Apart from World Economic Outlook, IMF also releases regionwise Economic Outlooks. Both are bi-annual publications. In its latest Asia outlook, IMF has an interesting chapter on Japan’s exit policies in its 1990s crisis and lessons that can be drawn from the same.
It breaks the Japan’s crisis in 3 phases (1990-97, 1997-2000, 2001-03) and shows how the crisis kept coming back. Each time there was some recovery, the policymakers pulled a bit of stimulus, there was an external shock (first Asian crisis and then dot com crisis) which pulled the economy again into recession. Infact, just like we saw in Great Depression , the second phase of recession in Japan was more severe.
The main reason for this slipping was Japan’s demand never picked up and the initital support was only seen in equity indices and export markets. It was only when there were proper plans to restructure the finance sector and unmask the full scale of problems, the economy recovered in the 3rd phase. This is in line with what Simon Johnson also said recently.
What are the lessons from Japan?
- A sustained upturn was possible only when indicators across all the components—trade, financial conditions, and private domestic demand—were displaying signs of tangible recovery by flashing green.
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In all three episodes, exports and industrial production seemed to be recovering strongly, but there was little spillover to private demand during the first two recovery attempts
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In the final episode, private demand was stronger—in particular, corporate investment— as firms had made progress in cleaning up their balance sheets and deleveraging
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Although it is difficult to tease out a precise sequence, it appears that certain financial market indicators, in particular the stock market, were typically the first to show signs of recovery, together with a cyclical correction in inventories that supported production. In the middle stages, there was a tendency for consumer and business sentiment to improve, bolstering domestic demand. In the final stage, only reached at the third attempt in Japan, private credit, house prices, and the labor market turned, sealing the recovery.
The article then points to lessons which can be applied today:
- Green shoots” do not guarantee a sustained recovery. On two occasions, emerging recoveries allowed stimulus to be withdrawn. However, both times the external environment subsequently deteriorated dramatically, and the shock to the economy was magnified by a still-fragile financial system. A more severe downturn ensued, necessitating even more aggressive stimulus.
- Sustained recoveries may not take hold until balance sheet problems at the heart of the crisis are addressed. A durable recovery took hold only after Japan’s banks became more aggressive about dealing with problem loans and capital shortages; and corporations finally shed the “triple excesses” of debt, capacity, and labor.
- While this restructuring is under way, policy stimulus may need to be maintained.
- Policymakers need to clarify “exit strategies.” At an early stage, they should set out medium-term plans for fiscal consolidation and specify the conditions under which monetary accommodation will be withdrawn
So keep them on but have some exit strategy in place is the one line lesson.
