Japan's Lost 30 Years
Isn't it a good thing if prices keep falling? Japan's "lost 30 years" shows how long and how stubbornly falling prices and stalled growth can weigh on an economy.
The Long Slump After the Bubble Burst
After Japan's asset bubble (stocks and real estate) burst in 1990, the slump that was expected to end quickly stretched into 10, 20, and 30 years. This is called the "lost decade" at first and later the "lost decades."
Average real growth in the 2000s was about 0.5%, and even in the 2010s only about 1.2%. The dynamism of what was once the world's second-largest economy stood still for a long time.
The Trap of Deflation
A defining feature of this period in Japan was "deflation" — the continuous decline of prices. Between 1999 and 2023, the GDP deflator (a price gauge) was negative in 18 years, a record hard to find a precedent for among advanced economies.
When prices fall, consumers put off spending, thinking "it will get cheaper, so I'll buy later," and companies, with falling sales, cut investment and wages. This vicious cycle freezes the economy further.
Nominal GDP was also stagnant for a long time. Nominal GDP in 2001 was similar to that in 1995, meaning years passed in which the economy failed to grow "even in the numbers."
The 'Balance Sheet Recession'
The economist Richard Koo explained this phenomenon as a "balance sheet recession." Companies and households that borrowed to buy assets during the bubble clung to "paying down debt" instead of new investment and consumption once asset prices crashed.
With everyone trying to repay debt at the same time, no matter how much the central bank lowered rates, there was no one who wanted to borrow, so monetary policy did not work well. Japan's case shows that "once an inflated bubble bursts, the aftermath can last a generation."
Preguntas frecuentes
Q. Is deflation worse than inflation?
Either is harmful if extreme. However, deflation tends to make people defer consumption and investment and inflate the burden of debt (in real value), creating a vicious cycle that freezes the economy. On top of that, Japan's case revealed that once you fall into it, escape is very hard.
Q. What does this case imply for investors?
If you concentrate on one country or one asset, you may have to wait a long time for recovery should that economy fall into a long slump. A representative example is that Japan's stock index took about 34 years to recover its 1989 high. This becomes the backdrop for why international diversification is discussed.
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