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Print Edition> World
UPDATED: May 17, 2010 NO. 20 MAY 20, 2010
Lessons From Japan
Japan's decade-long recession may be as a cautionary tale for China, but there are important differences between their economies

Tips for China

Statistics from China's Ministry of Land and Resources show that serious property bubbles have emerged in six large cities in China, including Beijing and Shanghai. The bubbles spread throughout every key city monitored by the state starting in 2008.

China should therefore adopt measures to keep Japanese-style asset bubbles in a controllable range before they burst, so as to avoid serious repercussions for the real economy.

First, China should maintain a steady but flexible monetary policy.

After the Plaza Accord, the Japanese yen appreciated significantly. However, yen appreciation itself was not the only cause of the economic bubbles and the later long-term recession. Other elements, including a series of policy mistakes made by Japan's central bank, should be blamed as well.

In the currently unbalanced world economy, current accounts will inevitably have a surplus or deficit. The unbalanced situation will be difficult to change because excess liquidity is a worldwide phenomenon.

As a result, it is very important for a country to keep a steady but flexible monetary policy. China should, in the face of possible economic backlash from home and abroad, make some preemptive and slight adjustments to its current policies to avoid drastic policy adjustment, which would cause large fluctuations in the financial market and its micro-economy.

Second, the government's monetary policy should not only aim at keeping consumer prices stable, but also should consider fluctuations in asset prices.

Japan failed to adopt a tightened monetary policy at the beginning of the economic bubbles during 1985-89 because its central bank was content with the stability of the general price level and ignored swelling asset prices, which resulted in the expansion and aggravation of the bubbles.

Considering its excess liquidity and surging property prices, China should make relevant adjustments to its monetary policy.

Third, the government should be careful in adjusting its macroeconomic policies.

Japan's monetary policy during the economic bubble period changed drastically, and the changes came too late. Despite the economic slide caused by Japanese yen appreciation, the Japanese economy began to bottom out in 1986 thanks to proactive financial and fiscal policies and improvements in trading conditions due to the yen appreciation. The Japanese Government was so slow to respond to the situation that it maintained its loose monetary policy until 1989, leaving enough time for the economic bubbles to expand.

Japan then hurriedly tightened its monetary policy in the early 1990s. The policy change successfully eliminated the asset bubbles, but it also plunged the economy into a long-term recession.

China's current monetary policy tends to be tight, so the government should take care that it doesn't become too tight and create a "hard landing" for the economy.

Finally, China should strengthen regulations on the real estate industry.

Japan's experience shows that a hike in real estate prices can easily trigger economic bubbles and a banking crisis.

This has already started to happen in China. Due to the overheated property market in recent years, the State Council, China's cabinet, has issued a series of policies since 2005 that aim to curb exorbitant development of the real estate industry.

But the effect has not been seen yet. The reason is that, in addition to the retarding effect of macroeconomic policies, some local governments use their power to prop up the real estate market.

The funds used to develop real estate come mainly from banks in China. If the sector had serious bubbles and if they were to burst, banks would be greatly damaged. The Central Government, therefore, should regulate local government's behavior when it comes to real estate development.

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