From the December 8, 2008 NY Times:
Economists and former Bank of Japan officials say the biggest lesson they learned was that cutting rates alone has almost no effect when the financial system has fallen into a crisis as deep as the one Japan faced in the 1990s.
Japanese banks simply refused to lend in an environment where borrowers could suddenly go bankrupt, saddling lenders with huge, unforeseen losses. The Bank of Japan tried even more extreme measures, like using its powers to create money to essentially stuff cash into the nation’s commercial banks in hopes they would start lending again.
Exasperated central bankers found that commercial banks just let the money pile up instead of lending it out.
Economists say the United States faces a similar situation, after the sudden collapse in September of Lehman Brothers created fears of additional failures. Economists also fault Washington for its inconsistency in dealing with the financial crisis, leaving the impression that it does not have a clear strategy for dealing with ailing lenders.
In Japan’s case, economists and former bankers say, credit began to flow freely again only after 2003, when regulators adopted a tough new policy of auditing banks and forcing weaker ones to raise new capital or accept a government takeover. Economists said the audits finally removed paralysis in credit markets by convincing bankers and investors that sudden failures were no longer a risk, and that the true extent of problems at banks and other companies was finally being revealed.
Economists say Washington needs to do something similar to make banks and financial companies more transparent, and reassure investors that there were no more collapses like that of Lehman Brothers on the horizon.
“The United States needs to do it like Takenaka did,” said Anil Kashyap, a professor of business at the University of Chicago, referring to Heizo Takenaka, the former banking minister who started the 2003 audits. “We need someone to come in and give a good housekeeping seal to banks.”
Economists and former central bankers said another lesson from Japan’s experience was the importance of consistency. This became apparent in 2000, they said, during one of the bank’s more embarrassing episodes, when it raised interest rates, and lowered them back to zero a year later when the economy faltered.
Former Bank of Japan officials said they learned that bankers and investors would lend in difficult times only if they believed that rates would stay low for a long period, ensuring them adequate profits. By raising the possibility of future interest rate increases, the Bank of Japan dampened enthusiasm for lending, say bankers and economists.
“We learned that zero rates work by building expectations,” said Rei Masunaga, an economist and former director general at the Bank of Japan. “Zero interest rates take time to be effective.”