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Japan's Lost Decade — 1989 to 2006

The 1997 Tax Rise and Japan's Bank Failures

Explain what happened to Japan's economy and banks around the April 1997 tax rise and the failures of November 1997, and what the IMF said caused the downturn.

Before you start

What you'll be able to answer

  1. Why did Japan's economy turn down again in 1997?
  2. What happened to Japan's banks and securities houses, firms that trade shares and bonds for clients, in November 1997, and what did the Bank of Japan, Japan's central bank, do?
  3. Why did Japanese banks have to pay more to borrow abroad?

Where this sits

Japan's Lost Decade — 1989 to 2006 · this module is lit

  1. Dec 1989Share prices in Japan peak
  2. Aug 1990The Bank of Japan's last rise in its discount rate, the interest rate at which it lent to banks
  3. Aug 1992The government announces the first of six spending packages up to 1995
  4. 1995-96The first direct use of taxpayers' money against financial instability covers losses at failed housing-loan companies, the jusen
  5. 1 Apr 1997The consumption tax rate, a tax on what people buy, is raised
  6. Nov 1997Sanyo Securities, Hokkaido Takushoku Bank and Yamaichi Securities fail
  7. Oct-Dec 1998Japan's parliament, the Diet, makes more public money available to deal with banks' bad loans, and the state takes over the Long-Term Credit Bank and Nippon Credit Bank
  8. Feb 1999The Bank of Japan begins its zero interest rate policy, pushing its overnight rate as low as possible
  9. Mar 1999Public capital, new capital paid for by the state, is put into the major banks
  10. Mar 2001The Bank of Japan begins quantitative easing, a target for the money banks keep in their accounts with it
  11. Oct 2002The Financial Services Agency, the banking regulator, launches its programme to cut bad loans
  12. Mar 2006The Bank of Japan ends quantitative easing

Japan in the spring of 1997

Japan's economy grew again in 1996 after years of slow growth. The recovery did not last. In the spring of 1997 the government raised the consumption tax, a tax on what people buy, as part of a wider tightening of its budget. By the end of November two securities houses, firms that trade shares and bonds for clients, and a large bank had failed. A 2001 paper for the Bank for International Settlements (BIS), the central banks' own bank, calls this the financial crisis of autumn 1997.

Predict first

The higher consumption tax rate applied from 1 April 1997. What do you expect happened to household spending in the months just before and just after that date?

The government raised taxes and cut its own spending in 1997

On 1 April 1997 the government raised the consumption tax from 3 per cent to 5 per cent. In June it ended an income tax cut given in earlier years. It also cut public investment, its spending on roads, buildings and other works, sharply. The budget deficit is the gap between what the government spends and what it collects in a year. The International Monetary Fund (IMF), which advises and lends to its member countries, estimated that the structural deficit fell by about 1.5 per cent of GDP, the value of everything the economy produces in a year. The structural deficit is the part of the deficit that would not shrink even if the economy picked up.

The aim, the IMF said, was to make the public finances sustainable ahead of demographic pressures. Demographic pressures here means the costs that come with a population growing older.

Household spending fell back after April, and output fell

Households had rushed to buy ahead of the tax rise, the IMF reported. After April that extra spending fell away, and GDP dropped sharply in the April to June quarter of 1997. Output picked up a little in the next quarter, then fell again from October 1997 to March 1998. The economy was back in recession, a sustained fall in output.

The fall in household spending after the tax rise was larger than expected, the IMF said in 1999. A 2019 brief from the Federal Reserve Bank of Richmond, part of the US central bank, describes household spending falling after the rise, then staying flat for about two years. Little published statistical work had tested whether the tax rise caused the recession, the brief noted; research it reported found that spending changed sharply as the tax rose, but stopped short of blaming the tax for the recession.