MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/FEBRUARY 2001

The Asset Price Bubble

and Monetary Policy:

Japan’s Experience

in the Late 1980s

and the Lessons

Background Paper

by Kunio Okina, Masaaki Shirakawa,

and Shigenori Shiratsuka

Since the latter half of the 1980s, Japan’s economy has experienced

the emergence, expansion, and bursting of a bubble economy,

characterized by a rapid rise in asset prices, the overheating of

economic activity, and the expansion of money supply and credit.

This paper examines the mechanism by which the bubble economy

was generated and summarizes lessons a central bank should draw

from the experience in order to prevent it from happening again.

Specifically, by focusing on the intensified bullish expectations

that played an important role behind the large fluctuations in asset

prices and the economy, the process of the emergence, expansion, and

bursting of the bubble is examined in relation to the monetary policy

at the time. Based on this analysis, the paper discusses a framework

for monetary policy conducive to achieving both price stability and

financial system stability.

Key words: Asset prices; Bubble; Intensified bullish expectations;

Monetary policy; Sustained price stability; Financial

stability; Forward-looking monetary policy

Kunio Okina: Bank of Japan (E-mail: kunio.okina@boj.or.jp)

Japan’s economy has experienced substantial fluctuations since the latter half of the

1980s. From the latter half of the 1980s to the early 1990s when the bubble emerged

and expanded, we saw a rapid and large surge in asset prices, a sizable increase in

money supply and credit, and the expansion of economic activity for a protracted

period. During the subsequent period of the bursting of the bubble from the early

1990s, Japan experienced a plummet in asset prices, the accumulation of huge

nonperforming assets and resulting difficulties faced by financial institutions, and a

prolonged recession.

There have been various discussions and analyses among central bankers,

academia, and economists both at home and abroad with respect to the mechanism

of how the bubble economy was generated, although up to now a consensus is

far from being reached.1Similarly, discussions are under way as to how monetary

policy should be conducted when asset prices rapidly rise. In fact, the evaluation of

monetary policy depends very much on financial and economic conditions under

which it is conducted. For example, from the latter half of 1987 when asset prices

rapidly rose and economic expansion became increasingly certain, the Bank of Japan

(BOJ) explored the possibility of monetary tightening in view of concern over

inflation and excessive monetary easing, but could not present an argument that was

regarded as sufficiently convincing for tightening. In contrast, immediately after the

bursting of the bubble, there were periods when monetary tightening was generally

praised as an appropriate measure. As the recession became protracted, the BOJ was

exposed to severe criticism that prolonged monetary easing since the latter half of the

1980s had brought about the bubble economy, which led to the subsequent deep

recession and nonperforming-asset problem.

Recalling the situation when the bubble emerged, the BOJ expressed concern, at a

relatively early stage, over inflationary pressure and the adverse effects of excessive

monetary easing. Such concerns were also shared by not a few economists at that

time. However, in view of stable prices indicated by various related indices, those

who were concerned with inflationary pressure had difficulty in reconciling stable

price indices with concern over future inflation. Furthermore, there did not exist a

commonly shared understanding as to what exactly are problems caused by the

increase in asset prices.

This paper intends to draw lessons based on the experience of monetary policy

during the bubble period rather than a simple afterthought. In view of such an

intention, this paper attempts to describe as accurately and as concretely as possible

the economic, financial, and social background under which monetary policy was

being conducted. Needless to say, the lessons derived from the experience during the

bubble period could differ depending on the economic theories that are being

applied and also on how the general public perceived the central bank. Some may

find this paper overstates the importance of monetary policy and others find it

396 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/FEBRUARY 2001

1. Literature that has dealt with Japan’s bubble period includes Ohta (1991), Noguchi (1992), Ueda (1992), Iwata

(1993), Ministry of Finance (1993), Suzuki (1993), Takao (1994), Ogata (1996), Cargill, Hutchison, and Ito

(1997), Ogawa and Kitasaka (1998), Yoshitomi (1998), Okumura (1999), and Mieno (2000).

Page 3

too detached or self-defensive, neither of which intention the authors had in mind.

The main purpose of this paper is to present the authors’ views on the cause of

the bubble since the late 1980s and the lessons for monetary policy as well as to

objectively describe the background behind these views, thereby further enriching

discussion on the bubble.

This paper is structured as follows. Chapter II reviews the development of Japan’s

economy during the bubble period, and Chapter III examines the mechanism behind

the emergence and expansion of the bubble. Chapter IV analyzes how monetary

policy was conducted in the process of the emergence and expansion of the bubble

as well as the influence of prolonged monetary easing on the process. Chapter V

considers the question of why monetary tightening was delayed, and Chapter VI

discusses the lessons learned from the bubble period that the BOJ should be aware of

in conducting monetary policy.

II. Overview of Japan’s Economy during the Bubble Period

A. Definition of the Bubble Economy

While the term “bubble” is used differently among people, based on the experience

of Japan’s economy in the late 1980s, let us characterize the bubble economy in this

paper by three factors: a rapid rise in asset prices, the overheating of economic

activity, and a sizable increase in money supply and credit (see Figure 1 for monetary

and economic conditions after the 1980s).

The definition of the bubble period may vary depending on which one of the

three factors one emphasizes. The rise in asset prices started around 1982 and

accelerated from 1985 to 1986. However, the rise was relatively moderate in the early

stage and two years (1985–86) coincided with the “endaka recession” (a recession

caused by the appreciation of the yen). While few view these years as being part of

the bubble period, many consider 1987 as the beginning of the bubble period for

the following reasons. First, according to the Economic Planning Agency’s (EPA)

reference dates of the business cycle, the economy bottomed out in November 1986

and 1987 was a year of expansion. Second, while the year-on-year growth rate of

money supply (M2+CDs) and credit had been declining somewhat in 1986, albeit at

a high level, it started to accelerate around 1987. As such, 1987 saw an accelerating

rise in money supply and credit, a rapid increase in asset prices, and the economy

entering a recovery cycle. Hence, many naturally regard 1987 as the starting year of the

bubble. However, some might argue that 1987 should not be included in the bubble

period since the recovery of the economy was not clearly recognized in the first half

of the year and there was a worldwide stock market crash in October of the same year.

Views differ as to when the bubble began to burst. Stock prices in terms of the

Nikkei 225 peaked at end-1989,2while land prices in terms of the Urban Land Price

Index (six major cities, commercial areas) of the Japan Real Estate Institute peaked

2. The Nikkei OTC Index hit a peak on July 9, 1990, increasing almost 60 percent even after the Nikkei 225 peaked