Back to the Future – The Tokyo Drift

The Back To The Future movie franchise introduced a mass audience to the complexities of time travel. Revisiting the series today also teaches us a lesson in how the world continually changes. But there are instances where the world does not change—for that matter, while History may not repeat, it often rhymes.

Despite some structural differences, some of Japan’s economic attributes can make it an attractive case study for policymakers. It establishes the premise that if a massive stimulus is maintained for too long, private sector attitudes change in ways that show up in low growth and deflation.

In short, ‘Japanification*’ ends up steering us in that direction.

Three broad policy measures of the monetary model practised by Japan in the late 1980s —collectively called Japanification—are of pushing the rates lower, depreciating the currency and the central bank buying sovereign bonds.

• The conventional wisdom is that lower interest rates stimulate economic activity, and higher rates dampen it. However, experiences cast doubt on this hypothesis. Empirical results show that the correlation between economic growth and interest rates is not negative but positive over most time periods.
• The consequences of “regime-induced” exchange rate depreciation are not generally positive for growth.  
• Central bank bond buying is normally expected to flood the system with liquidity, encouraging the private sector towards more leverage to create a wealth effect, boosting consumption and investment.

However, this may not work as intended when the loss of confidence is such that it leads to extreme risk aversion, destroying appetite for consumption and investment. In this context, the additional liquidity is left idling in the economy.

All three measures are undoubtedly dictated by the predominant influence of fiscal dominance.

The lower Sovereign Bond yields and the aggressive bond buying by the central bank save the government from the servicing cost on its large debt pile, and the depreciation in domestic currency indirectly minimises issuances.

History shows that even as these policies are thought to be reflationary, the irony is that they end up resulting in an opposite impact. So we can infer from the experiences that in a state called “Japanification”, the economy seems to be losing altitude in its growth trajectory for an extended period, associated with low interest rates, low inflation and high government indebtedness. The extent to which these factors are causal agents or just the side effects of these policies is still debated.

It is advisable to read ‘Japanification’ as a playbook instead of a prophecy of doom. 

Early Japanification
“Japanification” from the early 1990s was not the money-printing party that many imagine it to be. Broad money supply grew slowly, fiscal deficits remained at about 8% per year or lower, corporations deleveraged their balance sheets, and the massive rise in base money was contained in the financial system. It had issues, including zombification of aspects of the economy, but it wasn’t inflationary.

In 1988, Japan’s theoretical land value exceeded all of that in the US (which is almost 25 times the size of Japan) by a factor of four to five, and real estate prices climbed to dizzying heights. In the 1990s, Japanese household debt amounted to almost 70% of GDP. The Nikkei 225 stock index soared from one high to the next, trading at 70 times price to earnings, at the peak of the Japanese bubble.

The ratio of Japan’s national debt to its GDP has grown from 49% in 1989 to 212% today. But the stimulus, even to this day, only maintains the status quo. Japan’s economic drama appears to be continuing without a respite, and the key learning is that once the practice begins, it is a hard habit to kick.

Chinese Japanification
Japan is just a few stages ahead of China, and the two mirror each other in many ways. As was the case with Japan, China, too, quickly jumped on the back of state-sanctioned, debt-financed technological transformation, which led to a surge in exports. Post-GFC, China’s economic slowdown has spurred discussions about its prospect of Japanification—a protracted period of low growth and deflation. China's debt grew dramatically from 1990 to 2025, shifting from a low base (around 23% of GDP in 2000) to a massive figure, with total debt exceeding 200% of GDP by the mid-2020s. 

In both cases, leverage-fuelled excesses in property markets eventually cracked. Residents of both nations continue to prioritise saving, making a shift toward domestic consumption a challenge.  

The Chinese economy appears to be struggling with an overheated property market, though without the equity-market exuberance Japan experienced. China is now running out of time to avoid “Japanification”—decades of slow growth due to high debt and declining productivity. Yet there is good evidence to support an even more pessimistic assessment and suggest it would be a good outcome if only China were more like Japan.

Underlying Lessons
Before the lost decades in Japan and the current economic slowdown began in China, the broad similarities of depreciating the domestic currency, lowering the rates and bond buying by the central bank coexisted along with a toxic mix of expansionary fiscal policies and ballooning government debt, albeit domestic in nature, resulting in entrenched deflation. So, the conventional wisdom of expansionary monetary policies resulting in a positive outcome for the economies is negated in both cases.

Currently, in the global economic circles, the belief is widespread that excessive laxity of Japanese monetary policy from 1986 to 1989 caused the bubble in Japanese equity and real estate prices. Bank of Japan officials for the last three decades have bemoaned this fact, vowing not to repeat the mistake but having very little option otherwise.

Similarly, aggressive expansionary Chinese monetary polices post-GFC, coupled with the Yuan devaluation of August 2015, are seen as the primary causes for the current struggles of the Chinese economy.

Outside observers of a more monetarist bent have largely agreed with this lesson, thanking their central bankers for being able to resist pressures for undue ease. The lesson is that central banks should take asset prices into account explicitly when setting policy. Either way, according to this common view, the bubble arose, or at least grew large, because of excessive liquidity.

Unlike the Back To The Future series, no one is eager to watch a sequel. The main point to be made here is that it takes more than a bubble to become Japan.

*Any resemblance to the MPC’s current playbook is, of course, entirely unintentional.