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There is a significant difference between Japan’s economy in the last half of the 1980s and the recession that came before stagnation in the 1990s. It became a legendary miracle just as it had happened in the 1960s when Japan had stunned both itself and the world by emerging as a severe economic power. Japan was unable to adjust to the changes, and it is at this time that it started to experience stagnation. It is believed that the ideational and institutional matrix constructed to deliver an economic growth comeback in the 1970s is the one that has affected the fate, content, and direction of the economy in the bubble, bust, and reform era since the 1980s (Garside, 2012, pp. 1-3). After being defeated in the war, Japan concentrated on development in several ways, including the government offering incentives to the best firms and sectors. It also relied heavily on the exports and the expansion of its markets overseas to balance the import deficit. High tariffs and quotas were used to protect the growing domestic firms in their infancy. However, it failed to win the national political guarantees, thus limiting foreign investment penetration and a dependency to the American market. This essay aims to discuss the Monetary Policy in Japan and will cover the growth period (the 1960s), the dollar and oil shock (1970s), the bubble era (1980s), and the lost decade (1990s).

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High Growth Period of the 1960s

Japan’s active growth period is considered to have begun at the point when approximately 86% of the GDP was lost during the Second World War (Shirakawa, 2011, p. 2). The period started in the mid-1950s and reached a climax during the initial years of the 1970s (Shirakawa, 2011, p. 1). During this span of 15 years, the economic growth of the country stood at 10% annually (Shirakawa, 2011, p. 2). Three factors mainly enhanced this development. First, favorable demographics, where the total population had an annual growth of 1%, provided a large population of working youths who supported the economy both in the consumption and production (Shirakawa, 2011, p. 2). The farming population had reached 40% of the total people. This enabled city migration that helped boost productivity in the manufacturing sector (Shirakawa, 2011, p. 2). Second, the use of competitive forces in which entrepreneurship and innovation were promoted helped Japanese firms to be at the same level as the rest of the advanced economies. Third, there was the advantage of global free trade. Japan produced both consumer and producer goods for the expanding global market that enabled it to earn foreign exchange. That, in turn, helped in the importation of raw materials to promote the domestic market.

Oil and Dollar Shock (the 1970s)

The outsiders were mesmerized by Japan’s high growth as it concentrated on the reconstruction of the political economy to meets its post-war needs without paying attention to the rapidly changing global world. The oil shock resulted in the prices skyrocketing from $ 2.18 in 1971 to $ 5.12 in 1973. They then further shot up in 1974 to the highest rate in that era at $ 11.65 (Mihut and Daniel, 2012, p. 1042). It was this oil prices increase that affected the Japanese economy in three ways that include trade deficit, inflation, and economic recession. The oil shock made Japan sink into an economic downturn where it recorded a falling of approximately 10%. This decline was higher compared to other strong economies like the United States at 6% and the United Kingdom at -8.5% (Mihut and Daniel, 2012, pp. 1042-43). The condition powered the propensity to consume since Japanese purchasing power was significantly reduced. The decline in the production of the manufacturing sector and the increased cost of fixed assets resulted in trade deficits that would require urgent fiscal policies to counter. The government resolved to reduce the interest rates from 9% to 6.5% four times in a span of six months from April 1975 to October 1975 as well as public works execution (Mihut and Daniel, 2012, pp. 1042-43). Regarding inflation, Japan was highly affected as compared to the other major economies. As for the consumer prices, it registered an 18% inflation to stand at 23.20% from 5% about the United States with 9% and Britain with a low of 7.5% (Mihut and Daniel, 2012, p. 1043). The high inflation in Japan is due to its dependence on thermal electric plants that use oil.

The Bubble Era of the 1980s

The bubble and its collapse period happened during a time of economic decline in the Japanese economy, and this was due to several reasons that include the direct effect of collapsing the bubble. Private sectors experienced the balance sheet problems that constrained expenditures, as well as the banking industry capabilities. There was also the factor of deteriorating and non-performing loans. It resulted in a weak economy in the 1990s, but it was not the reason the growth period started (Shirakawa, 2011, p. 3). The second factor is that the model that had been set to promote growth was no longer compatible with the changing global market, while the emerging economic giants in Asia embraced the advancements in technology, making the global competition more intense. Third, the demographic changes decreased production since the working population had reduced in the mid-1990s (Shirakawa, 2011, p. 3). The population is aging rapidly at a pace that has not been experienced previously.

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With the decreasing economic growth, the country also experienced inadequate financial supervision. Lending to non-bank financial sectors, real estate, and construction increased rapidly at the same time lending conditions softened. The monetary accommodation due to the low inflation played a part, since it acted as a check to lower current account surplus and protect the strong yen.

The Subsequent Lost Decade of the 1990s

In the period of the 1990s, the economy of Japan was stagnant with an average growth of slightly over one percent since 1993 to 2003 (Ito and Mishkin, 2006, p. 131). The inflation measure in either Consumer Price Index (CPI) or gross domestic product (GDP) reflects a negative. For instance, in 2003 deflation was 3% below the level registered in 1997 (Ito & Mishkin, 2006, p. 131). In the same time span, the United States’ economy has experienced a 12% growth. The Japanese nominal GDP reduced by 4% from 1997 to 2002, while that of United States increasing by 25% (Ito and Mishkin, 2006, p. 131). Many factors have been pointed out as contributors to the lost decade, Nonperforming Loans and burst bubble being among them, especially in the initial stages of the period of stagnation. By 2003, stock price and land fell to around 1/3 and ? in 1989 and 1991 respectively. The response was slow to the nonperforming loan issue, and this led to the 1997-1998 banking crisis, which caused the weakening of the financial sector (Ito and Mishkin, 2006, p. 131). The income tax repeal of 1997 together with the tax rate increase on consumption was a fiscal policy mistake. Moreover, the organic sector’s slow reforms was another problem that had not got the advantage of the advancement in information and communication technology (ICT) that, on the contrary, has propelled the United States.

The monetary policy was the greatest failure that led Japan into inflation, since inflation is a monetary phenomenon. Despite its numerous efforts, Bank of Japan (BOJ) was not in a position to deter the increase from running it negatively. Even with lowering uncollateralized call rate virtually to zero in the period between February–March 1999, the call rate was raised by the BOJ to about 2.5% in August 2000 amidst protest from economists and the government. It later lowered the rates to zero once more in March 2001 (Ito and Mishkin, 2006, p. 132). The financial institutions weakened yet again in 2002 and, since the reintroduction of the zero interest rate policy, was to wait until the time the consumer index would be slightly above zero. The condition presented itself in 2003, but the board did not forecast in lowering back to deflation.

Masakaru Hayami Regime (1998-2003)

With the newly independent Bank of Japan in 1998, there were high hopes of BOJ improving the situation to the level of the previous decades of monetary success, but this was never to be the case (Ito and Mishkin, 2006, p. 141). The Hayami regime of five years had made the BOJ lose credibility and encountered serious problems in the process. Two reasons led to this situation, with the first being that the board members under the leadership of Hayami had misjudged the prevailing economic conditions, and mostly due to being eager to get to the level they had enjoyed in the period where they experienced desirable interest rates. For instance, the hike of the interest rates that happened in August 2000 was one of the mistakes (Ito and Mishkin, 2006, p. 142). Second is that the board members of the BOJ took their independence too seriously and did not want to offer the necessary cooperation when the need arose. Since the independence of the BOJ was considered important, especially in the establishment of credibility, policy actions became timid, tentative, and conservative. In 1998, the Japanese economy was in serious trouble of falling into financial instability and recession. This was due to the effects of economic instability of 1997 that had become prominent. One small bank and one large bank, medium-size Securities Company, a large securities company had all failed as financial institutions had become limited. The quantitative tactic did not work either, particularly in the raising of long-term bonds from September 2001 at 400 billion yen a month to October 2002 at 1.2 trillion yen a month (Ito and Mishkin, 2006, p. 143). It is evident that Hayami Regime sunk the country to greater deflation.

Toshihiko Fukui Regime (2003-2008)

Fukui Regime continued with the quantitative easing, but when the deflation continued to sink deeper, he embraced the “orthodoxing” Monetary Policy in 2006. It shifted its current account balance targeting lending rates. The BOJ maintained zero interest rates to allow the withdrawal of the liquidity from the economy to avoid disruption, and the interest rate was raised 0.25% after that. It further implemented an increase of 25 points basis to equal nominal rates of interest at 0.5% (Bernanke, 2016). These efforts gave hope of the economy getting out of the trough. Fukui maintained that it was important to plan against inflation. However, his strategy was met with skepticism. Additionally, in the bank sector, he had expressed his fear of the prolonged zero interest rates and opted for a phased small interest rate hikes so as to attain sustainable economic growth. The deflation seemed to be dealt with since inflation rate was at 0.2% in 2006 (Bernanke, 2016). It was now clear that the economy had taken a recovery trend.

Possible Solutions to Japan Monetary Policy

The first solution involves an understanding of the fact that the interest rates adjustment is not the primary solution to the deflationary pressure, since this way will not solve the deflation aspects in other sector’s assets prices collapse, investment spending, and the banking problems. Therefore, it should apply the aggregate demand while supplementing it with the monetary policies. Second, in the modern market, zero interest rate should be avoided as the current economy makes more use of the credit, unlike the nineteenth century. Economic measurements in the price index bias are crucial in the contemporary economy, unlike in the past 100 years, where deflation or zero inflation was not a significant issue (Bernanke, 2016, pp. 151-156). The treasury ought to adopt long-term open market operations debt since the monetary conditions in Japan are ineffective to support short-term loans (Bernanke, 2016, pp. 151-156). It is the time for Japan to consider other ways of solving its prolonged economic stagnation.


Japanese monetary policy by the central bankers today is irrelevant and should adjust with regard to the global market. In this case, I recommend some measures that the monetary authorities would use to stimulate the economy. The monetary policy would be more effective if it focused on dealing with the price levels and the aggregate demand. This is the best way to get out of the liquidity trap by making the market adjust itself due to the consumer interaction with the market. This will mean that even considering the external forces, the domestic market will be in a position to help in the adjustment of the market by providing a realistic change to the supply and demand. The BOJ should avoid being vague in its monetary policies. In this case, they should give definite and precise information so that private institutions may make critical decisions based on the information provided in a more articulate way, depending on the condition of the macroeconomic (Bernanke, 2016, p. 159). Another way in which the deflation can be brought about is through a slight depreciation of the yen via open market. Its import inflation effects will jump-start the deflation journey in Japan.


In summary, the phenomenal economic growth in Japan in the 1960s was as a result of the combination of the age bonus where the working population was high and the oil prices were relatively insignificant besides having a broad market. Oil and dollar shock was the turning curve for the rapidly growing economy. This happened because Japan had been relying on the thermal electricity generated by use of oil. Therefore, with the oil prices sky-rocketing, it had an increased cost of production and loss income generation. This also happened when the country was still mesmerized by the previous success. Thus, the monetary policies were formulated when it was already too late. It is out of this panic that the decisions made during the bubble era failed to help the economy back to its best. Subsequent Lost Decade of the 1990s came about as a result of mixed aspects of the economy that involved the collapse of the leading economic institutions, such as the banks regarding poor performance on the loans. The Masakaru Hayami Regime was full of confusion and had failed to read the market, thus making uninformed decisions that proved counterproductive. Toshihiko Fukui Regime, on the other hand, was well informed and with the “orthodoxing” monetary policy the economy seemed to get back on track. Finally, the action that the Japanese economy requires is the use of aggregate demand so that it can solve all the sectors of the economy.

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Executive Summary

The Japanese economic curve is an excellent case study for any country that has enjoyed a period of high growth and is in a downtrend. In 1960s, the economy was doing great, but declined in the subsequent years due to poor monetary policies. During the High Growth Period, the working population was plentiful, so high productivity, the low prices of oil, and the large market base for the manufactured products helped the development. Production cost was relatively low with foreign exchange to purchase imports being high. During oil and dollar crisis, oil price shot from $ 2.18 in 1971 to $ 11.65 in 1974, and this created a huge economic problem in Japan. Oil was the primary source of energy in the production of electricity. The high cost of oil meant the high cost of production. This also meant that the yen lost value against the other main currencies, so the imports became expensive. Bubble Era was the period when the economic infrastructures, such as the banks, worked inefficiently, and this led to constrained expenditure. The loans were non-performing, and this resulted in a weak economy. The country’s economy was also not compatible with the changing global market. Lost Decade was the period when both the GDP and the CPI showed negative inflation. The GDP reduced by 4% in a span of 5 years. This era of stagnation was a result of the burst of the bubble era that had led to the collapse of institutions. Hayami regime was a failure, mostly due to making uninformed decisions that did not meet the market conditions. Hayami and his board failed to cooperate with other institutions when it mattered. One the other hand, Fukui regime embraced the aggregate demand, which seemed to work.

Japan needs to solve its economic situation from a comprehensive point of view, so that it can cover all industrial sectors. Interest rate adjustment should not be taken as the primary monetary policy, but should be a supplement to other methods. It is, therefore, advisable that Japan uses the price level and aggregate demand approach.

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