What caused the decline of the Japanese economy in the 1990s?

The Japanese economy in the 1990s declined due to the bursting of the asset price bubble and subsequent banking crisis.

In the late 1980s, Japan experienced an economic bubble, characterised by rapid acceleration of asset prices and overheated economic activity. The bubble was driven by a combination of speculative and potentially irrational behaviour in lending and investment, facilitated by excessively loose monetary policy. The Bank of Japan, the country's central bank, kept interest rates low, encouraging high levels of borrowing and investment in real estate and stocks. This led to inflated asset prices, particularly in the property market, creating an 'asset price bubble'.

However, in the early 1990s, this bubble burst. Asset prices plummeted, leaving many banks and financial institutions with bad loans and non-performing assets. This led to a banking crisis, with many banks becoming insolvent and needing to be bailed out by the government. The financial sector's troubles had a knock-on effect on the rest of the economy, leading to a period of economic stagnation known as the 'Lost Decade'.

The government's response to the crisis was criticised for being slow and inadequate. Initially, the authorities were reluctant to acknowledge the scale of the problem, and their interventions were often too little, too late. The Bank of Japan was also slow to lower interest rates, which could have helped to stimulate economic activity. Furthermore, structural problems in the economy, such as rigid labour markets and a lack of competition in certain sectors, exacerbated the downturn.

The decline of the Japanese economy in the 1990s serves as a cautionary tale about the dangers of asset price bubbles and the importance of swift and effective policy responses. It also highlights the potential risks of structural economic problems and the need for ongoing economic reform.