Japan Offers a Possible Road Map for U.S. Economy

Japan Offers a Possible Road Map for U.S. Economy

By MARTIN FACKLER
Published: December 19, 2008

TOKYO — When the Federal Reserve cut its benchmark rate to virtually zero earlier this week, what was a historic move in Washington seemed old hat here in Tokyo.
The Bank of Japan kept rates near zero for most of the last decade in an effort to end a long economic stagnation, and raised them only two years ago. Many economists say they believe that the zero interest-rate policy finally worked in Japan after regulators took aggressive steps that succeeded in restoring faith in Japan’s financial system and Tokyo’s ability to oversee it.
Now, with the Fed and President-elect Barack Obama turning to the same sorts of unconventional policy tools to battle the worst global economic crisis since the Depression, economists and bankers say they hope that Japan’s lessons are not lost on Washington. They say the United States needs to take the same kinds of confidence-building steps, and much more quickly than Japan did.
“Japan had years of trial and error to gets its response right, but the United States doesn’t have that kind of time because markets are changing so fast,” said Akio Makabe, an economics professor at Shinshu University. “The Fed has to move, and has to move fast, to restore confidence.”
On Friday, the Bank of Japan cut its benchmark rate to 0.1 percent, from 0.3 percent, saying in a statement that it was following the Fed’s “dramatic rate cut” to lower borrowing costs and jolt global demand. On Tuesday, the Fed lowered short-term rates to a range of zero to 0.25 percent, and vowed to pump money directly into the credit markets by buying mortgage-related debt and corporate bonds.
The Bank of Japan also announced that it would try to shore up Japan’s credit markets by buying commercial paper, a type of short-term corporate debt. Central banks in Europe have also reduced rates amid concerns the global economy could contract next year for the first time in decades.
Tuesday’s rate cut by the Fed also made short-term borrowing costs lower in the United States than in Japan for the first time in 15 years. This helped drive up the yen to 13-year highs, as investors tend to favor currencies that offer higher rates of return. The Bank of Japan said its rate cut on Friday was partly aimed at capping the yen’s gains.
The Bank of Japan first lowered interest rates to zero in 1999 for a year and then again in 2001 for five years. The Japanese central bank was trying to contain a domestic financial crisis not unlike the one now crippling global markets, in which collapsing real estate and share prices caused the bankruptcy of large financial companies, like Yamaichi Securities in 1997.
The central bank’s hope was that by lowering borrowing costs to virtually nil, it could encourage commercial banks to lend more money to businesses and consumers, rekindling demand.
Economists and former Bank of Japan officials say the biggest lesson they learned was that cutting rates alone has almost no effect when the financial system has fallen into a crisis as deep as the one Japan faced in the 1990s.
Japanese banks simply refused to lend in an environment where borrowers could suddenly go bankrupt, saddling lenders with huge, unforeseen losses. The Bank of Japan tried even more extreme measures, like using its powers to create money to essentially stuff cash into the nation’s commercial banks in hopes they would start lending again.
Exasperated central bankers found that commercial banks just let the money pile up instead of lending it out.
Economists say the United States faces a similar situation, after the sudden collapse in September of Lehman Brothers created fears of additional failures. Economists also fault Washington for its inconsistency in dealing with the financial crisis, leaving the impression that it does not have a clear strategy for dealing with ailing lenders.
In Japan’s case, economists and former bankers say, credit began to flow freely again only after 2003, when regulators adopted a tough new policy of auditing banks and forcing weaker ones to raise new capital or accept a government takeover. Economists said the audits finally removed paralysis in credit markets by convincing bankers and investors that sudden failures were no longer a risk, and that the true extent of problems at banks and other companies was finally being revealed.
Economists say Washington needs to do something similar to make banks and financial companies more transparent, and reassure investors that there were no more collapses like that of Lehman Brothers on the horizon.
“The United States needs to do it like Takenaka did,” said Anil Kashyap, a professor of business at the University of Chicago, referring to Heizo Takenaka, the former banking minister who started the 2003 audits. “We need someone to come in and give a good housekeeping seal to banks.”
Economists and former central bankers said another lesson from Japan’s experience was the importance of consistency. This became apparent in 2000, they said, during one of the bank’s more embarrassing episodes, when it raised interest rates, and lowered them back to zero a year later when the economy faltered.
Former Bank of Japan officials said they learned that bankers and investors would lend in difficult times only if they believed that rates would stay low for a long period, ensuring them adequate profits. By raising the possibility of future interest rate increases, the Bank of Japan dampened enthusiasm for lending, say bankers and economists.
“We learned that zero rates work by building expectations,” said Rei Masunaga, an economist and former director general at the Bank of Japan. “Zero interest rates take time to be effective.”

http://www.nytimes.com/2008/12/20/business/worldbusiness/20yen.html?em