Quotes of the Day

After a 15-year economic eclipse, a stream of good news is finally brightening the outlook for Japan. Banks have started to lend again, companies to hire and invest, and consumers to spend. Things are so good, in fact, that the Bank of Japan has just declared victory in its epic battle with deflation. The country has the world's second largest economy; its recovery will have implications around the globe.

It's worth remembering how Japan got to where it is now. The crushing collapse of the country's financial markets at the beginning of the 1990s exposed Japan to an economic debacle equivalent in scale to the one that laid waste the U.S. after the Wall Street crash in 1929 and the Great Depression. Scores of Japan's banks and insurance companies imploded, unemployment and bankruptcies soared, real estate values melted, and the credit system turned to mush.

After an initial period of shock, complete paralysis gripped policymakers—and for an agonizingly long period the economy contracted. The initial policy reflex to raise interest rates, curb investment and dampen consumption rendered a dire situation worse, just as similar Hooverite measures had once done in the U.S. In the late 1990s, with social and political upheaval at hand, Japan was finally jolted into action. To quell a threatening run on the banks, the government declared that it would guarantee every deposit in the country, and injected trillions of yen into the financial system. Still the economy failed to respond. With all of Asia then in a state of unprecedented financial collapse, the Bank of Japan adopted a series of measures that took it into a realm where no central bank had ever previously dared venture. Lending rates were slashed to zero, and the Bank became a vast money-printing machine. Yet so concerned were the authorities that these extreme measures could lead the economy in unmanageable directions that they moved too soon to reduce spending and raise interest rates. That sent the economy into a still deeper deflationary dive. Then the government threw all caution to the wind, and began to spend, spend, spend to create demand. Decision makers held their breath and waited. For an excruciatingly long period of time, nothing positive seemed to happen. Then imperceptibility, in early 2003, the rate of decline began to slow, then to steady, before fragile signs of reversal started to appear.

First to arrive on the scene were the value players, who saw in the crash the opportunity to find treasure. And diamonds there were aplenty; after all, Japan has a massive and highly sophisticated economy. Some of the early successes in recovery, such as Nissan, and Shinsei Bank, created from the shell of the bankrupt Long-Term Credit Bank, served to create an inkling of confidence. Companies began to clean house. Entire sectors of the economy were reorganized. Twenty steel businesses became four; nearly two dozen banks became three. Then China's explosive growth and a rebound in the U.S. kicked the fabled Japanese export machine back into gear. Firms began to invest again and, for the first time in almost a decade and a half, people started to look to the future. Unemployment stopped rising, and consumers, very nervously at first, started spending. Slowly, over the past three years a new dynamic has taken hold, such that in the last few months banks have begun to increase new lending, and prices have stopped falling. The economy appears to have slipped the deflationary noose that had been tightening around its neck.

This rebound has allowed the Bank of Japan to conclude that it can now safely begin to wean the economy from extreme monetary measures. But it will do so with utmost caution. Everything will be done to maintain confidence, for Japan has not yet put all challenges behind it. The economy carries unprecedented levels of government debt—just as public budgets are programmed to confront the double whammy of a society aging faster than any other on earth, and a contracting population. Inevitably, this will one day mean significantly higher taxes, together with reduced social welfare and pension payments. At the same time, Japan faces ever more intense international competition, from China in low-value-added sectors through to South Korea and the U.S. in more technologically advanced products.

But these are challenges for the future. Nothing is fatal in economics. Japan continues to have massive strengths. It out-invests the world in technology. It has mastered complex manufacturing processes in the way that few yet even understand. Its work force continues to be highly educated and disciplined. And it has survived, finding within itself the strength to bounce back from grave financial and economic dislocation. That sets a base for the future, and provides a source of quiet confidence as Japan moves now to what I believe will turn out to be an exciting and surprising period of positive change and reform.

• Kenneth Courtis
• How the nation's central bankers won their war against deflation