Financial Institutions

Japanese Government Response to the Banking Crisis

* The effects of the 1990 banking crisis were still being felt in 2005, as Japan was stuck in a

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* State of stagflation, which means a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high.

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* Critics argue that the government response not only lacked commitment, but was simply too little, too late.

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* In terms of monetary policy, the Bank of Japan took five years to reduce interest rates to the 0% nominal bound.

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* And in terms of fiscal policy, government account balances only turned significantly negative as of 1995.

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* This data demonstrates that Japanese policy makers underestimated the extent of the 1990 bust and ensuing banking crisis.

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* Consequently, the immediate response was slow and not nearly aggressive enough.

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* In terms of the long-term response, the government decided to provide subsidies to banks, that would otherwise fail, and by pushing them to extend credit to firms despite limited prospects of repayment.

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* Japanese banks are today both dependent and paralyzed by these subsidies, coining the term “zombie banks”

Japanese and U.S. episodes were both caused by similar factors. The financial architecture (deregulation and liberalization, innovation and monetary easing lead both cases to large price swings. Measures need to be taken.

* Regulation and liberalization, new international and domestic regulation started in U.S. (Financial Stability Board, Basel III and the Dodd Frank Act) (stricter capital requirement of a ban on proprietary trading, they limited banks).

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* Keep up with innovation, while financial innovation is not bad per se, regulation has failed to keep up. Efforts to improve financial efficiency improvement need to continue, but regulatory bodies also need to keep up.

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* Conservative monetary policy,...