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Japan's Asset Bubble

Why Japan's Asset Bubble Grew, and What Followed

Explain why share and land prices in Japan rose so far in the late 1980s, why the Bank of Japan waited to raise its rate, and what the fall left behind.

Before you start

What you'll be able to answer

  1. Why did share and land prices rise so far?
  2. Why did the Bank of Japan wait until 1989 to raise its rate?
  3. What did the fall leave behind?

Where this sits

Japan's Asset Bubble · this module is lit

  1. 22 Sep 1985In the Plaza Agreement, a joint statement by their finance ministers and central bank governors, five countries agree that the dollar should fall against the other main currencies
  2. 23 Feb 1987The Bank of Japan cuts its discount rate, the rate at which it lends to banks, to 2.5 per cent
  3. 31 May 1989The Bank of Japan raises its discount rate to 3.25 per cent
  4. Dec 1989The Nikkei 225, an index of Japanese share prices, ends the year at its peak
  5. 30 Aug 1990The Bank of Japan raises its discount rate to 6 per cent
  6. 1 Jul 1991The Bank of Japan begins cutting its discount rate again
  7. 17 Nov 1997Hokkaido Takushoku Bank says it can no longer carry on its business on its own
  8. Oct 1998Japan's parliament, the Diet, provides public money to deal with banks' bad loans, loans unlikely to be repaid in full

Five countries agreed in 1985 that the dollar should fall

On 22 September 1985 the finance ministers and central bank governors of France, West Germany, Japan, the United Kingdom and the United States issued a joint statement. In what became known as the Plaza Agreement, they agreed that the other four currencies should rise against the dollar. Japan said it would run its monetary policy, its setting of interest rates and the supply of money, "with due attention to the yen rate", the value of its currency. That month a dollar bought about 237 yen on average.

Predict first

A stronger yen makes Japanese goods dearer abroad, which hurts exporters. What do you think the Bank of Japan did with its discount rate, the interest rate at which it lent to banks?

The Bank of Japan cut its rate to 2.5 per cent and kept it there

By January 1987 a dollar bought about 154 yen, and Japan had been through what the Ministry of Finance's history calls the yen-appreciation recession. Between January 1986 and February 1987 the Bank of Japan cut its discount rate five times, halving it to 2.5 per cent, and then held it there for about two years and three months.

On the account of Bank of Japan economists writing in 2001, only the first of the five cuts came purely from the Bank's own judgement. The other four were strongly influenced by Japan's commitments to work with other countries on policy: two were decided at the same time as cuts in the United States, and the last was announced on the day a further currency agreement was reached in Paris. The chart shows the discount rate each month from January 1985 to August 1995.

The Bank of Japan's discount rate, January 1985 to August 1995Per cent a year, each month; the rate at which the Bank lent to banks
0246198519871989199119931995Plaza AgreementFirst riseFirst cut

Source: International Monetary Fund, Monetary and Financial Statistics: Interest Rates, Japan, discount rate. IMF data, used with credit.

Banks looked for new borrowers in the 1980s

Banks had their own reasons to lend, on the account of Bank of Japan economists. From around 1980 large firms were freer to raise money by selling shares and bonds, so they relied less on banks. As limits on the interest banks paid on deposits were lifted, deposits cost the banks more. Banks turned instead to small firms and property firms, lending against land as security, or collateral: something the lender can take if a loan is not repaid. On the Cabinet Office's figures, bank lending to the property industry more than doubled between 1985 and 1990. The Ministry of Finance's own history names this lending as one of the factors that set off the bubble.