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October 13, 1997

New book by UCSC economist examines Japan's "bubble economy"

Michael Hutchison

By Jennifer McNulty

When Japan's powerhouse "bubble economy" of the late 1980s burst on the last day of 1989, it signaled the end of phenomenal growth and more than two decades of rapid overseas business expansion. The remarkable combination had provoked discussion among economists, who have continued to watch the country's subsequent reforms nearly as closely as the policies that contributed to impressive growth.

One of those who has tracked the roller-coaster ride of Japan's modern economy is Michael M. Hutchison, a professor of economics at UCSC. Hutchison is coauthor of a new book, The Political Economy of Japanese Monetary Policy (Cambridge, MA: MIT Press, 1997), which provides a detailed analysis of what went right, what went wrong, and where Japan is headed now.

"During the 1980s, a lot of credit for Japan's success was aimed at their management techniques, their educational system, their trade policies--even the harmony of their traditional culture," said Hutchison. "What we've tried to do is look at their successes and failures within the context of Japan's financial and monetary systems."

The book covers the history of the modern Japanese economy from about 1975 to the present; monetary and exchange-rate policies; the banking crisis that began in 1990 and continues today; and Japan's political economy--the politics of business cycles, oversight of its central bank, and reforms adopted in the wake of the downturn.

"Basically, Japan went from an economy that was enjoying above peak level growth in the last half of the 1980s, with soaring real estate and stock prices and major overseas expansion of banking operations, to a 60 percent decline of asset prices within about two years," said Hutchison. "It's a decline that rivals the Great Depression, and they've been working through it ever since."

The book describes the impact of the "bandwagon effect" on the bubble economy. "We call it a bubble economy because it wasn't supported by the fundamentals," said Hutchison. "Investors were buying up stocks at inflated prices not because they expected a solid dividend return but because they expected further gains in the value," said Hutchison. "Real estate prices were so out of line that at one time the land beneath the Emperor's Palace in Tokyo was considered more valuable than all of California."

Although the collapse was anticipated by many economic observers, experts had been intrigued for years by another compelling aspect of the economy's performance: From 1975 to 1994, Japan enjoyed an inflation rate of only 2 percent--the lowest in the industrialized world. "We had to ask ourselves how Japan was able to deliver this," recalled Hutchison. "Clearly, you didn't need high inflation to have high growth. Japan had the best of both worlds."

Hutchison and his coauthors Thomas F. Cargill, a professor of economics at the University of Nevada at Reno, and Takatoshi Ito, professor of economics at the Institute of Economic Research at Hitotsubashi University, credit Japan's central bank with adopting conservative policies after the 1973 oil crisis sent inflation soaring to 20 percent. "It's not that Japan had a particularly independent central bank from a legal perspective," said Hutchison. "Rather, they had a very tough-minded bureaucracy that resisted party politics."

In the wake of the banking crisis, political pressure focused on the Ministry of Finance, which ironically sought to deflect charges of incompetence by offering up the central bank for reform. "There was no problem with the central bank," noted Hutchison. "But the Ministry of Finance granted the bank more independence at a time when most countries suffering from very high inflation were seeking to give their central banks more autonomy from the whims of politicians."

If anything, the Ministry of Finance itself suffered from a tendency to micromanage the terms of financial regulations while operating under a set of unwritten rules that favored personal relationships, said Hutchison.

Hutchison and his coauthors devote two chapters to Japanese exchange-rate policy, which is Hutchison's specialty. Although the value of the yen has fluctuated over the past 25 years, Japan has for the most part enjoyed long-term appreciation of its currency--another important factor that helped gird the country's economy, said Hutchison. "We give a lot of credit to the monetary policy side of things," he noted. "It has been quite well run."

By contrast, Japan's financial system has not fared so well, and Tokyo is scrambling to gain ground with the international financial powerhouses of London, New York, and Singapore. "Japan's system of limited foreign access, unwritten regulations, and discretionary decision making has not allowed it to keep up with the demands of the world economy. Even Japanese corporations go abroad for financing now," said Hutchison. "Japan is having to run as fast as it can to modernize and update its policies, and it remains to be seen whether it is flexible enough to adapt to modern realities."

Hutchison and his coauthors have already signed a contract with the MIT Press to publish a follow-up book that examines Japan's push to modernize its financial system.

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