the banking crisis is finally near, given the evidence that market forces are at work in the Japanese economy as cross-shareholding diminishes and buyout firms and investment funds become more involved in acquiring and turning around Japanese firms.
(Paper: "The Japanese Banking Crisis: It's Not Over Until the Fat Lady Sings (PDF-Format 70KB)")


2. Comments by discussants

(1) Masaya Sakuragawa(on Kashyap's presentation)
    Overbanking (used in the sense of overlending) is due to overdeposit (deposits which exceed lending capacity) as well. This made its way to zombie companies in the 1990s. Overdeposit is due to lack of corporate governance. Japanese banks aimed for the maximization of lending. This led to non-performing loans, overbanking, and lack of capital. The inadequate enforcement of capital adequacy ratio regulation is also a problem.

(2) Tsutomu Watanabe(on Peek's presentation)
    It is necessary to differentiate main banks lending to firms with problems of liquidity (not zombie companies, but those with temporary problems). Did loans to zombie companies reduce loans to healthy companies? There is ample money supply and there was no increase in issuance of corporate bonds.
(Paper: "Comments on Peek paper (PDF-Format 129KB)")


3. Q&A

Kashyap
    If the capital adequacy ratio were properly regulated, overlending would not have occurred and improvement in efficiency would have taken place earlier.

Speaker
    Capital injection should be discussed together with management reform. In Japan, capital reinforcement was carried out with public funds. Without management reform of existing banks, public funds will be put to waste.

Speaker
    Depositors do not pay attention to risk because of deposit insurance.

Speaker
    If there are governmental financial institutions, banks cannot make profit.

Speaker
    I don't think there is overbanking in Japan. The reason for low ROA is a bad financial system.

Kashyap
    Expanding deposit insurance is not a good idea. Competition with the postal savings system does hurt the banks, but that has not prevented them from trying to develop and market higher margin products and services. When they have tried to come up with such products and services they have not been successful.


Session 3: Change in the Japanese economic system

1. Presentation by presenters

(1) Kiyohiko Nishimura    "Fixed-Cost Economy: Understanding Japanese Industry-wise Labor-Input Adjustment in 1980-2002"
    Japanese firms still value a long-term relationship with its employees and business connections. This means that Japan (on a short-term basis) is a fixed-cost economy. Employment adjustment is on a long-term basis for the most part (even for many part-time workers). Since the burst of the bubble around 1990, Japanese firms have slowly but firmly made adjustments to reduce fixed labor costs. The contraction of indirect sectors and a drastic rise in the ratio of part-time workers are characteristics of this adjustment.
(Paper: "Fixed-Cost Economy": Understanding Japanese Industry-wise Labor-Input Adjustment in 1980-2002 (PDF-Format 300KB)")

(2) Keiko Murata, Masahiro Hori    "End of the Convoy System and Market Discipline"
    Financial administration in Japan is undergoing change from the so-called convoy system to a market-oriented model since the 1990s. Accordingly, we have verified the validity of market discipline among depositors in the 1990s using financial data of small and medium-sized regional financial institutions (panel data of 687 credit associations and credit cooperatives). Results indicate that discipline among depositors functions fully even in credit associations and credit cooperatives which are mainly composed of small amount depositors. Furthermore, the nature of its effectiveness is one that can be fully increased according to the design of the system's scheme.
(Paper: "End of the Convoy System and the Surge of Market Discipline: Evidence from Japanese Small Financial Institutions (PDF-Format 100KB)"

(3) Satoshi Shimizutani    "Change in Japanese Employment Practices in the 1990s"
The long-term employment and wage seniority have been discussed as notable characteristics of Japan's employment practices. In the 1990s, average years of tenure in a firm increased, rather decreased, with the exception of male workers in their 30s. The wage curve by age still has a steep slope. The slope is slightly flatter for male workers and slightly steeper for female workers.


2. Comments by discussants

(1) John Fernald (on Nishimura's presentation)
    Empirical tests are difficult. It may be due to nonelasticity of labor supply, rather than fixed cost. Is there change in production because of change in productivity and operation rate, since there is fixed cost? Working hour per capita is changing in the US.
(Paper: "Comments on Professors Nishimura and Nagahama, "Fixed Cost Economy: Understanding Japanese Industry-wise Labor Input Adjustment..." (PDF-Format 25KB)")

(2) Jenny Corbett (on Murata and Hori's presentation)
    In the deposit supply function, variables of interest, income, and region are necessary. With the partial lifting of the moratorium on payoff, if depositors shift to deposits still covered by payoff, there is concern that discipline may decline. This can undermine the desired effect of policy. If Japan truly aims for a system governed by depositors' discipline rather than by the protection of depositors, deposit insurance should be abolished. In addition, the transparency of credit associations should be improved and depositors should be educated so thatthey can distinguish superior credit associations.
(Paper: "Comments on "End of Convoy System and the Surge of Market Discipline" by K Murata and M Hori (PDF-Format 23KB)")

(3) Kiyoshi Ohta(on Shimizutani's presentation)
    Although there is question regarding bias resulting from the influence of longer years of service of workers with high capacity who are detained by firms, this influence of capacity can be eliminated to a certain degree by the repeated cross-section analysis in this report. Also, comparison with the American case is useful.


3. Q&A

Hori
    We did not verify the validity of policy. Rather we indicated that when market discipline becomes necessary, the necessary condition that depositors will take such action is fulfilled.

Speaker
    Depositors with loans from credit associations should be distinguished from other depositors. May it not be the case that such depositors changed their deposit accounts to demand deposits since they cannot transfer their deposits to other financial institutions?

Speaker
    I would like to see analysis on how market discipline influenced interest. Credit associations with high risk should have to set their interest high.

Shimizutani
    Although I think there is bias in the coefficient on tenure years, I don't think the degree changed through the 1990s.


Round Table Discussion I: The sustainability of the current economic recovery in Japan and policy requirement

1. Presentation by lead speakers

(1) Hiroshi Yoshikawa
    Rise in labor productivity and development of new products are important for economic growth. Structural reform is not only supply side policy, but also demand creating as well. The latter is very important. Even if population drops, the sustainable growth of over 2% is possible.

(2) Randy Kroszner
    The key to Japan's growth from now on is productivity. To raise productivity, the elimination of obstacles for competition and the distribution of resources by the market; the promotion of privatization accompanied by clear and ensured property rights; the provision of a transparent and effective corporate governance; the preservation of a stable economy and low tax rates are necessary.
(Paper: "Promoting Global Economic Growth: The Productivity Challenge (PDF-Format 73KB)"


2. Q&A

Speaker
    Movement of the population must be taken into consideration. In addition, the Bank of Japan must not abandon the zero-interest rate policy, saying that the present economic growth rate is fair. It must be maintained. Time is not right for fiscal restructuring yet.

Speaker
    The labor market is becoming flexible. It is similar to that of the US rather than Europe's.

Speaker
The present policy of the Bank of Japan is in the broadest sense, an inflation target policy. As a condition, core CPI must be more than zero in order to not to return to deflation. The important thing is to stabilize expectation. In order to do so, it is necessary to communicate with the market step by step.

Speaker
    There will be no demand without restructuring zombie companies.

Speaker
    Technological advance in the non-manufacturing sector is necessary. Moreover, a higher retiring age is necessary to cope with an aging population.

Speaker
    Since growth depends on the China factor, it will fall on a short-term basis. However, because employment adjustment is reaching its end, in the long run, growth will recover.

Speaker
    Since debts, production capacity, and excess labor have been resolved considerably and growth centers on internal demand, recovery is sustainable.

Speaker
    The rise in employment of young people and an increase in young people that lack skills are insecurities for growth.

Yoshikawa
    An aging population creates new demand such as robots for the care of the elderly. In the 21st century, an aging population will become a global phenomenon, including China. If Japan's technology development advances in this field, it would surely be a source of international competitiveness for Japan in the future.


Round Table Discussion II: The picture of the Japanese financial system after economic revitalization (with around year 2030 in perspective)

1. Presentation by lead speakers

(1) Takeo Hoshi
    Japan's pre-war financial system was market-oriented. Households' financial assets are held predominantly in the form of marketable securities, and the corporations depended more on financing though bonds and equities than bank financing. During the war and the immediate post-war period, heavy financial regulation suppressed the working of the financial markets and increased the role of banks. The regulation continued during the rapid economic growth period and the bank-dominance came to characterize the Japanese financial system. Following the gradual financial deregulation that started in the late 1970s, the Japanese financial system started to change from the bank-dominated system to a securities market oriented system. The Japanese financial system in 2030 will be a market-oriented system. Any reform plan of governmental financial institutions and FILP must be consistent with this transformation of the financial system from a bank-dominant one to market-oriented one. It is important to note that "privatization" is neither necessary nor sufficient for a reform plan to work. The government financial institutions may have played important role in the past, but their role has been diminishing and will continue to diminish. It is thus important for any reform plan to make it possible for these government institutions to shrink as their role declines.
(Paper: "Future of the Japanese Financial System (PDF-Format 248KB)")

(2) Naoyuki Yoshino
    Analysis of the behavior of Japanese banks during the period of financial instability in 1982-1995 showed that banks were not engaged in maximization of profit and that lending exceeded the level of profit maximization. The action of banks followed the principle of maximization of revenues under the restriction of obtaining fixed returns. The demand for postal savings depends primarily on the number of post offices and fixed amount savings. Postal savings increased in regions where financial institutions went bankrupt. Since postal savings are not in the red, savings are ensured, and there are post offices nearby, the Japanese people do not support its privatization. Competition will be enhanced by using the post office as a marketing base for financial products of the private sector.
(Paper: "An Empirical Analysis of Japanese Banking Behavior in a period of Financial Instability (PDF-Format 52KB)")

(3) Yuko Kawamoto
    The final goal of reform is made clear by discussing the financial system in 2030. The two pillars of the goal are 1) complete withdrawal of government as a shareholder of private financial institutions, and 2) abolition of the loan function of governmental financial institutions. This will allow the Japanese financial system more private-controlled and sustainable. As aging in society develops further, the overall saving ratio in household will continue to fall, and financing in Japan is likely to depend on more from abroad. As a result, rules of the global capital market will be broadly applied in Japan, and transparency and accountability will continue to be keywords.


2. Q&A

Speaker
    Downsizing governmental financial institutions is politically difficult. Debtors are satisfied, and ensuring employment for workers is a hurdle. A market solution through privatization is better.

Speaker
    Since the saving rate will fall drastically, Japan will come to depend on overseas capital. Also, since the working population will pass its peak, there will be a drop in ROA and capital will shift to the US.

Speaker
    The government should standardize reverse mortgage.

Speaker
    Whether there will be marketization of core parts of financial affairs is skeptical. Since the financial system is complementary to other systems, the financial system alone will not bring change.

Speaker
    The inspection of the Financial Services Agency on governmental financial institutions should be made equal to that on private financial institutions. Government guarantee for governmental financial institutions should be gradually abolished.

Hoshi
    Complementarily is important, but it does not imply the system as a whole cannot change. Indeed, a change in the financial system is likely to cause the other parts of the economic system to change. Privatization of the postal savings may not be necessary. An alternative is to convert the postal savings into a narrow bank (core bank) with the government's guarantee on the postal deposits intact. One of the important benefits of this alternative is that it allows the government to get rid of the guarantees or insurance on bank deposits, which creates serious moral hazard problems as many speakers today pointed out.

Yoshino
    Reverse mortgage did not go well due to a drop in land prices and because children receiving inheritance disliked it.

Kawamoto
    The trigger for change in the financial system is disclosure. Costs hidden to the public will become clear and this will change the attitude of the public.

Speaker
    I would like to thank the numerous response we received for the questionnaire regarding how the financial system is likely to be around 2030. The response pointed to a similar direction.


Q&A with the press

Q)
    What is necessary for a sustained recovery of the Japanese economy?

A)
    We need to proceed with structural reform.


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