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Can U.S. avert a Japan-style economic bust?

Similar crises have hit other nations, but Sweden bounced back far faster than Japan.

By Staff writer of The Christian Science Monitor / March 21, 2008

SOURCES: "Is the 2007 US sub-prime ?nancial crisis so different?" by Carmen Reinhart and Kenneth Rogoff; Charles Calomoris and David Beim (2000)/Rich Clabaugh–STAFF


From Japan to Sweden, other nations have traveled from real estate busts to financial crises in recent years, leaving behind a simple lesson: Effective policy makes the difference between a long or a slow recovery.

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For US policymakers, Japan is the case study in what not to do when a credit bubble is followed by a real estate bust. Regulatory delay resulted in a "lost decade" of economic stagnation there.

Sweden faced similar challenges but now serves as a model for how decisive action can mend a banking system.

So far this year, the Federal Reserve has already moved in creative ways in a bid to contain what may be America's worst financial crisis since the Great Depression. Its most recent actions brought a measure of calm to Wall Street this week.

But finance experts say the fundamental problem – the burden of bad loans on financial firms – still needs to be worked through. Future steps will determine whether America follows the Japanese or the Swedish path.

"If you're shoving it under the rug, then it's going to take you 10 years, like it did in Japan," says Carmen Reinhart, a University of Maryland economist. America's situation "can best be called the Japanese problem....

The scale and scope of the losses are as yet unknown."

Federal Reserve and other US policymakers are certainly aware of the Japanese precedent and want to avoid it.

But the scale of the problem, Ms. Reinhart says, is larger and more complex than the challenges faced by Sweden and other Scandinavian nations nearly two decades ago.

That doesn't mean the outcome will be catastrophic – thanks in part to the lessons policymakers have learned.

"My best hope, and I put no more than 40 percent probability on the outcome, is that we are amidst a protracted slow patch," rather than a recession, Reinhart said last month at a congressional hearing.

In any case, the US appears to be following a familiar pattern. Reinhart and Kenneth Rogoff of Harvard University have analyzed recent financial crises in advanced economies.

The common progression begins with a housing boom, money flowing in from overseas, and rising government debt. Then economic growth cools and banks see a rise in delinquent loans. The lenders tighten up on credit, further squeezing the economy. Often the result is a severe recession..