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Commonalities between Japan, United Kingdom, US and the Eurozone – Fixing the Financial System but not necessarily the Economy

The Bank of Japan (BoJ) was the first central bank to adopt quantitative easing (QE) to fight the upsurge of a deflationary path in 2001. At that time, the feeble GDP reflected the collapse of aggregate demand following a financial crisis in the late 1990s.

The most vicious side effect of a collapsing aggregate demand was a generalized decline in prices and production, which was already a reality in Japan at the beginning of the 2000s. In response to highly negative events, the BoJ launched the Quantitative Easing program (QE), with the aim of re-establishing credit conditions in the Japanese economy by accelerating inter-lending between banks and, consequently, supporting the overall level of aggregate demand in the economy.

The original proposition of Prof Richard Werner, the economist who proposed the QE scheme to the BoJ, was different from the scheme adopted by the bank. He viewed the QE policy as a way of expanding credit to the private sector, which is the same view adopted by the central bank. However, in 2001, he advised the Japanese bank to enter into private long-term contracts to borrow from commercial banks. This practice would allow the private banking sector to create money and, consequently, expand the credit to private companies and consumers. It would, ultimately, push up aggregate demand.

In practice, the central bank increased its liabilities significantly to capitalize the commercial banks through the purchase Japanese bonds from the private sector. The ultimate goal of the scheme was to print money, or create money electronically, to consolidate the debt of the banking sector in an attempt that they would expand cheap credit to firms and consumers. The version of the QE scheme proposed by Prof Werner was ruled out from the very beginning.

This first experiment with QE, which ended in March 2006, became popular amongst developed countries affected by the Great Financial crisis of 2008. The immediate positive outcome from the QE program adopted in Japan was the recapitalization of the financial system followed an increase in the price levels and production. The modified version launched by the BoJ in 2001 and subsequently adopted by the Federal Reserve, Bank of England and European Central Bank follows the same basic structure.

Central bank liabilities increase following QE policies (billions)
Please note that the numbers are calculated in billions of dollars and euros for the United States and the Eurozone, respectively, and 100 billion yen for Japan.

The banking sector in Japan suffered two major reductions in its net income and profit, which was in line with the recession periods of the beginning and end of the last decade. The industry recovered supported by the QE scheme adopted by the Japanese central bank. After the introduction of the first experiment with QE in 2001, the profitability of the entire banking system returned to positive figures in 2004.


From 2010 to 2013, during the Great Financial Crisis of 2008 and the Tohoku Earthquake of 2011, the BoJ re-launched the QE scheme reaching the purchase level of JPY111tn (24% of GDP, or approximately USD1tn) from 2010 to 2013. As expected, the banking sector, which reported losses of JPY1,610bn (approximately USD15bn) in 2008, quickly returned to profitability from 2009 onwards. The BoJ aided the industry to consolidate colossal losses. In 2012 the industry reported a net income of JPY3,031.1bn (approximately USD29bn).

The aggressive quantitative easing has changed the economic trajectory of Japan after more than a decade of negative inflation and slow economic growth. The promising signs are coming from a positive real GDP growth of 1.8% in 2013 and a projected expansion of real GDP by 1.5% in 2014. Inflation is peaking up after years of low consumption and deflation.

In light of the Japanese experience, the financial sector in the United Kingdom, United States and in the Eurozone should equally be benefiting enormously from their respective QE schemes. The financial sector might be using the scheme to boost its profitability and to build up its reserves in the expectation of future negative events.

However, contrary to the Japanese experience, over the last couple of years, most of the developed economies affected by the financial crisis have bore sluggish rates of economic growth. The depth of the crisis convinced entrepreneurs to refrain from investing due to the lack of demand even if the robustness of the financial sector is restored.

More than 6 years into the crisis, most developed countries affected by the Great Financial crisis have remained in a chronic condition of subnormal activity, particularly the Eurozone. This is probably one of the main reasons why those economies, apart from the United States, are struggling to return to their long-term average rate of growth. Their QE schemes have not being as effective as the Japanese scheme.

According to John Maynard Keynes, one of the most prominent economists of all times, these economies, if left to their own devices, without any government intervention in the production process, will remain stuck “without any market tendency either towards recovery or towards complete collapse”. In light of the low pace of the economic recovery, the right government policy choices over the next couple of years will determine the path of the economic recovery in the coming decades. In order to have an efficient and relatively stable market system, government intervention in the production process is required.

For more information, take a look at our Case Study:

Japan’s Economy – Sailing into uncharted seas of printed money Case Study

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