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Explaining the Japanese Economy’s Lost Decades Using Macroeconomic Models

Kozo Ueda
Professor, Faculty of Political Science and Economics, Waseda University

From a student majoring in physics to an expert in economics

In college, I majored in physics and continued studying it in graduate school. After working at the Bank of Japan for 14 years, I became a university teaching staff. Whenever I tell people that I changed my major from physics to economics, people usually get surprised. However, recent economics, particularly macroeconomics in which I specialize, requires much simulations and data estimation using theoretical models, and economists cannot purse their studies unless they master mathematics. I applied my knowledge of mathematics—which I had gained when I majored in physics—to economic analysis and acquired expertise in economics at the workplace.

Ever since I was a student, I wanted to become a researcher. But at the same time, I had had a strong desire to go out into the world and become independent at an early age. Hence, I joined the Bank of Japan (BOJ), where I was fortunate enough to engage in work where there was more emphasis placed on research. To sum up my job at the BOJ in a sentence, it was to collect and analyze information to help board members determine the optimal monetary policy that the BOJ should adopt as a central bank. I made forecasts on economic variables such as GDP, prices, capital investment, and simulated the effects of monetary policies such as the quantitative easing and zero interest rate policy as well as economic policies such as Abenomics. I gained experience through job rotation every two to three years, during which I conducted microeconomic surveys by visiting many private enterprises to interview managers about their production and financing plans.

While my jobs at the BOJ enabled me to see various aspects of the economy as the times changed, the actual speed of business was so fast that it was extremely difficult to examine any issue in depth. I personally investigated and analyzed subjects that interested me outside working hours and over the weekend.

The collapse of the bubble economy and the bankruptcy of Lehman Brothers

Me and my friends at Oxford University

Between my fourth and sixth year at the BOJ, I passed an internal screening test and was given the opportunity to study at the University of Oxford, from which I obtained a master’s degree and Ph.D. in economics. During my three and a half years studies at Oxford, I was completely absorbed in my research, staying away from the workplace. In the first two years, I devoted myself to attending lectures at the graduate school to systematically re-learn what economics is. Subsequently, I chose the “Japanese economy’s lost decades” as my research topic and worked on research to use macroeconomic models to explain theoretically why Japan’s economic depression has prolonged for so long, and why the Japanese economy could not escape from deflation.

In social sciences, no one researcher can say, “This is the correct answer,” to any issue or question. Even economists outside Japan worthy of a Nobel Prize have different views on Japan’s lost decades. One easy-to-explain hypothesis is that the Japanese economy was unable to shake off the aftereffects of excessive investments during the bubble economy so long that it suffered a prolonged slump. However, I continued to be in a fog while I was unable to find the absolute answer. This is my main research topic and I have continued delving deeply into it even after returning to Japan.

After I returned to Japan from England, I proposed that it was important to painstakingly verify what effects the zero interest rate policy would have on the economy if it was prolonged and worked to build macroeconomic models. On the other hand, I also took a deep look at the theme of a doctoral dissertation a little at a time when I had free time.

Me receiving the 2016 Waseda Research Award (High-Impact Publication) which recognizes the achievements I had made since I worked with the BOJ. The photo shows me with President Kaoru Kamata.

In retrospect, on the threshold of the depression was the failure of financial institutions such as Yamaichi Securities, restricted bank lending, and businesses’ reluctance to take on loan. Multiple problems—as exemplified by these and other events—combined to cause the depression. Why, then, did the financial crisis occur in the first place? And how many events in the Japanese economy can be explained by elucidating the financial crisis? How did the financial crisis affect prices and capital investment? I worked not only to provide plausible explanations about the lost decades but also to use macroeconomic models and data to quantitatively analyze the mechanism by which they occurred.

In 2008, as I continued to work, Lehman Brothers fell into bankruptcy, and it became clear that phenomena such as the collapse of a bubble economy and financial meltdown were not restricted to Japan and that they could actually occur in other developed countries, including the United States. I have developed macroeconomic models based on a hypothesis that “the globalization of financial institutions heightened the international ripple effects of a financial crisis in one country. They then became reluctant to provide loans to organizations outside their own country, and this led to a global, simultaneous recession” and conducted a theoretical analysis of the hypothesis. This research paper attracted much public attention outside Japan when it was published in an overseas journal in 2012. The collapse of Lehman Brothers supplied a nice tailwind for my research. Under these circumstances, my desire to devote myself to research grew, and I left the BOJ, and in 2013, I became a teacher at Waseda University.

Examining the Japanese depression using big data

Amid the emergence of big-data analysis, I work on a research project to analyze price trends using point of sale (POS) data from supermarkets. People often say deflation or depression, but I want to analyze the actual conditions. In Japan, an unusually large number of limited versions of products are marketed, and why is this so? For example, in Japan KitKat chocolate products have nearly 100 varieties, including those limited to school entrance examinations, Halloween, and particular seasons. There are only a few varieties of KitKat in the U.K. (laugh). A hypothesis emerged that states that marketing limited versions of products is an ingenious idea to retain customers’ interest and one of the corporate strategies to avoid deflation.

It is often said that there are more bargain sales because of deflation, but is this true? An analysis of POS data has led to a hypothesis that as depressions cause family finances to tighten—increasing bargain hunting—retailers work hard by implementing sales campaigns in response to consumer needs. When I was at the BOJ, I analyzed product prices indicated at stores in Japan and found that they were ten times as flexible as those in the U.S. Prices changes quickly, in a cycle of about three days, in Japan, but in the U.S., the quickest they change is once a week. Price viscosity is an important factor in monetary policy, but what it actually is cannot be clarified through simple price statistics. Only by using big data such as POS data can researchers understand what is happening to prices and build up theoretical models.

Although researchers can conduct more interesting analyses if data on not only retail prices but also distributors’ wholesale prices as well as procurement and other prices become available, the business-to-business (B2B) data are not published, preventing researchers from easily stepping into this area. But this is an area I definitely want to approach. I hope that these data will be made available as the trend to utilize big data becomes widespread.

Students simulate being an economist

I became a university teacher and came to have students in my laboratory. At this laboratory, I ask students to manually collect and analyze data and make forecasts on the Japanese economy. They are divided into six teams, and roles including consumption, housing, and capital investments are divided among them. They forecast GDP and price changes and compare them with each other quarterly. Students do not read newspapers that much, a trait that troubles me. Only when they start job hunting in the fourth year do they finally appreciate the value of what they learned in the third year (laugh). Graduate students are asked to work on academic research properly using mathematic tools as well. It is demanding to require students in the humanities to have an understanding of mathematics, but fortunately, Waseda University has a well-developed educational system in this area.

A view of a residential seminar

White board used for discussion

I feel that I am blessed with an extremely favorable research environment. Many of my fellow colleagues work on theory and empirics in a well-balanced manner. A full array of experimental equipment for behavioral economics makes joint research between macroeconomics and microeconomics easy. My intellectual curiosity, which urges me to constantly go after new research areas, is the driving force behind my research. Going forward, I will proactively work on international joint research with researchers outside Japan.

Kozo Ueda
Professor, Faculty of Political Science and Economics, Waseda University

In 1997, Kozo Ueda graduated from the Faculty of Science at the University of Tokyo where he majored in physics, and in 1999, he completed the master’s course in physics at the University of Tokyo’s Graduate School of Science. In the same year, he joined the Bank of Japan. He obtained a master’s degree from Oxford University in 2004 and a DPhil in economics from the same university in 2006. In 2013, he left the BOJ and became an associate professor at Waseda University Faculty of Political Science and Economics. In 2015, he was promoted to professorship. The posts he has taken include a research associate at the Federal Reserve Bank of Dallas from 2010 and at the Australian National University from 2013, a visitor at the Bank of Japan Institute for Monetary and Economic Studies from 2013, and a member of the editorial board for Japan and the World Economy (Elsevier B.V.) from 2016. In 2016, he received the 2016 Waseda Research Award (High-Impact Publication).