Global Financial Crisis Of 2008 & Japan's Economy

Introduction

Have you ever played with domino tiles?

(Source- Leader's Beacon)

When you strike one tile all the tiles all down, it causes a chain reaction; this is nothing but the domino effect where one event sets off a chain of similar events. 

This is what happened to a large extent in 2008- the housing market and financial market of USA fell and this effect spread throughout the world, globally major economies were affected

What led to the Global Financial Crisis?

The epic center of the Global financial crisis was in the housing market of the USA. Households borrowed more than what they could afford, banks provided loans at low-interest rates (Lund, 2018). Because of low-interest rates, the housing demand started to rise so did the housing prices. Credit was provided to subprime borrowers in the USA.

Soon the housing price hit its ceiling and started to fall. Households had accumulated more debt than the value of their houses (Lund, 2018).

In the housing bubble burst of 2006, the number of defaulters on loans increased drastically. Individuals no more could afford these mortgages. The value of the security on these mortgages was hit.

Banks had invested heavily on these securities since they were AAA-rated by credit rating agencies implying low-risk investment. But when the value of these securities fell there was a major liquidity crisis. Many financial institutes globally had purchased US mortgage securities. 

Well, renowned financial institutes like Lehman Brothers were shut down. There was a spillover effect to other countries since the foreign banks invested large sums in the US housing market

 (nd, 2018). The downfall of the US housing market led to an impact on foreign financial system and economies. 

There was a panic in the financial market globally- banking and financial sectors were in a downfall.

Every crisis in the world is mainly triggered by something first, so what exactly cause this crisis?

They can be divided into 3 broad categories-

1. Large risk appetite among individuals and institutes and deregulation 

1999 - Financial Services Modernization Act allowed the banks to use deposits and invest in derivative markets. The Commodity Future Modernization Act made credit defaults swaps and other derivatives deregulated (Amadeo, 2020).

Economic growth before the great recession was strong, unemployment and interest rates were low- this soon became the environment for housing demand to rise. The market expected the housing prices to rise, housing development firms started to borrow excessively. There was a sharp rise in risky borrowing. Subprime borrowers who had a high rate of defaulting loans were provided loans. 

Banks and lenders did not evaluate the borrowers’ ability to repay the loans, they did so mainly since they sold these large amounts of loans as mortgage-backed securities to investors i.e they were involved in “ originate and distribution business” where the banks’ balance sheet does not hold the loans anymore they sell it to external individuals as credit default swaps. Investors invested excessively in these securities since they were AAA-rated ( Bank of Australia, 2018).

2. Increase in borrowing among investors and banks

Financial firms and banks started to borrow heavily to purchase these securities since they expected the housing prices to rise and thereby lead to large profits. But, soon when the housing prices hit its ceiling and started to fall, investors and banks incurred heavy losses since they borrowed heavily ( Bank of Australia, 2018).

3. Lack of regulations in the housing and banking market

There was a lack of regulations on institutes that created and sold mortgages backed securities to investors. 

Subprime borrowers were provided loans at times since they overstated their income and there was a large delusion regarding the mortgage-backed securities being of low risk and safe.

Policymakers and the government hadn’t known the extent of bad loans being provided in the market. The heath of the financial system deteriorated. 

Now that we know what causes the crisis, let's have a look on how it impacted a country that strives to achieve greatness has the best Multi National Comapnies and has a booming techioloy sector- the birthplace of Toyota Motors, Mitsubishi finance and corp, Hitachi, Nissan motors, Nippon Telegraph communications. The country that always have come out stronger after every crisis- Japan

Impact on Japan from the Global Financial Crisis-

(Source- mrkiji -Bloomberg View)

Even though Japan had the least exposure to mortgage-backed securities, its economy was the hardest hit- the GDP fell by 12% with a drastic fall in aggregate demand globally (Satio, 2019).

Japan was comparatively less affected by the financial impact of the subprime mortgage crisis. Japanese banks did not invest in many mortgage-backed securities compared to the other economies.

Yet, the GDP of Japan fell more than the USA during that period- this was due to multiple consequences of the Great Recession Of 2008 (Satio, 2019)

A sharp fall in Japan’s exports since the US economy was facing a financial crisis, the people postponed buying houses, cars and electrical appliances, majority of the parts of these goods are manufactured and imported from Japan. The decline in the US economy’s demand led to a fall in Japan’s exports. The fall in exports led to a fall in export producing firms. These firms got their e intermediate goods from other production firms in Japan, with a decline in exports there was also a fall in other industries of Japan too (Satio, 2019).

There was an appreciation of Yen during the mortgage crisis. The Yen/Dollar exchange rate was above 124 in June 2007 but appreciated to 108 in August 2008 and then appreciated further below 90 by December (Satio, 2019). Such appreciation discouraged exports since it became expensive for other economics to import goods from Japan.

Further, there was a limitation in trade finance since the financial institutions fell apart. Leading to fall in International Trade by shard reduction in financing.

(Source World Bank, World Bank Indicators)

Fig- shows a sharp decline in exports from 2007 to 2009 in Japan

But, there was a limited impact on unemployment in Japan compared to other countries. The rise of Japan’s unemployment rate was at 3.9% at the beginning of 2008 to only 5.5% at its peak in July 2009 whereas the USA  had a 5% increase at the beginning of 2008 and went to 10% at its peak in October 2009 (Satio, 2019). This may be because there was a lifetime employment system prevailing in Japan. Firms don’t sack their worker and try to keep them on the payroll.

The Global Financial Crisis of 2008 emerged from the downfall in the housing market of the USA. There was a spillover effect of this crisis to Japan’s economy. Japan was affected by this external shock because of dominant reliance on its export sectors and weak domestic demand.

(Source- Hedgey-BRich)

Policy Measures

 Though the mortgage-backed securities that Japan purchased were small compared to the USA and other European countries and Japan’s bank sector was less exposed to toxic assets, still, Japan’s economy was severely affected (Sato, 2009).

Globally all economies were largely saved by Government intervention, or else the Great Recession of 2008 would have turned into the Great Depression of 2008. Central banks took actions to recapitalise lenders, buy up toxic assets, inject liquidity into the shrieking economies and lowered interest rates at times to zero per cent too.

Monetary Policies undertaken in Japan are branched out in three categories-

Bank of Japan’s monetary policy objective was to ensure stability in the financial market and facilitate corporate financing (Sato).

Bank of Japan took short term policies like-

Sustaining bank lending to enable more borrowing thereby increasing demand in the economy. To provide capital injections for banks to maintain a sufficient capital base and provide loans to the private economy. Intensive supervision was undertaken to review banks lending practices to ensure that Japan’s financial intermediary functions smoothly (Sato,2009).

BOJ undertook large monetary easing measures to overcome deflation. Well before the Lehman Shock.BOJ had already taken up zero interest rate from 1999 to 2000 then further it introduced qualitative easing policies from 2000 to 2006. These measures were taken to keep inflation under control and prevent it from worsening the economy (Momma & Kobayakawa).

Policy measures during the Great Recession

Provision of the US Dollar in the economy

BOJ agreed to US Dollar swap with the Feds of up to 60 billion US Dollars it further circulated US Dollar funds to economic agents in Japan. It continued to increase the swap amount from 60 billion to 120 billion US Dollars and in October 2008 it provided funds at a fixed rate for unlimited amounts against pooled collateral  (Momma & Kobayakawa). 

This continued till February 2010 and post that it was terminated since there was an improvement in the financial market functioning.

Reducing the policy interest rate

BOJ uncollateralized overnight call rate was reduced from 0.5% to 0.3% in October 2008 and further to 0.1% in December 2008 ( Bank of Japan). This played a major role in increasing the loan amount from 10 trillion yen to 20 trillion in March 2010 (Momma & Kobayakawa). By doing so they stimulated the domestic demand in the economy. With interbank interest rates being lowered it stimulated demand through providing accessibility of funds.

(Source Bank Of Japan)

Fig- Shows a sharp decline in interest rates from 0.5% to 0.1% over the Great Recession Period 

Measures to ensure market stability

In October 2008 3 fundamental measures were taken up (Momma & Kobayakawa).-

i) Improve the liquidity in the JGB repo market by making a range of JGB eligible for repo operations. The bank lowered the minimum fees rates applied to its security lending facility from 1% to 0.5% in October 2008 ( Bank of Japan). Further, it decided to provide subordinate loans to banks.

ii) Provide ample liquidity over the year-end

iii) Introduce the “complementary deposit facility”, under which the BOJ pays an interest rate of 0.1% to excess reserves (Momma & Kobayakawa). 

In December 2008 the amount of JGB  was increased from 14.4 trillion yen to 16.8 trillion yen per year (Momma & Kobayakawa). 

Measures to facilitate corporate financing

Since there was a large fluctuation in the stock market - it worsened the funding conditions for firms in the economy. BOJ further believed that because of this, the low-interest-rate policy won’t provide the needed impact in the economy.

It implemented an unprecedented measure of taking up corporate debts as collateral.

It implemented a special fund supply operation under which it provided funds over the fiscal year and for unlimited amounts against the corporate debt taken as collateral (Momma & Kobayakawa).

 BOJ expanded the range of corporate debt as eligible collateral ( BOJ eased the criteria on the credit rating from “A rate or higher” to “BBB rate or higher”), this was terminated in March 2010 (Vollmer & Bebenroth).

Outright purchases of corporate debt were taken up- making BOJ assume the credit risk of the firm issuing corporate debt (Bank of Japan, 2009).

In October BOJ introduced comprehensive monetary policy easing this policy was taken up to again overcome deflation and return to stability (Momma & Kobayakawa).

The QQE measures introduced in April 2013

Fundamental features were to have a clear and strong commitment to achieving price stability. Bank committed itself to achieve price stability of 2% within two years. BOJ introduced large-scale monetary accommodation through purchasing JCBs (Momma & Kobayakawa).  QQE was also expected to raise the inflation expedition, this was critical to overcoming the deflationary state of Japan. By raising inflation the real interest rate would reduce since the nominal interest which was already low couldn’t reduce any further. This would stimulate private consumption and investment in the economy (Momma & Kobayakawa).

This resulted in positive economic development and it has certainly to a large extent overcome the deflation trend the economy was trapped in for nearly 15 years. QQE provided intended effects within a year since Japan’s economy achieved the 2% price stability target (Bank of Japan).

IS-LM Framework-

Since there was a sharp decline in exports in Japan accompanied by weak private consumption demand the IS curve shifts from IS0 to IS1 (leftward shift of the curve). With the above mentioned monetary policies undertaken by BOJ led to lowering the interest rate and increasing the money supply circulation into the economy which led to stimulating private domestic demand (Golmohammadpoor Azar, 2009). This results in the LM curve from shifting from LM0 to LM1 with further fall in the interest rate from r* to r**. Output in the economy rises from Y* to Y**.

 

(Source- World Bank, World Development Indicators)

Fig- Shows CPI of Japan increasing from 2013 positively indicating the QQE measures of achieving price stability and recovery of the economy from the deflationary trend.

(Source-  World Bank, World Development Indicator)

Fig- Shows a positive GDP growth rate from 2011 and maintained the same

Concluding Remarks

The Great Recession hit Japan as an external shock with a downfall in the housing market of USA. Japan’s exports declined drastically which impacted the aggregate demand of the economy since there was a weak consumption demand. Japan’s economy was struck due to heavy reliance on its export sector.

Several monetary policies were implemented by the Bank Of Japan to escape and control the deflationary trend it has been suffering from and achieve price stability in a sustained manner. The monetary policies implemented by BOJ led to promote household consumption and private fixed business investment in the economy. The measures taken up from 2008-2010 was to control the deflation and financial crisis in the economy. The QQE measures of 2013 led to Japan in achieving positive real GDP growth and price stability of 2% within one year of its implementation.

Overall the Bank Of Japan has been able to achieve long term growth in the economy to a large extent from the measures taken up by them.

Finally, Japan has grown to be the third largest economy in the world. It has overcome challenges of the deflationary trend and revitalized its economy.

 The Japanese population is  incredible as a one force people and when they are focused on a joint goal, nothing can stop them.

References

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The Bank of Japan. (n.d.). Retrieved August 02, 2020, from https://www.boj.or.jp/en/mopo/outline/cfc.htm/

Golmohammadpoor Azar, K. (2009, May 09). 2008 Economic Crisis Analysis: The Macroeconomic Approach. Retrieved August 02, 2020, from https://www.econstor.eu/handle/10419/49648

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Lund Susan Lund, S. (2018, September 13). How secure is the global financial system a decade after the crisis? Retrieved August 02, 2020, from https://www.mckinsey.com/industries/financial-services/our-insights/how-secure-is-the-global-financial-system-a-decade-after-the-crisis

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MOMMA, K., & KOBAYAKAWA, S. (n.d.). MONETARY POLICY AFTER THE GREAT RECESSION: JAPAN’S EXPERIENCE. Retrieved from file:///C:/Users/HP/Downloads/001art04.pdf

Nakaso, H. (2017, October 20). Hiroshi Nakaso: Evolving monetary policy - the Bank of Japan's experience. Retrieved August 02, 2020, from https://www.bis.org/review/r171020d.htm

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SAITO, J. (2019, September 27). | Why Was Japan Struck So Hard by the 2008 Crisis? Retrieved August 02, 2020, from https://www.jcer.or.jp/english/why-was-japan-struck-so-hard-by-the-2008-crisis

Sato, T. (n.d.). Global Financial Crisis: Japan’s Experience and Policy Response. Retrieved from https://www.frbsf.org/economic-research/files/Panel_Sato.pdf

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