Japan's Great Recession: What Went Wrong?

Japan's economic growth rate dropped from three percent in the first half of the 1980s to one percent in the 1990s and beyond. It's not unreasonable, then, to call this Japanese economic situation "the Great Recession." What went wrong in Japan? First, we surveyed some proposed explanations, many of which argue that some structural problem caused the Great Recession. Some growth accounting studies, however, found that TFP (Total Factor Productivity) of the Japanese economy didn't decline in the 1990s compared to the first half of the 1980s. The studies also found that the decline of labor and capital inputs explains the overall growth decline of the 1990s. Second, we conclude that understanding the reasons why the two inputs decreased is key in solving the puzzle of the Great Recession. A possible answer is deflation caused by strict monetary policy. Deflation may produce real economic stagnation through wage rigidity and deflation expectations. Third, we construct a VAR (Vector Autregression) model that includes a real-wage rate and a nonperforming loan variable to the usual VAR model developed by many economists. The results are preliminary, but basically support the above conjectures. Monetary policy variables are important in explaining the Great Recession, and wage rigidity is also important. A non performing loan variable used here was not important, but it is too early to conclude that the impact of the bad loans is small, because the variable used here is proxy one. We still need to explore the real impacts of bad loan on the economy.