What happened with Japan?
It really is true that the united states demanded a lot of things of Japan when the bilateral trade imbalances became large in the mid-1980s and among the demands was an appreciation of the yen. It really is true that the yen appreciated sharply from 260 yen/ dollar in February 1985 to 155 yen/dollar in August 1986, that was among the fastest appreciation episodes ever sold. It really is true that Japan underperformed its prospect of the majority of the 1990s and 2000s. The common growth rate from 1993 to 2003 was just above 1%, and the decade was marked by one crisis after another in the banking sector. Nonetheless it is too simplistic to state that the united states pressured Japan into accepting sharp yen appreciation and that, subsequently, caused two lost decades.
THE UNITED STATES pressure is most vividly remembered in the context of the Plaza Agreement of 22 September 1985. The yen appreciated from 240 yen/dollar right before the agreement to 200 yen/dollar by the finish of the entire year. The yen continued to understand to 155 yen/dollar by the summertime of 1986 – that’s, a 45% appreciation in a single year following a Plaza agreement. (See Ito 1987 for information on the Plaza Agreement and the aftermath.)
Was the Plaza Accord the foundation of the 20-year stagnation?
Given the timing, if the pressure led to making the bubble bigger than otherwise, causality could plausibly be suspected. However, the simple truth is just the contrary.
- First, the Plaza Accord was to improve an overvalued US dollar vis-à-vis other major currencies, like the German mark, the French franc, and the British sterling. So that it was not really strain on the yen but a demand for a coordinated action to improve misalignments with the dollar.
- Second, the movement from 240 yen/dollar to 200 yen/dollar was well within the number of correcting the overvalued dollar – and Japan agreed with the theory. Subsequently the US decided to stabilise the exchange rates in the Louvre Accord in February 1987 and that, essentially, was the end folks pressure.
Just how much damage did the yen appreciation cause japan economy?
Exports declined as a result of yen appreciation 1 . 5 years following the Plaza Agreement (based on the J-curve), and that acted to lessen the surpluses from an extremely high to a standard level. However the appreciation in 1986 coincided with oil price declines, therefore the cost of production in Japan was quite definitely reduced, providing a cushion for the squeeze on profits. There is quite little evidence that the sharp yen appreciation had major impacts on japan economy in the next half of the 1980s. Those were the famous bubble years – high economic growth with soaring asset prices.
In relating yen appreciation (which might have been partly the consequence of US pressure) and the bubble, the next observation is crucially important. Monetary policy was relaxed from 1986 to 1987, and the record-low discount rate (at that time) of 2.5% was maintained from February 1987 to May 1989, in the hope that the reduced interest would stop or moderate the speed of yen appreciation. Hence, it had been not caving directly into yen appreciation demand but resisting US pressure (or the united states “wish” to become more precise) that made monetary policy too lax and contributed to bubble enlargement. The logic is merely the contrary of what Chinese officials and the ones who draw strong parallels between your Japan and China, may actually believe to be the case
The on-and-off 20-year stagnation has been mainly as a result of ramifications of the bubble burst and a number of policy errors, not really a slump in the exporting sector caused by the yen appreciation. Actually, the export sectors continue being an engine of growth, regardless of the yen appreciation. Exports are actually a higher proportion of Japanese output than these were in the 1980s. That’s part of what made Japan’s industrial production so fragile when confronted with the global financial meltdown. Furthermore, over the bursting bubble US pressure was mostly helpful in urging quick actions to correct banking fragility.
There was only 1 other bout of yen appreciation that may be seen as caused by US pressure. Trade conflicts in 1994 to 1995 resulted in US frustration and a heavy-handed approach however the yen appreciation pressure from 1994 to 1995 was more informal compared to the first episode. This took the proper execution that the yen/dollar market reacted with yen appreciation whenever Japan resisted US pressure for numerical targets of “voluntary import expansion.” From a macroeconomic perspective there have been no factors requiring or supporting the sudden appreciation from 100 yen/dollar to 80 yen/dollar that occurred over five months during this time period. The rapid V-shape adjustment – sharp appreciation and sharp depreciation – can be evidence that the appreciation had no fundamental basis. Since appreciation was only sustained for such a brief a period, it really is doubtful that exporting sectors suffered permanent damage. THE UNITED STATES demands for voluntary import expansions – in apparent violation of GATT/WTO rules – frustrated Japan but if indeed they caused any more misery to the already weakened Japanese economy it had been not through the exchange rate channel.
What caused the bubble to expand and be more dangerous was the reduced interest policy of 1987-1989. What brought the onset of the slow growth period was the belated and aggressive tightening of monetary policy from late 1989 to 1990 when interest levels were raised from 2.5% to 6 %. There continues to be a debate about the entire list of factors behind the prolonged stagnation in Japan from the first 1990s nonetheless it was certainly a complex mixture of factors. Included in this were the fragility of the bank operating system, which suffered near collapse over a 5 year period, producing a market meltdown at least for small- and medium-enterprises Even worse, problems in the banking sector weren’t addressed properly in the first stages by the supervisory authority. Simultaneously an ageing population, falling labour force participation and slow productivity growth hampered the supply side of the economy while political inertia was struggling to deliver significant deregulation permitting structural change. Major policy failures, such as for example an aggressive fiscal tightening in April 1997, undermined confidence at moments when recovery may have removed (see Corbett and Boltho 2000). Through the entire whole of the 1990s and early 2000s monetary policy was excessively tight, as evidenced by continuing deflation. Although economy faced a liquidity trap with nominal interest levels at zero, real interest levels in a deflationary environment were high (see Ito and Mishkin (2006) for a fuller discussion of monetary policies in the 1990s and early 2000s).
Deflation and the lost decade
It has additionally been argued a continuing reluctance by the united states to permit depreciation of the yen through the lost decade created deflationary expectations that reduced policy options for Japan (see McKinnon 2006). That is a far more subtle version of the “US pressure argument” and, though it really is less obvious how it pertains to China at the moment, it adds another element creating an atmosphere of anxiety about appreciating currencies. The argument is an expectation of a continuously appreciating currency in a high-growth economy with rising labour productivity will demand that wage growth be moderated to keep competitiveness (purchasing power parity). If the currency were held constant, nominal wages would instead rise, matching productivity rises and leading to the same reduced amount of competitiveness as though the currency appreciated. Although international outcome could be broadly similar, the domestic outcome with wage growth, instead of deflation, is usually to be preferred, therefore the policy choice ought to be for fixed exchange rates. In theoretical terms this argument assumes that wages are set by employers in response to perceived competitiveness needs and these wages are accepted by labour. Could it be likely that this may be the case in China? If the argument is extended globally (what’s best for the goose is wonderful for the gander), then slower-growing, deficit countries with a dependence on currency depreciation should depend on falling nominal and real wages, instead of currency realignment, to boost their competitiveness. So far as the evidence goes, the hyperlink between currency movements and real wage changes is notoriously unpredictable. The decline in Japanese wages through the 1990s was mainly the effect, not the reason, of slow growth. The root cause of deflationary expectations was the continuing failure of monetary policy to invest in fighting price declines. An additional example is Britain, where wage inflation was likely to undo the advantage of the depreciation of sterling following the exit from the European monetary system. It never happened and the depreciating currency ended up being an advantage for British growth. The hyperlink between exchange rate policy and what might happen in labour markets seems an uncertain argument which to base a currency technique for China that may have other undesirable consequences.
Advice for China
Refusing to simply accept yen appreciation (not caving directly into yen appreciation) was among the factors behind the bubble economy toward the finish of the 1980s in Japan. This is a grave policy error for Japan with long-term consequences. So, the lesson is exactly the opposite of the main one a lot of people take from Japan’s experience. Usually do not resist the currency appreciation when the economy is booming. Keeping interest levels low and providing large liquidity, through interventions, as a way to avoid the currency appreciation will create a property bubble and eventual burst – a tragedy. There has already been a risk that China is underestimating the extent of its property bubble (see Ito 2010). China ought to be willingly using currency appreciation as a way to push away potential domestic inflation. The actual fact that this can help international imbalances can be an added bonus but do not need to be a element in China’s decision. China ought to be looking carefully and critically at the proper lessons from Japan and in addition at lessons from successful appreciations that achieved exactly the alleviation of inflationary pressures and structural changes that China needs. One particular example is Australia in the 1980s.
Corbett, Jenny and Andrea Boltho (2000), ““The Assessment” in “Special Issue: Japan””, Oxford Overview of Economic Policy, Vol 16 , Summer.
Ito, Takatoshi and Frederic S Mishkin (2006), “2 DECADES of Japanese Monetary Policy and the Deflation Problem,” in Takatoshi Ito and Andrew Rose, (eds.), Monetary Policy with SUPRISINGLY LOW Inflation in the Pacific Rim, NBER-University of Chicago Press: 131-193.
McKinnon, Ron (2006), “ China’s Exchange Rate Trap: Japan Redux?”, SIEPR Policy Brief, Stanford Institute for Economic Policy Research, April.