Inflation

Many policymakers during this time in Japan may have hastily made responses to economic policy, without fully and accurately forecasting potential rates of inflation. There were implications and fluctuations of macroeconomic stability for Japan in the mid-1990s and through the early 2000s.

To fully understand what was happening during the late 90s and 2000s, it is important that we understand what took place the decade or so prior to this timeframe. Focusing on monetary factors, it is important to note the widespread market expectations that the then low interest rates would continue for an extended period, in spite of clear signs of economic expansion within the country of Japan during this specific timeframe. The boom toward the end of the 80s was referred to as the Heisei boom, where prices increased dramatically under long-lasting economic growth and stable inflation, which many often refer to as the “bubble period”. Okina et al (2002) define the “bubble period” as the period from 1987 to 1990, from the viewpoint of the coexistence of three factors indicative of a bubble economy, that is, a marked increase in prices, an expansion in monetary aggregates and credit, and an overheating economy (Okina & Shiratsuka, 2002).

As reported by Okina et al (2002), the expected growth rate of nominal GDP computed from the equity yield spread in 1990 is as high as 8% with the standard assumption based on the discount factor, but one may argue that in view of the low inflation at the time, it was unlikely that the potential growth rate of nominal GDP was close to 8% (Okina & Shiratsuka, 2002). Although the importance of cyclical aspects cannot be denied, further declines in asset prices after the mid-1990s seem to reflect the downward shift in the trend growth rate beyond the boom-bust cycle of the price “bubble”.

Against the background of financial liberalization, many banks were only allowed to enter the securities business gradually, thus banks were concerned...