Reversal of fortune: Macroeconomic policy, International Finance, and Banking in Japan
an appreciation is indeterminant. In McKinnon’s view the history of US-Japanese 247
economic relations over the past 30 years makes very clear that yen appreciation 248
did not have any lasting impact on the structural surplus in Japan’s international 249
accounts. At the same time, this appreciation imposed a deflationary bias on 250
monetary policy ultimately pushing Japan into a liquidity trap from which it has yet 251
to emerge. New demands emanating from the United States that Japan further 252
appreciate the yen even while it is continuing to experience deflation make little 253
sense to McKinnon. Moreover, he fears that intense US pressure now to break of 254
the peg between the renminbi and the dollar will push China down the same 255
unhappy path that Japan has gone. 256
In preference to using exchange rate changes to mitigate international economic 257
imbalances, McKinnon believes that not only the renminbi but all currencies in 258
East Asia, including the yen, should be pegged to the dollar. If each country’s 259
monetary policy permits nominal wage growth to reflect increases in productivity, 260
international adjustment will take care of itself far more readily than is the case 261
under today’s ad hoc regime. 262
3.3 Monetary regimes and stabilization policy 263
While McKinnon argues for the superiority of the dollar peg system on medium 264
and long-term grounds, the model constructed by Koichi Kamada and Izumi 265
Takagawa in their paper, “Deepening Interdependence in the Asian-Pacific Region: 266
An Empirical Study Using a Macro-Econometric Model” is able to test a dollar peg 267
system versus other regimes over shorter-time horizons. Insofar as coping with 268
economic crises are concerned, Kamada and Takagawa find that a currency-basket 269
regime is clearly superior to both dollar-peg system advocated by McKinnon as 270
well as the current ad hoc regime. This is true for China and Japan, as well as for 271
most other countries in East Asia. At least on short-run stabilization policy 272
grounds, a regime where all countries peg their currencies to the dollar is worse for 273
many countries in East Asia, not only compared to a regime where all countries peg 274
to a currency basket, but also to the present regime. 275
4 Banking, structural adjustment and Japanese economic performance 276
4.1 Government policy and the banking system 277
Even if the Bank of Japan had pursued a highly expansionary money policy in the 278
mid and late 1990s it is by no means that a recovery of the Japanese economy 279
would have ensued. By that time the balance sheets of Japanese banks had de- 280
teriorated to such an extent that the conventional monetary transmission system 281
had broken down (Bernanke 2000). If banks will not lend simply increasing a 282
supply of base money will do little to stimulate the economy. In his paper, “Reform 283
of the Japanese Banking System,” Kawai investigates how Japanese banks ceased 284
to be effective financial intermediaries and the role that government policy has 285
played in the banking sector’s distress and slow recovery. 286
The asset-price bubble in the late 1980s and its subsequent collapse were 287
largely responsible for the emergence of non-performing loans (NPLs) and the 288