Investing
Richard Werner argues that the Bank of Japan's control of credit shaped Japan's boom, bust and economic transformation.
Officials often explain a long downturn as proof that deep structural reform is needed. The author tested this claim against Japan's data and found no support for it. In his account, the recession came from a shortfall in credit creation, and supply-side weaknesses were not the cause.
The author argues that the amount of new bank credit, not the price of borrowing, drives an economy. Credit markets are imperfect, so banks ration loans and lending is set by how much they choose to supply. On this view, cutting interest rates does little if banks are not actually creating new loans.
Deciding which sectors get new bank credit can remake an economy's structure more than any headline rate. The author credits Japan's fast postwar growth to a central bank that set strict lending quotas for each bank and steered money toward productive industry.
When banks are pushed to lend for speculation rather than for producing goods, asset prices rise without new output behind them. The author says this kind of lending inflated Japanese land to the point where the grounds around one palace were valued like an entire American state. When the boom collapsed, it left bad debts worth a fifth of national output.
The author argues that a central bank may hold back credit on purpose, accepting a slump to force changes it wants. He claims Japan's central bankers could have ended the 1990s recession by creating credit. Instead, they refused because a crisis would push through banking and structural reform.
After a bust, banks loaded with bad loans stop lending, and the economy stalls for lack of new purchasing power. The author argues the fix was to direct fresh credit to productive sectors such as research, software, education and telecommunications.
A central bank's most powerful levers can be informal ones that the public never hears of. The author finds that the Bank of Japan's unwritten, extralegal lending instructions mattered more than the official rate policy. Meanwhile, observers wrongly credited the finance ministry with being in charge.
The same control over credit that drives rapid growth can, when misdirected, produce the boom and bust that follows. In the author's account, Japan's postwar success and its lost decade had one shared cause: the creation of money by banks.
An independent central bank can pursue its own political agenda and fight turf battles with other agencies, while presenting itself as purely technical. The author describes Japan's central bank acting as an unelected second government that reshaped society, without citizens being told.
The author argued that a powerful, unaccountable central bank anywhere can repeat this pattern of credit booms, asset bubbles, banking crises and recessions. He warned in 2003 that the European Central Bank was likely to produce that cycle in the eurozone.