Japan's Lost Decade is the case every central bank studies

On December 29, 1989, the last trading day of the 1980s, the Nikkei 225 index closed at 38,957.44. Japanese asset prices at that moment were, by most measures, at the most extreme levels any major developed economy had ever reached. The grounds of the Imperial Palace in Tokyo were said to be worth more than all the real estate in California. The Japanese stock market was the largest in the world by capitalization.

The market opened on January 4, 1990, and started falling. It did not stop for nineteen years.

What caused the bubble

The Bank of Japan had pursued an unusually loose monetary policy through the second half of the 1980s. Credit was cheap. Banks lent aggressively against real estate, often using the real estate itself as the valuation model for other real estate. Cross-shareholding between Japanese corporations, a feature of the keiretsu system, made equity markets unusually insensitive to normal valuation metrics. Everyone was holding everyone else's shares, and the whole structure levitated on shared belief.

In 1989, the Bank of Japan, led by Yasushi Mieno, raised the official discount rate from 2.5 percent to 6.0 percent over roughly twelve months. The stated purpose was to prick the asset price bubble. The tightening worked. The asset price collapse it caused was larger and longer than Mieno's critics or supporters predicted.

The long bottom

The Nikkei reached its post-bubble low on March 10, 2009, at 7,054.98. That is an 81.9 percent decline from the 1989 peak, spread across nineteen years. Japanese real estate prices followed a similar pattern. Economic growth was anemic for most of that period. The Bank of Japan cut rates to zero in 1999 and introduced quantitative easing in March 2001, making Japan the first major economy to try both tools.

Why other central banks study it

Every significant monetary policy tool deployed in the United States after 2008, and in Europe during the sovereign debt crisis, had a Japanese precedent. Zero interest rates. Quantitative easing. Purchases of government bonds to lower longer-term yields. Purchases of corporate debt (which the Bank of Japan began in 2010). Direct purchases of equity ETFs (Japan from 2010, much earlier than any Western central bank).

The Japanese experience suggests that once asset-price deflation becomes embedded in expectations, unwinding it is extraordinarily difficult. The Nikkei finally regained its December 1989 peak in late February 2024, thirty-four years later. For a generation of Japanese investors, holding the stock market index was a losing strategy over an entire working lifetime. The lesson American and European policymakers drew is that you do not want to get into that position in the first place. The lesson they applied, post-2008 and post-2020, was to respond faster and larger than the Bank of Japan did in 1990. Read this alongside Kindleberger's five-stage framework for the cleanest view of how modern central banking grew out of avoiding Japan.