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japan and delfation - 220 Takatoshi Ito Inflation Targeting...

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In fl ation Targeting and Japan: Why has the Bank of Japan not Adopted In fl ation Targeting? Takatoshi Ito 1 1. Introduction By any historical or cross-sectional standard, the Japanese economic slump from 1992 to 2004 has been quite unusual. The economy that was once regarded as ʻ number one ʼ fell into a state of low growth, falling prices, and chronic banking crises for more than a decade. 2 The average growth rate from 1993 to 2003 was just above 1 per cent, in contrast to the average growth rate of 4 per cent between 1975 and 1992. Slow growth was accompanied by disin fl ation in the fi rst half of the 1990s and, eventually, de fl ation since the mid 1990s. The de fl ation in prices was associated with a shrinking of the Japanese economy – a rare phenomenon among advanced economies. From 1997 to 2002, Japanese nominal GDP (in yen) shrank by 4 per cent, while the nominal GDP of the United States (in US dollars) increased by 25 per cent. Many factors have contributed to the stagnation of the Japanese economy since 1992. The long stagnation re fl ects the adverse combination of the negative wealth effects from the crash in asset prices, external shocks like the Asian currency crisis, and policy errors in bank supervision, fi scal policy, and monetary policy. In the early to mid 1990s, the burst bubble – a decline of stock prices by 50 to 60 per cent and the beginning of a long slide in real estate prices – meant that many corporations and households suffered from capital losses, and consumption and investment spending were curtailed. The most severely affected companies stopped interest and principal payments to banks. Non-performing loans became a serious policy problem by 1995. Large fi scal stimulus packages were implemented in the mid 1990s, and the call interest rate was lowered to an unprecedented level of 0.5 per cent in the fall of 1995. The stagnation of the Japanese economy from 1990 to 1995 can be largely explained by the extraordinary negative shocks to asset markets and the subsequent damage to the balance sheets of households and corporations. After the mid 1990s, policy errors prevented the Japanese economy from returning to a fi rm recovery track. The two opportunities for recovery in 1996 and in 2000 were followed by negative growth and a (near) banking crisis. After a long stagnation, the Japanese economy began to recover in 1996, partly due to 1. The author is grateful for comments by Governor Ian Macfarlane, Robert McCauley, Frederic Mishkin, Warwick McKibbin, and other participants of the conference. 2. Japan as No.1: lessons from America was the title of a book written by Ezra Vogel (1979). A comprehensive description and analysis of the Japanese economy up to 1990 is available in Ito (1992).
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221 In fl ation Targeting and Japan: Why has the Bank of Japan not Adopted In fl ation Targeting?
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