After the dust over the 1990’s crisis settled, it became very clear that the trigger of the ensuing downturn lay in the crash of asset prices. Japanese stock prices toppled to over 50 % by 1992. The after shocks were still to come. On the back of the stocks crash, land prices swung north of the economy almost a year later. The decline extended into the early years of the new millennium. The wipe off in stock prices led to a chain reaction. Falling prices of stock affected banks’ commitments and liquidity and eventually erased a lot of their capital.
Those firms, which had resorted to extensive, financing before the bubble burst, now faced mountains of debt and unutilized capacity. (Edelman, 2005) Initially, the slowdown was attributed as a reaction to falling equity prices. It was anticipated that fiscal corrections would follow. Disappointingly, the hope for improvement did not come. Analysis has revealed the role financial institutions played in the crisis was a crucial one as they had fuelled much of the expansion during the 1980’s.
Encouraged further by the gains notched in property and stock prices, banks went on financing the wheels of economy. When the downturn came, these financial institutions had to stop lending operations in order to ensure that capital reserves were maintained adequately. Cash strapped banks had to pull out of the economic system, which left households and business in the lurch unable to respond to resuscitating measures to pump up the economy as they now, had no money to spend in response to macroeconomic policies put into place to ward off the severe crunch.
Another possible catalyst could have been the decline in productivity of Japanese businesses unused to the nimbler ways of their business counterparts elsewhere in the world. Japanese business was traditionally aligned with homegrown philosophies and not exposed to deregulated procedures, which could have helped push the economy much faster. The New Industrial revolution was upon the world and during much of the 90’s much of business was realigned to take advantage of the huge benefits offered by an information technology enabled age.
Japanese companies were presumed to have ignored these indications and this led to the economic crisis of the 90’s. What is more, depressed demand for goods and services drove down the economy on the back of a liquidity crunch, which ensured interest rates would never come below the Plimsoll Line (the zero interest stage) and stay high enough to stem economically productive activity of any sort. It is natural, during economic fallout to witness a number of complex forces working at just that exact time to grind the economic engine to a halt. Therefore, it was in Japan’s case.
It turned out that the banks, largely non-functional in the crisis were even more so when it struck. They had still not begun to muster enough capital in the face of the downward spiralling asset prices and therefore dampened the impact of monetary policies to ameliorate the situation and fight deflationary swings because adequate capital was unavailable. Banks had still not begun to downgrade assets, which were soon to be damp squibs in the market, or they would have been able to scrape out of the impending disaster. (Dollard, 2006) Fiscal management and patchy progress in regulatory measures added their weight.
Fiscal management, which otherwise could have helped push up aggregate demand, was stuck in rural public work projects which in any case would not have resulted in any incremental gains to the economy. The regulatory environment in Japan at the time did not service each industry on its merits. Had the opposite been true, the country’s dynamic electronics export sector would have been on par with an equally productive domestic sector. The combined effects of the two led to poor capacity utilization, constricted demand, and rising unemployment.