Japan's Ultraloose Monetary Policy Has Undermined Savings and Prosperity
Uncertainty over the corona crisis has raised the household savings in many countries. The closure of stores, restaurants, and borders has restricted people from spending money. The support of furlough, rescue credit, and the grant of tax-free bonuses by governments stabilizes incomes. Even in Japan where most stores and restaurants have remained open, the generous handout of around 950 US dollars to all residents increased the savings. Nevertheless, this is unlikely to reverse the long-term downward trend in household savings.
Figure 1: Japan: Interest Rates and Household Net Saving Rate
Source: IMF and Thomson Reuters. Net saving as a share of disposable income.
The savings of Japanese households have dramatically declined since the 1990s. In 1991 households saved ¥46.9 trillion (ca. $451 billion dollar). The savings rate exceeded 15 percent as a share of disposable income. In 2019, the savings have dropped by nearly 70 percent to ¥14.4 trillion (ca. $138 billion), which corresponds to a savings rate near 5 percent (figure 1). In 2014 the savings rate had even turned negative as the spending surged ahead of the consumption tax rate hike. Since then, this trend had been reversed by the temporarily positive impact of Abenomics on the business cycle and aggregate income, but this has abruptly ended with the corona shock.
The drastic dissaving of Japanese households originates in the Plaza Accord of September 1985. The five largest industrial nations decided on a strong appreciation of the yen, which plunged Japan into a deep “endaka fukyo”—i.e., a high-yen-induced recession. The sharp reduction of interest rates by the Bank of Japan mitigated the recession but also caused a stock and real estate market bubble. With the bursting of the bubble economy in December 1989, Japan fell into a lasting stagnation. The Bank of Japan flooded the economy with cheap money by lowering the policy interest rate from over 8 percent in 1990 to zero in 1999, where it has remained (figure 1). The Bank of Japan's balance sheet expanded from 10 percent as a share of GDP in 1990 to almost 140 percent today (figure 2).
Figure 2: Bank of Japan Balance Sheet as a Share of GDP
Source: IMF, Bank of Japan. 2020 estimate.
The unprecedented flood of cheap money did not deliver the desired recovery (Murai and Schnabl 2019). Tax revenues declined, while the rapidly aging society caused government subsidies for the pension and healthcare system to increase substantially (Murai and Schnabl 2020). The large gap in public finance could only be filled by government borrowing, which caused the national debt to rise from 67 percent of GDP in 1990 to close to 250 percent today. The only way of preventing a sovereign debt crisis has been for the Bank of Japan to buy large amounts of government bonds. No central bank anywhere in the industrialized world has intervened in the government bond market more heavily than the Bank of Japan since 2013 under former Prime Minister Shinzo Abe (hence the term "Abenomics").
The persistent crisis and monetary expansion in Japan caused a turnaround of its savings culture. During the high-growth phase of the Japanese economy after World War II, Japanese households accumulated large savings. The substantial growth of household savings resulted from rising wages (including high bonus payments), a growing middle class, and tax incentives for saving (maruyû). Also important to the saving motive were the (then still) comparatively small wealth of Japanese households, the (then still) rudimentary social security system, and the (then still) tight regulation of consumer credit and mortgage loans.
Dissaving in Japan started in 1990. Economists often give as an explanation the lifecycle hypothesis of savings: people save when they are employed and dissave when they retire. As more and more people in fast-aging Japan are over sixty-four, the hypothesis implies a decline in savings. The Family Income and Expenditure Survey says that the Japanese over sixty-four indeed have significantly decreased their savings since the 1990s. Nevertheless, the saving rate of the old is still positive and savings are higher than those of the working generation. Some also expected the increasingly uncertain economic situation to increase precautionary saving, but the three lost decades since 1990 tell that this was not the case.
Moreover, there are three reasons why the persistently loose monetary policy of the Bank of Japan has been closely connected with Japan’s declining savings rate. First, the incentive to build up savings has weakened since the lowering of interest rates by the Bank of Japan reduced interest on bank deposits. In addition, the Bank of Japan has made it difficult to accumulate assets such as stock and real estate prices, as it kept prices high or has boosted them again with the Abenomics. Both of these factors have contributed to a rise (fall) of the propensity to consume (propensity to save).
Second, the Bank of Japan has made financing conditions increasingly favorable. The cheap financing made an increasing number of Japanese firms dependent on low interest rates and forbearance lending by Japanese banks. The cheap money reduced the once high productivity gains of Japan to almost zero. Productivity gains are the prerequisite for the growth of real wages. With declining productivity gains, Japan’s real wages have been put under pressure, trending downward since 1998. The once high bonus payments fell to modest levels. The negative distributional effects of monetary policy work in favor of the rich and at the expense of the middle class, which has narrowed the room for savings for many Japanese.
Third, the Japanese government has expanded the social security system, which has significantly reduced the incentive to save for retirement. The Japanese government could increase pension and healthcare benefits because the Bank of Japan indirectly financed the ever-growing public subsidies. Note that most Japanese enterprises could not expect increasing demand, because due to the lasting low interest rate experiment the incomes of Japanese people from wages and interest declined. Therefore, they hesitated to expand capacities by investment. The upshot is that—along with the household savings rate—the savings rate of enterprises increased, whereas investment as a percent of GDP continued to decline.
The Japanese experience offers valuable lessons for the United States and Europe. A loose monetary policy can stabilize in a recession for the short term; however, a persistent flood of cheap money paralyzes productivity gains and growth. If, in a creeping crisis with falling interest rates and wages, the incomes of growing parts of the population come under pressure, the household savings can hardly grow. If the social security system is financed by a combination of borrowing by the government and purchases of government bonds by the central bank, the propensity of the household to save will further decline.
After all, savings and investment remain linked. If both decline, a nation’s wealth is endangered. Higher savings and thereby higher investment thus remain the keys to maintaining economic prosperity in Japan, the United States, and Europe.