It Takes More than a Bubble to Become Japan

Abstract

Did monetary easing in the 1980s cause Japan's bubble, as is often suggested? Drawing on both a new cross-national consideration of the monetary policy-asset price linkage and a reexamination of what actually occurred in Japan during 1985-90, I conclude that the bubble was just as likely to occur, whatever monetary policy within reason would have done. Did the bubble's bursting cause Japan's Great Recession? In fact, Japan's recession of 1990-94 was mild, and only a combination of policy mistakes turned this normal recession into extended stagnation. This is borne out by cross-national investigation suggesting that the frequency of extended downturns following asset booms is relatively low. Comparing the post-bubble response of the US and Japanese economies, did the bubble itself impede restructuring? Given very different responses in the two economies to similar bubbles, a bubble itself is not sufficient to cause real-side disruption. Central bankers should learn from Japan's bubble the benefits of a more thoughtful approach to assessing potential growth and of easing rapidly in the face of asset price declines and not be concerned with targeting asset prices or pricking bubbles per se.