Revisiting the lost decade

Japan8217;s errors show that crises need bold, quick moves to restore liquidity

As a result of the combined recession Japan experienced in the 1990s following the collapse of stock and real estate market bubbles, banks saddled with massive bad loans tightened up their screening for businesses and even called in loans, thereby making the recession worse and causing their own bad assets to increase further. This vicious cycle, in which a financial crisis weakened domestic demand and thereby worsened the crisis itself, pushed the nation deeper into recession.

The synchronized stock market tumbles ominously suggest the crisis that originated in the United States and Europe is developing into a similar global combined recession.

8230;In the United States, the financial storm that started on Wall Street has begun to drag down the real economy. US vehicle sales in September plunged 26 percent from a year earlier. Lenders are now beginning to shut off lines of new credit to consumers as well as to businesses. Many American consumers have been sustaining their brisk shopping pace with borrowed money. The current credit crunch could lead to a sharp drop in consumer spending in the country. Europe is also suffering a vicious cycle involving a downturn in the real estate market, a credit contraction and an economic decline.

..Japan first responded to the combined recession with massive rounds of simple public spending to boost demand, delaying cash injections into undercapitalized banks. The upshot was the now-famous 8220;lost decade,8221; in which a credit contraction and a deflationary downturn reinforced each other in a vicious cycle.

At a news conference on Tuesday, Bank of Japan Governor Masaaki Shirakawa said the lesson of Japan8217;s bitter experience is that there can be no economic recovery under such circumstances without fixing the problem of undercapitalised banks.

The US and European authorities must protect their banking systems and end the credit crunch to prevent a toxic combination of a contraction in lending and an economic downturn. That requires bold moves to infuse the banking system with public funds.

Excerpted from a leader in Japan8217;s 8216;Asahi Shimbun8217;