japan's bubble, the usa's bubble and china's bubble

47China & World Economy / 47 – 62, Vol. 19, No. 1, 2011

©2011 The AuthorChina & World Economy ©2011 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Japan’s Bubble, the USA’s Bubbleand China’s Bubble

Kazuo Ueda*

Abstract

This paper compares the three recent episodes of boom and bust cycles in asset prices:Japan in the late 1980s to the 1990s; the USA since the mid-1990s; and China during thepast decade. Although we have not yet seen a collapse of Chinese property prices, theirincreases so far are comparable to those in the other two episodes and a careful comparativestudy is warranted. The present paper first examines the behavior of asset prices, of propertyprices in particular, in the three cases, and highlights some similarities. The paper emphasizesthe role played by extremely easy monetary policy in generating bubble-like asset pricebehavior in the three cases. The reason for easy monetary policies is investigated. In the UScase, the monetary authority was concerned about the risk of deflation in the early to mid-2000s. The experiences of Japan and China are quite similar in that the monetary authoritiesof both countries were seriously concerned about the possible deflationary effects of exchangerate appreciation on the economy. The implications of such a finding for the future ofChinese macroeconomic policy are discussed.

Key words: bubble, inflation, monetary policy, real and nominal exchange ratesJEL codes: E52, E58, E65, F41

I. Introduction

With China overtaking Japan as the second largest economy in the world, many aspects ofthe Chinese economy have been attracting worldwide attention, including the recentbehavior of asset prices, especially the sharp rise in property prices. Among many possible

* Kazuo Ueda, Professor of Economics, University of Tokyo, Tokyo, Japan. Email: [email protected]. Earlier versions of the paper were presented at the 2010 three country (China, Korea and Japan)conference on the Global Financial Crisis and Asian Financial Markets held in Tokyo on 20 August, andthe 2010 meetings of the Turkish Economic Association, held in Girne, Turkish North Cyprus on 1–3September.

mailto:[email protected]

48 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


reasons for the property price inflation, some observers point to the role played by theextremely easy monetary environment. The usual story behind easy money is that worldwidemonetary easing in response to the economic and financial turmoil since 2007 has beenreplicated in China in the authority’s attempt to keep the renminbi–US dollar exchange ratestable. The Chinese monetary authority seems to have been afraid of the deflationaryimpact of renminbi appreciation on the Chinese economy. Hence, China’s foreign exchangerate policy has been one of the causes of the property price inflation.

Regarding the relationship between exchange rate appreciation and monetary policy, wefind an interesting parallel to Japan in the 1980s. Japan’s experience was different from that ofChina’s in the sense that the yen rose sharply in response to the so-called Plaza Accord in1985. The Bank of Japan (BOJ), however, due to concern over the deflationary effects of theyen appreciation on the economy, carried out ultra easy monetary policy in the late 1980s,which led to the famous bubble in property and stock prices, its collapse in the 1990s, andserious consequences for the financial system and the economy since then. This experienceprovides some interesting implications for the future of the Chinese economy.

In this short essay, I will compare the two episodes, that is, asset price increases inrecent China and in Japan in the second half of the 1980s, with occasional references to therecent US experience with property price inflation.

II. Comparison of Data on Asset Price Inflation

Let us begin with a casual examination of the data on asset prices. Figure 1 shows propertyprices in China, Japan and the USA. The axes have been adjusted so that the three propertyprice data series reach their peaks at the same point in the chart. Thus, the data starts in1980 for Japan, in 1996 for the USA and in 2000 for China.1 At the peak, the price level isadjusted to equal 100 for each country. Of course, there is no knowing when Chineseproperty prices will peak out. Therefore, the assumption of the peak year of 2010 for Chinais only one of convenience and involves no judgment as to the future course of Chineseproperty prices. For the sake of convenience, however, let me refer to recent movements inChinese asset prices as a “bubble.” There would probably be no objection to calling theother two episodes Japan’s bubble and America’s bubble. The data sources are the UrbanLand Price Index for Japan (nationwide), the Case–Shiller Index for the USA and theCommodity Building Selling Price (National Bureau of Statistics) for China.2

1 The corresponding peak years are 1990 for Japan, 2006 for the USA and 2010 for China.2 The so-called 70 city property price index shows much milder increases. Here, I have chosen an indexthat accords better with anecdotal stories about the recent Chinese property markets.

49Japan’s Bubble, the USA’s Bubble and China’s Bubble


Figure 1 shows a striking similarity for the three economies. During the decade leadingup to the peak, property prices rose 100–150 percent in the three countries and then camedown sharply in Japan and the USA, although the downturn has been sharper in the USAthan in Japan. The US and Japanese property prices follow typical behavior of asset pricesin boom–bust cycles. The rise in Chinese property prices so far has been slightly largerthan in the other two cases and seems to justify the concern over the risk of its collapse.

To examine more carefully whether such property price movements are bubbles or not,it is useful to compare property prices with incomes that properties generate. For want ofbetter measures, I use nominal GDP for Japan, real GDP for the USA (because the Case–Shiller Index is already divided by CPI) and income per capita for China (National Bureau ofStatistics). The results are shown in Figure 2. For China and Japan, both nationwide andregional series are shown. For China, one series is the Commodity Building Selling Price for35 cities divided by income per capita for a city average and the other is the correspondingseries for Shanghai. For Japan, the indexes of land prices for the entire nation and for the 6largest cities have been divided by nominal GDP. The result for Japan is not very differenteven if various income series for the entire nation and large cities are used.

Figure 2 provides a substantially different view of property prices from Figure 1. Interms of the economy-wide average, property prices did not rise much more than incomeseither in Japan or China. For large cities, however, they seem to have risen much more than

Figure 1. Index of Property PricesJapan (1980–2009), China (2000–2010) and the US (1996–2009)

Source: Nikkei data base, Case–Shiller home page and CEIC data.Year

Peak = 100

Inde

x

0

20

40

60

80

100

120

1980 1990 2000

Japan: urban land prices (nationwide)Case-ShillerChina: commodity building selling price

50 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


incomes. Presumably, the contrast would have been less striking had we had better data onrents by region. Therefore, one obtains the impression that property bubbles in Japan andChina were mainly urban phenomena. There is some evidence that property prices werehigh relative to incomes nationwide in the USA. It is also noteworthy that the propertyprice–income ratio for Japan as a whole, despite the absence of a sharp rise around 1990,has continued to decline since the early 1990s. This might be explained by the declines inthe expected future growth rates of the economy, which are partly a result of declines inasset prices. This is an important example of what a mismanagement of economic policy cando to the economy; Japan has been suffering from a negative feedback loop between assetprices and economic growth.

Turning to stock prices, Figure 3 presents stock price movements in the three countriesbefore and after the peak of the bubble. In the figure, year 0 corresponds to the peak of theproperty price bubble, as explained above. The USA and Japan look similar, although thedownturn has been milder for the USA, at least so far. The behavior of Chinese stock pricesis quite extraordinary; they almost quadrupled in the first 2 years (2006–2007) in the figureand then most of the gains were erased in the aftermath of the so-called Lehman shock.They are now at approximately half the peak level. The US and Japanese stock pricesbehaved in exactly the way that would be expected in a bubble, while the Chinese stockprices already passed their peak in 2007. In fact, the peaks of the Chinese and US stockprices coincided in October 2007.

Figure 2. Property Price–Income Ratios

Source: Nikkei data base, Case–Shiller home page and CEIC data.Year

1980 = 100

0

50

100

150

200

250

1980 1990 2000

All JapanChina: 35 cities averageShanghaiUSAJapan: 6 large cities

Rat

io



The divergent behavior between Chinese property and stock prices seems to beexplained by the fact that stock prices, despite the presence of capital controls, haverecently moved in tandem with global stock prices, whereas property prices have beenunder heavier influence of domestic economic factors.

Figure 4 presents the rate of growth of domestic credit. The USA and Japan are similar,although the US bank credit has contracted more sharply since the burst of the bubble thanwas the case in Japan. Reinhart and Rogoff (2007) argues that prior to the peak of a largebubble, there is almost always a large buildup of private/public debt. Japan’s experienceaccords with this view. Chinese credit growth has been more complicated; it has two peaksin Figure 4, one in 2007 (year –3) and the other in 2009 (year –1). The first peak correspondsto that of stock prices. The second peak seems to reflect the strong fiscal expansion thattook place in response to the Lehman shock, but is also partially related to the sharp rise inproperty prices, as identified in Figure 1.

II. Monetary Policy and Asset Price Inflation

A significant boom and bust cycle in asset prices is usually associated with an extremelyeasy monetary environment (e.g. Kindleberger and Aliber, 2005). Normally, monetary policyis the major cause of such an environment. Therefore, let us examine what was going onwith monetary policy during the three episodes.

Figure 3. Stock Prices (Year 0 Corresponds to the Peak of Bubble)

Peak = 100

Source: Bloomberg.

China

0

20

40

60

80

100

120

Year 5

Year 4

Year 3

Year 2

Year 1

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Japan

USA

Stoc

k pr

ice

52 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


Figure 5 presents Japan’s overnight call market rate along with a version of the Taylorrule rate. The Taylor rule, which relates the central bank’s policy rate to inflation and GDP, wasfirst proposed by John Taylor as a description of the Fed’s monetary policy, but is nowwidely used as a rule of thumb for the optimal level of the policy rate. The parameters necessaryfor the calculation of the Taylor rule rate are assumed to be: inflation target = 2 percent,potential growth = 3 percent, and natural rate of interest = 3 percent. In addition, theweights on the inflation gap and output gap are both assumed to equal 0.5.3 It can be seenthat the actual short-term rate had been well under the Taylor rule rate for 2 years beginningin the second half of 1986. This must have been an important factor behind Japan’s bubblein stock and land prices.

Figure 6 carries out the same exercise for the USA. The actual federal funds rate and theTaylor rule rate are plotted. The assumptions for the Taylor rule are: inflation target = 2 percent,potential growth = 2.5 percent, and natural rate of interest = 2.5 percent. The result is quitesimilar to that of Japan. During much of 2001–2005, the federal funds rate was significantlylower than the Taylor rule rate. This seems to correspond very well with the sharp rise in USproperty prices in the early to mid-2000s.

The exercise is more difficult for China. This is because the Chinese monetary authority

3 I used the gap between the potential growth rate and the actual growth rate for a proxy for the outputgap for want of a good estimate of the output gap. This simplification tends to exaggerate the responseof the Taylor rule rate to actual output growth. Therefore, the argument to follow needs to be discountedfor this simplification. There is, however, no shortage of more rigorous estimates of the Taylor rule ratesthat show similar results, especially for the USA. See, for example, Taylor (2009) for the USA.

Source: Datastream.

Figure 4. Growth of Domestic Credit(Year 0 Corresponds to the Peak of Bubble)

Perc

ent

(year 0 corresponds to the peak of bubble)

-15

-10

-5

0

5

10

15

20

25

30

35

40

Year 5

Year 4

Year 3

Year 2

Year 1

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

JapanUSAChina



does not seem to have used changes in interest rates as the major tool of monetary policy.Instead, it has relied more heavily on moral suasion of banks regarding their lending attitudesand/or changes in required reserve ratios to affec monetary conditions. Nonetheless, thecomparison of the actual and Taylor rule rates might be instructive. Figure 7 demonstratesthis using the discount rate as the interest rate. The result is striking in that the actual ratehas always been lower than the Taylor rule rate, which seems like a recipe for an ever-expanding bubble! The gap between the two narrows with the use of the (1-year) lending

Figure 5. Comparison of Actual and TaylorRule Policy Rates for Japan

Year

Perc

ent

Source: Datastream and author’s estimates.

0

1

2

3

4

5

6

7

8

9

1985 1986 1987 1988 1989

Japan: TaylorJapan: actual

Figure 6. Comparison of the Actual and TaylorRule Policy Rates for the US

Year

Perc

ent

Source: Datastream and author’s estimates.

0

1

2

3

4

5

6

2001 2002 2003 2004 2005 2006 2007

US: TaylorUS: actual

54 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


rate, as shown in the figure. The Taylor rule rate, however, is still above the lending rate,except in the first and second quarters of 2009.

There have certainly been other causes of the three bubbles. In Japan and the USA,regulatory policies have played important roles. In the Japanese case, liberalization of thecapital market regulation occurred in the late 1970s, which prompted large firms to rely moreon the bond and equity markets for financing their investments. As a result, banks lost asignificant part of their lending business and went into property-related lending activities,where banks thought credit analysis was easy. After all, there had been no episodes ofprotracted declines in land prices in post-war Japan. Therefore, banks developed hugeexposures to the property market. Neither the banks nor the regulators, however, paidmuch attention to the risk such bank balance sheets entailed (e.g. Ueda, 2010).

The regulatory failure in the recent US case is well known. A significant part of financialintermediation shifted towards the so-called “shadow banking system,” which was notpoliced very well by the regulators. Regulators did not know much about, and, therefore,were not able to contain, excessive risk taking in the shadow banking system. They also didnot provide a necessary safety net in the shadow banking system for avoiding systemicrisks.

Reinhart and Rogoff (2009) discuss other causes of bubbles, including a widespread“this time is different” psychology, which blinds people to the risk of the collapse ofbubbles. In the recent US case, prominent economists, including Alan Greenspan, praised

Figure 7. Comparison of Actual and TaylorRule Interest Rates for China

Year

Perc

ent

Source: Datastream, CEIC data and author’s calculations.

0

5

10

15

20

25

2000 2002 2004 2006 2008 2010

China: TaylorChina: discount rateLending rate(1 year)



the US economy for its increased flexibility and the resultant ability to minimize the effectsof negative shocks on the economy.4 In Japan, in the late 1980s, there was talk of “Japan asNo. 1.” A similar psychology seems to be observed in China today.

Rather than pursuing the various causes of the bubble, I would like to return to thediscussion of the relationship between monetary policy and the bubble in the next section.Specifically, I will focus on the question of why monetary policy was so easy prior to theformation of the three bubbles.

IV. Backgrounds for Easy Monetary Policy

Monetary easing in Japan in the late 1980s and China today are both related to the concernover possible deflationary effects of a stronger currency. That of the USA in the early 2000sseems to have been motivated by a more genuine concern over the risk of deflation. In the US case, the intention of the monetary authority behind the easing in the earlyto mid-2000s was clearly stated by Bernanke (2003, p. 4), who argued that: “a substantial fallin inflation at this stage has the potential to interfere with the ongoing US recovery, andthat in conceivable – though remote – circumstances, a serious deflation could do significanteconomic harm. Thus, avoiding a further substantial fall in inflation should be a priority ofmonetary policy.”

Here, we see a clear concern over the risk of deflation and the damage it could cause tothe US economy. Perhaps the concern was partly motivated by a study of the experience ofJapan in the late 1990s and the early 2000s.

In a sense, the USA carried out monetary policy in a textbook manner. In retrospect, theconcern for the risk of deflation was somewhat excessive, and the monetary easing duringthis period led to the serious housing and credit bubbles in the mid to late 2000s. In otherwords, the Fed had underestimated the risk of strong monetary stimulus generating seriousfinancial imbalances.5

The motivation behind the BOJ’s easing in the second half of the 1980s was similar butcentered more on the role of a single variable, the exchange rate; the BOJ was worried,perhaps too excessively, about the deflationary effect of a stronger yen on the economy.

Figure 8 shows movements in the yen–US dollar rate and the BOJ’s official discountrate, which had been the BOJ’s major policy variable until the early 1990s. There is a strong

4 For example, Greenspan (2004, p. 4) argues that: “it is difficult to dismiss improved flexibility as havingplayed a key role in the US economy’s recent relative stability. In fact, the past two recessions in the USwere the mildest in the postwar period.”5 See, for example, White (2010) for the relationship between monetary policy and financial imbalances.

56 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


correlation between the two variables. Each time the yen appreciated sharply, the BOJeased policy quite aggressively.6 Specifically, the relationship can be seen quite clearly inthe early 1970s, the late 1970s, the late 1980s and the mid-1990s. Of these four cases ofmonetary easing, two led to serious negative consequences for the economy: the easing inthe early 1970s, which generated serious inflation, and that of the late 1980s, associatedwith the asset price bubble.7

The BOJ’s concern about the deflationary effect of yen appreciation on the economyby itself was not misguided, but it might have been somewhat excessive judging from thecomparison of the actual policy rate with the Taylor rule rate. We have to be careful herebecause analyses of the Taylor rule are typically undertaken in a closed economy contextand, hence, do not address fully the question of how monetary policy should respond tothe exchange rate.8 The subsequent events in the Japanese economy, however, still indicate

6 Although not shown in the figure, this also was a time of large current account surpluses.7 For a more careful analysis of this correlation and its effect on Japan’s bad loan problem in the 1990s,see Ueda (2000).8 The analysis of optimal monetary policy in an open economy context would still indicate that thepolicy interest rate should respond to the expected inflation and output. To the extent, however, thatexpected output is affected by current exchange rate appreciation, the response of the BOJ to the yenmovement by itself might not have been incorrect. The question then boils down to whether the degreeof the response was adequate.

Figure 8. Yen Appreciation (Right) and the Bank of Japan’sOfficial Discount Rate (Left)

Source: Datastream.Year

Perc

ent

Perc

ent

0

1

2

3

4

5

6

7

8

9

10

1970 1985-40

-30

-20

-10

0

10

20

30

40Official discount rate

Yen appreciation



that the monetary easing was somewhat excessive.9

China, in the recent period considered, seems to be following a similar pattern. It hascertainly resisted sharp appreciation of the renminbi. The resistance, however, has resultedin a very strong domestic monetary easing. Figure 9 demonstrates the increases in basemoney and in foreign exchange reserves. There is a mild correlation between the two, butwith the correlation becoming more salient since 2007. This can perhaps be explained byattempts at sterilization becoming increasingly difficult as the People’s Bank of China hascontinued to sell domestic assets it holds to extract funds from the system. Alternatively, inthe aftermath of the Lehman shock the Chinese monetary authority might have decided notto withdraw the funds supplied through foreign exchange market intervention. Comparedwith late 2006, the increases in both base money and foreign exchange reserves almostdoubled in 2007 and 2009. Figure 10 shows the ratio of foreign assets in the total assets ofthe Chinese monetary authority. After a pause in 2005 and early 2006, the ratio has beenrising again, as in the early 2000s, and is now more than 80 percent. The increase in basemoney must have been the fundamental cause of asset price inflation and the inflation ofthe general price level, which was, although moderate, more elevated than in most developed

9 It would be unfair to place all the blame for the mismanagement of monetary policy on the BOJ. Therewas significant political pressure on the BOJ to ease at times of large yen appreciation. It has to berecalled that until the late 1990s the BOJ was not as independent as it is now. In addition to the domesticpolitical pressure, the USA had reportedly put pressure on Japan to ease monetary policy in the late1980s. On this point, see, for example, Funabashi (1988).

Figure 9. Increases in Base Money and ForeignExchange Reserves

Source: Datastream.

Bill

ion

yua

n

Year

in China

-500

0

500

1000

1500

2000

2500

3000

3500

4000

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Δ (HM)Δ (Forex)

58 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


countries. In addition, the more general tendency for the maintenance of low interest ratesthroughout the 2000s, as we saw in the previous section, might have been partially motivatedby concern over the value of the renminbi.

Let us now examine what has been happening to the exchange rate. Figure 11 showsthe nominal effective exchange rate calculated by the Bank for International Settlements for

Figure 10. Foreign Assets/Total Assets,Chinese Monetary Authority

Year

Perc

ent

Source: CEIC data.

30

40

50

60

70

80

90

2002 2003 2004 2005 2006 2007 2008 2009 2010

TimeSource: The Bank for International Settlements.

Figure 11. Nominal Effective Yen (1971-2010)and Renminbi (1994-2010)

1973 = 35

0

20

40

60

80

100

120

140

January

-1971

Janua

ry-19

73

Janua

ry-1975

Janua

ry-19

77

January

-1979

Janua

ry-19

81

Janua

ry-19

83

Janua

ry-19

85

Janua

ry-19

87

Janua

ry-19

89

Janua

ry-19

91

January

-1993

Janua

ry-19

95

January

-1997

Janua

ry-19

99

January

-2001

Janua

ry-20

03

Janua

ry-20

05

Janua

ry-20

07

Janua

ry-20

09

YenRenminbi



Japan and China. It is again drawn in such a way that China today corresponds with Japanin 1990. The renminbi has appreciated somewhat from 5–6 years ago, but the size of theappreciation is nothing compared with that of the yen in the 1980s. This is why the BOJeased monetary policy aggressively during the period. The direct negative effect of thesharp appreciation of the yen on the economy, the subsequent volatility in asset prices andthe financial system, and the ultimate stagnation of the Japanese economy must have beenmajor reasons behind the prevention of a large renminbi appreciation by the Chinesemonetary authority. The figure shows clearly that China has avoided a renminbi apprecia-tion of the scale we saw for Japan in the late 1980s.

In contrast, Figure 12 shows the behavior of the real effective yen and renminbi. It isevident that the renminbi has recently appreciated in real terms in the order of magnitudecomparable to, although still smaller than, Japan in the late 1980s. The reason for thedivergent behavior between nominal and real renminbi is straightforward. The Chinesemonetary easing, as discussed above, raised inflation by more than her competitors. Chineseinflation has been moderate during the recent period, but still higher than for many of herG7 competitors.

The implications of the above finding for the Chinese economy are not straightforward.Although China has succeeded in avoiding a large-scale renminbi appreciation in nominalterms, the very attempt to avoid it has led to an ultra easy monetary environment, some

Figure 12. Real Effective Yen (1971-2010)and Renminbi (1994-2010)

Time

1978 = 100

Source: The Bank for International Settlements.

0

20

40

60

80

100

120

140

160

180

Janua

ry-19

71

Janua

ry-197

3

January

-1975

Janua

ry-19

77

Janua

ry-197

9

January

-1981

Janua

ry-19

83

Janua

ry-19

85

Janua

ry-198

7

January

-1989

Janua

ry-19

91

Janua

ry-199

3

January

-1995

Janua

ry-19

97

Janua

ry-19

99

Janua

ry-200

1

January

-2003

Janua

ry-20

05

Janua

ry-20

07

January

-2009

Yen Renminbi

60 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


inflation of the general price level and, therefore, real appreciation of the exchange rate.Monetary easing has also generated bubble-like behavior in stock and property prices.Real appreciation of the exchange rate and asset price inflation are the two majormacroeconomic phenomena that Japan experienced in the late 1980s. In this sense, theattempt by the Chinese monetary authority has been only partially successful. It has notbeen able to prevent the workings of basic economic forces.

IV. Macroeconomic Policy Options for China

In October 2010, China’s CPI inflation rate reached 4.4 percent over a year earlier. Thegeneral price level, not just property prices, is rising, although inflation is still somewhatconfined to food prices. In response, the People’s Bank of China announced a 25-basispoint hike on key policy interest rates for the first time in nearly 2 years. This wasfollowed by two 50-basis point increases in the reserve requirement ratio in November,making them the fourth and fifth increases in 2010. Clearly, the authorities are trying hard toavoid the overheating of the economy. However, some developed nation policy-makersand market participants argue that there has not been enough use of standardmacroeconomic tools, interest rates and exchange rates to curb inflationary pressures inthe economy.10 What is the appropriate mix of economic policy tools for China at thisjuncture?

What is apparent from outside is the existence of the fear of large-scale appreciation ofthe renminbi. In fact, I argue that this fear has been the root cause of the inflationarypressure in the economy.

China might be trying to draw lessons from Japan’s mismanagement of its economy.Japan saw dramatic appreciation of the yen between the mid-1980s and the mid-1990s. Itsmacroeconomic performance since the early 1990s has not been satisfactory. Japan’s poormacroeconomic performance, however, seems to have been due more to the overlyexpansionary monetary policy of the 1980s that led to the formation of the bubble, and tothe inappropriate handling of the bad loan problem generated by the burst of the bubble,than to the appreciation of the yen itself. Even the appreciation of the yen in the 1990s canpartially be explained by the decline in the risk-taking ability of Japanese financial institutions

10 For example, Bernanke (2010, p. 4) remarks that: “the exchange rate adjustment is incomplete, inpart, because the authorities in some emerging market economies have intervened in foreign exchangemarkets to prevent or slow the appreciation of their currencies.” He argues that in the event of moreexchange rate flexibility, “emerging market economies would tighten their own monetary policies to thedegree needed to prevent overheating and inflation.”



and investors in the aftermath of the burst of the bubble (Ueda, 1998). Therefore, Japan’sexperience does not seem to offer a lesson to avoid the use of exchange rate and interestrate changes in the face of the risk of the economic overheating and possibly a drasticreversal of asset price movements. If anything, Japan did not raise interest rates enough inthe late 1980s to avoid the boom–bust cycle in asset prices and the economy, as I arguedin Sections II and III.

I would hasten to add, however, that heavy reliance on moral suasion and regulatorytools to curb inflationary pressures, especially bank lending growth, is somewhatunderstandable in the current Chinese context. Given its political structure, moral suasiontoward bank lending growth might produce a quicker result than an increase in interestrates. Sometimes it has not been easy, however, for the Chinese central authorities topersuade local political interests to curb lending growth. In such cases, referring tointernational financial regulatory standards, as contained in the Basel capital regulations ormacro-prudential regulations to be contained in Basel III, might be an effective tool fordisciplining local banks. It is important to keep in mind, however, that for such tools to beeffective in the face of strong upward momentum in the economy, simultaneous use ofstandard macroeconomic policy tools is indispensible. For example, Japan relied heavily onso-called window guidance (use of moral suasion by the BOJ to curb bank lending growth)during periods of monetary tightening in the 1960s and 1970s. This measure sometimesproduced very quick results for bank lending, but was deemed unsuccessful unlessaccompanied by significant interest rate hikes.

On the international scene, further monetary easing measures deployed by the Fedsince the fall of 2010 under the name of QE2 have had an element of beggar-thy-neighbor-policy through lowering the value of the US dollar. Such a situation may not have beenwelcome under normal circumstances. The risk of the overheating of the Chinese economy,however, seems to provide a good case for accepting further exchange rate appreciation. Inthe absence of this, inflationary pressures would spill over to other countries in Asiabecause no small economy wants to be the first to revalue its currency significantly. Thiswould generate further inflationary pressures for the entire region. All in all, even thoughChina’s multi-front approach for macroeconomic management is understandable, moreaggressive use of standard macroeconomic tools seem appropriate, depending, of course,on the development of the Chinese and world economies in the near future.

References

Bernanke, Ben S., 2003, “An unwelcome fall in inflation?” Speech given before the EconomicRoundtable; 23 July, University of California, San Diego,

62 Kazuo Ueda / 47 – 62, Vol. 19, No. 1, 2011


Bernanke, Ben S., 2010, “Rebalancing the global recovery,” Speech at the Sixth European CentralBank Central Banking Conference, 19 November, Frankfurt.

Funabashi, Yoichi, 1988, Tsuuka Retsuretsu (in Japanese), Tokyo: Asahi Shinbun Publications.Greenspan, Alan, 2004, “Economic flexibility,” Speech before the HM Treasury Enterprise Conference;

26 January, London.Kindleberger, Charles P. and R. Aliber, 2005, Manias, Panics, and Crashes, 5th edition, Hoboken,

New Jersey: John Wiley & Sons.Reinhart, Carmen M. and Kenneth Rogoff, 2009, This Time is Different: Eight Centuries of Financial

Folly, Princeton: Princeton University Press.Taylor, John B., 2009, “The financial crisis and policy responses: An empirical analysis of what

went wrong,” NBER Working Paper No. 14631, National Bureau of Economic Research,Cambridge, MA.

Ueda, Kazuo, 1998, “The East Asian economic crisis: A Japanese perspective,” International Finance,Vol. 2, No. 1, pp. 327–38.

Ueda, Kazuo, 2000, “Causes of Japan’s banking problems in the 1990s,” in Takeo Hoshi and HughPatrick, eds, Crisis and Change in Japan’s Financial System, Norwell, MA: Kluwer AcademicPublishers, pp. 59–84.

Ueda, Kazuo, 2010, “Regulation, supervisory lessons from Japan since the 1990s,” Journal ofRegulation & Risk, North Asia, Vol. 2, No. 1, pp. 87–97.

White, William R., 2010, “Some alternative perspectives on macroeconomic theory and some policyimplications,” Mayekawa Lecture given at the 2010 International Conference of the Instituteof Monetary and Economic Studies, Bank of Japan; 26–27 May, Tokyo.

(Edited by Xiaoming Feng)

japan's bubble, the usa's bubble and china's bubble

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