Big Bank Bailout
Subject Deflation
Topic International Finance, Monetary Policy
Key Words Interest Rates, Deflation, Unemployment
News Story

Japan's banking industry has been struggling for some time. Bank balance sheets are saddled with bad debts and falling stock prices. Many Japanese officials feared that the banking industry might collapse and throw the economy into turmoil. To prevent this potential disaster, the Bank of Japan, Japan's central bank, announced a plan to purchase stocks from banks. Japan's central bank, like most major central banks, is currently prohibited from owning equities, and legislative change would be required to implement this proposal.

The bailout proposal was unexpected. Massaru Hayami, governor of the Bank of Japan, had long argued against his bank providing direct assistance. Mr. Hayami believed that Japan's legislature should provide any additional relief and that the Bank of Japan, by pushing short-term interest rates close to zero, had already done its part.

Economists have argued that Japan needs to take two major steps in order to bring stability to the banking industry. The first is the disposal of hundreds of billions of dollars in bad loans that are currently held by Japanese banks. Disposing of these bad debts, however, would result in some small businesses and construction firms going out of business, and there is extensive lobbying against doing so. The other needed measure is a significant expansion of the money supply to combat deflation. As consumer spending increases, retail sales, profits and stock prices are predicted to increase.

Some analysts fear that the proposed stock purchase plan would result in the Bank of Japan owning the riskiest and least salable stock. There would be pressure for the Bank to hold, rather than sell, these shares and consequently, the central bank would be forced to absorb large losses in its portfolio.

The announcement of the bailout plan caused Japan's stock market to increase more than 200 points. Japanese stock prices have been falling and at current stock prices, it is estimated that Japanese banks would have to register more than $30 billion in losses at the end of the fiscal year.

(Updated October 10, 2002)


What is the deflation? Why might deflation be a problem in Japan?

2. Why are economists and policymakers concerned about the state of the Japanese banking sector?
3. What are the primary function's of Japan's Central Bank?
Source Ken Belson, "Japan Will Buy Shares From Its Troubled Banks," The New York Times, September 19, 2002.

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