The Asset Price Bubble and Monetary Policy: Japan's Experience in the Late 1980s and the Lessons

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1. The authors characterize the bubble economy by three factors: "a rapid rise in asset prices, overheating of economic activity, and a large increase in money supply and credit," and define the four-year period from 1987 to 1990 as the "period of the bubble's emergence and expansion" (II.A).
2. The Nikkei Average accelerated its rise in 1986, peaking at 38,915 yen at the end of 1989. This was 3.1 times the level at the time of the Plaza Accord (September 1985, 12,598 yen). In August 1992, it was 14,309 yen (a drop of over 60% from the peak) (II.B.1).
3. The Urban Land Price Index (six major cities) peaked in September 1990, later than stocks, at about 4 times the level of September 1985. By 1999, it was about 20% lower than in September 1985, and about 80% lower than the peak (II.B.1).
4. Total capital gains from stocks and land from 1986–89 were 452% of nominal GDP (193% in 1972–73). Capital losses from 1990–93 were 159% of nominal GDP (II.B.1, Fig. 4).
5. Growth of M2+CD peaked in April–May 1990. According to the Economic Planning Agency's reference dates, the business cycle bottomed out in November 1986 and peaked in February 1991 (51 months of expansion). Capital investment rose to nearly 20% of GDP (II.A, II.B.2).
6. The Bank of Japan explored the possibility of monetary tightening from the second half of 1987 but failed to present a convincing rationale. After the collapse, it was criticized for having caused the bubble by prolonging monetary easing (I).
7. Non-performing loans of major banks were 20.3 trillion yen at the end of March 1999 (4.1% of nominal GDP); including the cumulative total of direct write-offs since fiscal 1992, the figure is 44.6 trillion yen (9.0%). The Financial Revitalization Law of October 1998 prepared 60 trillion yen in public funds (12% of GDP), which became 70 trillion yen with the revision of the Deposit Insurance Act (II.C, pp. 404–405, note 9).
8. Comparison with the post-WWI bubble: Land capital gains were 335% of GNP from 1913-19, with losses of 43% from 1924-30. From 1986-90, they were 367%, with losses of 107% from 1991-93. The rate of stock price fluctuations did not differ, but the economic downturn after the collapse was smaller in the 1980s (II.C, pp.405–407, Table 1).
9. The causes were not singular but an interplay of factors: aggressive behavior of financial institutions, prolonged monetary easing, land tax systems and regulations, weak discipline, and confidence in Japan, all intertwined through 'reinforcement of bullish expectations.' The stock yield spread fell below 2% in early 1987 and widened to about 6% by 1990 (III.A, pp. 407–409, Figure 13–14).
10. The aggressive stance of financial institutions began around 1983; liberalization of deposit interest rates (from 1985) and large corporations moving away from banks led them towards real estate-collateralized loans to SMEs and real estate-related lending. The seven failed second-tier regional banks had low profitability from the early 1980s and expanded real estate-related lending from the mid-1980s. The equity capital of city banks, long-term credit banks, and trust banks increased from 35 trillion yen at the end of September 1988 to 46 trillion yen at the end of September 1989 (III.B.1, pp. 410–413).
11. There are three channels through which monetary easing pushes up asset prices: a decrease in the cost of funds for speculation, procurement in the capital market due to high stock prices, and an increase in collateral value due to rising land and stock prices. However, easing is a necessary but not a sufficient condition (III.B.2, pp. 414–415).
12. A tax system with low taxes on land holding and high taxes on land transfer suppressed the supply of land. The expectation of rising land prices increased the present value of the "benefits of the system," further pushing up land prices. The expectation of converting farmland to residential land also worked in the same direction (III.B.3, pp.415–416).
13. Japan's share of international bank lending peaked at 41% in the fourth quarter of 1989. Phrases like "the world's largest creditor nation" and "Tokyo as an international financial center" captured the mood of the era. The National Land Agency (1985) projected that office demand in Tokyo would increase by an amount equivalent to 250 skyscrapers (III.B.5, p.417, Note 26).
14. The official discount rate was cut five times between January 1986 and February 1987, for a total of 2.5 percentage points. The 2.5% rate continued for two years and three months, from February 1987 to May 1989. Of the five cuts, only the first was a unilateral decision by the Bank of Japan; the second and third were simultaneous with the US and Germany, and the fourth and fifth were on the same day as the US-Japan joint statement and the Louvre Accord, respectively (IV.A.1, pp.418–419, Table 2).
15. The statement by the Chairman of the Policy Board mentioned the stability of the exchange rate in all five rate cuts, and until the third cut, it also mentioned the reduction of the current account surplus through the expansion of domestic demand (IV.A.1, Table 4, p.420).
16. From the summer of 1986, the Bank of Japan, concerned about excessive monetary easing, which it called "dry firewood," began guiding short-term market interest rates higher at the end of August 1987, but this was interrupted by Black Monday on October 19. From the second quarter of 1987, window guidance shifted to gentle persuasion, calling for a "prudent lending attitude." A new method of money market operations was introduced in November 1988 (IV.A.2, pp.421–423, Table 5).
17. Official discount rate hikes: May 31, 1989, 2.5→3.25% (with window guidance requesting "disciplined lending in both quantity and quality"); October 11, 3.75%; December 25, 4.25%; March 20, 1990, 5.25% (in the same month, the Ministry of Finance instructed to curb real estate-related lending); August 30, 6.0% (Gulf Crisis). About one month after the August 1990 rate hike, stock prices had fallen to half their peak, and land prices began to decline around 1991 (IV.A.3, pp.424–425, Table 7).
18. Ministry of Finance circular and guidelines of March 1990: (1) For the time being, curb the increase in lending to real estate-related companies to within the scope of the increase in total lending, excluding loans to public residential land development agencies. (2) For the time being, collect reports on lending to the real estate, construction, and non-bank sectors. The introduction of these quantitative restrictions coincided almost exactly with the collapse of the bubble. The authors state that direct intervention in lending policies is best avoided, as quantitative restrictions create loopholes when expectations of land price appreciation are strong (IV.B.4, pp.430–431, Note 45).
19. According to an estimate by Bernanke–Gertler (1999), the bubble could have been prevented if the target interest rate had been raised from 4% to 8% in 1988. The authors question whether it would have been possible to raise it to 8% at once when the CPI was at 0.7% (in 1988). They assess that even an early tightening might not have prevented the bubble's formation, but could have brought forward the timing of its collapse and curbed credit expansion (IV.B.2–3, pp.428–430).
20. The year-on-year CPI was 1.1% in March 1989, 2% in April 1990, and 3% in November 1990. In the third quarter of 1988, the domestic wholesale price index was -0.7% and the CPI was 0.2%; this price stability weakened the case for raising interest rates (V.A.2, pp.432–434).
21. The Bank of Japan's April 1990 Monthly Report pointed out that economic agents were implicitly assuming the "land myth" (that land prices will continue to rise, or at least not fall), and warned, citing examples from the US and UK, that a fall in land prices could undermine the soundness of financial institutions (V.A.4, Note 54, p.435. Based on the authors' English translation, as the original text was not consulted).
22. The background for the delayed tightening included the policy challenges of the era: international policy coordination, avoiding a stronger yen, and reducing the current account surplus by expanding domestic demand. Additionally, fiscal consolidation led to an over-reliance on monetary policy to expand domestic demand. Former Governor Mieno recalled, "Raising interest rates to curb domestic demand was seen as a violation of our international commitments" (V.B, pp.436–441, Note 55).
23. The long stagnation after the collapse occurred through three channels: the correction of bullish expectations, a decline in the economic value of capital investment made during the bubble period, and balance sheet repair as falling asset prices eroded the capital of both lenders and borrowers, contracting credit. Loans where the collateral value and the borrower's profitability move in the same direction are effectively unsecured (V.C, VI.B.5, pp.441–443, 446).
24. There are four lessons: forward-looking monetary policy (a Type II error, mistaking a bubble for a "new economy," is more fatal); grasping economy-wide risks (the interaction of the supply-demand gap, money and credit, asset prices, the behavior of financial institutions, and risks); the relationship with the policy challenges of the era; and the importance of institutional design (VI, pp.443–447).

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