Reversal of Fortune: Macroeconomic Policy, International Finance, and Banking in Japan

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

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