The Plaza Accord, Revisited

The stagnation that Japan has experienced since its real estate bubble ended in 1991 has caused much anguish and speculation for how Japan can turn its economy around and recapture some of the dynamism it experienced in the 1980s.  Many observers blame the Plaza Accords, pinpointing it as a cause of Japan's decline as an economic power.  The Nikkei Asian Review has an interview with Toyoo Gyohten, the former chief of the International Finance Bureau at the Ministry of Finance, and an official who was involved in the negotiation of the Plaza Accord.  He takes a more balanced view of the genesis of the Plaza Accord, and the cause of Japan's subsequent stagnation:

Q: How do you assess the Plaza Accord from a historical perspective?

A: As the U.S. status as the predominant economic power was declining, the leading industrial nations tried to correct international current-account imbalances through exchange rate manipulations. It was the last case in which the G-5 — Japan, the U.S., Britain, Germany and France — worked out a framework for financial policy cooperation. For Japan, the agreement led to the yen's rapid appreciation, the formation of the bubble economy and eventually to the prolonged period of deflation that started in the 1990s.

Q: Do you think the deal was a mistake?

A: In retrospect, Japan was ill-prepared (to deal with the consequences of the agreement). Concerted interventions in currency markets to lower the value of the strong dollar at that time proved to be too effective. We failed to work out some important details of our plan to respond to the situation, such as the specific targets and the actions to be taken after they were achieved. We thought the upward momentum of the dollar was very strong, but it turned out to be weaker than believed. What we did was like kicking a ball down a slope. The ball might have started rolling even if nothing had been done.

Q: Are you saying Japan succumbed to pressure from the U.S.?

A: No, I'm not saying that. Because of its trade disputes with the U.S., Japan was the most supportive (of the U.S. policy) among the G-5 nations. Japan made its own decision. Excessive consumer spending in the U.S. was the principal problem (behind the country's huge trade deficit), but no other country would dare to criticize American consumption, on which the world economy depended back then.    

There are several points in here which I would like to highlight.  First, Gyohten observes that because the world economy depended on high levels of consumption by Americans, it was difficult for Japan and the other economic powers to turn the US away when it sought help in closing its trade deficit; it was important to help rebalance the American economy in order to preserve global growth.  In 1980, the US represented approximately 25% of global GDP, and was the primary engine of growth for the world economy.  While many interpreted the Plaza Accord as a bit of bullying by the US, it was actually a mutually beneficial action designed to preserve the economic strength of the G5, as a crisis in the US would drag down the others.

I present the following as evidence to this effect, keeping in mind that Plaza was implemented in 1985.  

Here was Japan's real GDP growth in the 1980s:

1980: 3.2%
1981: 4.2%
1982: 3.4%
1983: 3.1%
1984: 4.5%
1985: 6.3%
1986: 2.8%
1987: 4.1%
1988: 7.1%
1989: 5.4%

And here was Germany's:

1980: 1.3%
1981: 0.1%
1982: -0.8%
1983: 1.6%
1984: 2.8%
1985: 2.2%
1986: 2.4%
1987: 1.5%
1988: 3.7%
1989: 3.9%

I often see claims from the anti-American crowd that Plaza destroyed the Japanese economy. That assertion is not evident in the numbers. The real estate bubble was not inevitable, and could have been avoided with better monetary policy (just like the US real estate bubble), but to put Japan's lost decades entirely on the shoulders of Plaza is misguided. It's clear that Plaza didn't destroy the German economy either. In fact, in this fascinating account of the lead up to the Plaza Accords and the after-effects, it's clear that Germany essentially single-handedly was responsible for the USD devaluation, doing far more than either the US or Japan (pp. 12-13 of the pdf, pp. 303-304 of the text in the upper left corner). And to complete the picture, the USD had already depreciated as much in the six months leading up to Plaza as it did in the six months following Plaza, so the trend was already in place. Plaza simply accelerated it.

Gyohten confirms this in the interview above:

We thought the upward momentum of the dollar was very strong, but it turned out to be weaker than believed. What we did was like kicking a ball down a slope. The ball might have started rolling even if nothing had been done.

That said, the Plaza Accord did have a dramatic effect.  The Deutche Mark:


And the Japanese Yen:

So what was the fundamental cause of Japan's stagnation?  Let's return to the interview:

Q: Are you saying Japan succumbed to pressure from the U.S.?

I would rather say that Japan made misguided policy responses to the yen's appreciation than argue that the yen's rise itself was detrimental to Japan. Japan should have started serious structural reforms earlier. What is now called the "third arrow" of Abenomics represented a major policy challenge at that time too. The government received various proposals (about structural reforms) including those in the Maekawa Report (a set of measures to stimulate domestic demand and make the Japanese economy less dependent on exports recommended by an advisory panel headed by Haruo Maekawa, a former governor of the Bank of Japan). But there was no motivation to implement such measures among politicians or the public.

Q: The way Japan postponed necessary structural reforms and relied on monetary easing to stoke economic growth in those days is exactly the same as how the nation is acting right now, isn't it?

A: Since the BOJ operated under the old BOJ act (which gave the government the power to sack the BOJ governor) in those days, the Finance Ministry was equally responsible (for the policy failures). The government didn't want to carry out structural reforms, but a huge budget deficit deterred it from fiscal expansion. The only policy means available to boost domestic demand was monetary easing. Signs of financial bubbles emerged in 1987, but the Black Monday global stock market crash (in October that year) eliminated the option of monetary tightening. Japan was too late in tightening the monetary policy when bubbles started forming and later did too much monetary tightening to prick the bubbles.


Really, it's as simple as that.  Gyohten identifies the lack of structural reform, mistaken monetary policy, and the inability to use the fiscal stimulus tool as the main causes of Japan's downward economic tragectory.  Why Japan has been unable to recover since then, and what happened to the fearsome Japan, Inc. machine will be a discussion we will save for another time.