Japan ; Saving and investment - Japan ; Crowding out (Economics)

Hang-Sheng Cheng

English

Research Papers in Economics

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March 19, 1982 
Crowding-Out: Japanese Experience 
Many analysts are concerned that large 
Federal-budget deficits combined with tight 
monetary policy would spell a crowding-out 
of  private investments from the credit market, 
and thus would abort economic recovery in 
the United States. This concern is also widely 
shared in the rest of the world, as anxiety 
mounts over the impact of high U.S. interest 
rates on the world economy. However, will 
this policy mix inevitably lead to such dire 
results? A look at other nations' experiences 
may help provide an answer. 
What is "crowding-out"? It may be defined as 
a state in which, at given market-interest 
rates, government borrowings pre-empt 
some private investments in the credit 
market. By definition, the pre-empted private 
investments did nottake place, so they would 
be statistically unobservable. Nonetheless, 
with that caveat, certain plausible inferences 
can be drawn from the experience of one 
major nation -Japan -during the 1973-80 
period and these inferences are relevant for 
the assessment of current u.s. economic 
prospects. 
Japan's experience 
Japan in 1974, like the United States, was hit 
hard by a double-digit inflation and a severe 
recession. Inflation, as measured by the 
GNP-deflator, increased 20 percent over the 
preceding year, while real output declined by 
one percent after rising at a 1  O-percent aver-
age annual rate during the preceding decade. 
In this situation, the Bank of Japan drastically 
reduced the annual money-growth rate-as 
measured by M-2 plus bank certificates of 
deposit-from 23-percent during 1971-73 to 
12 percent in 1974. Subsequently, the Bank 
narrowly confined the money-growth rate in 
a range between 11  and 13 percent in almost 
every year from 1975 to 1979. In the mean-
time, the Government ran an increasingly 
large budget deficit, including off-budget 
borrowi  ngs. The deficit rose from less than 
one percent of national output in 1973 to 
nearly 1 °  percent in 1978, quickly exceeding 
the comparable U.S. ratios (see Chart 1). 
Similarly, as a share of credit-market funds, 
government borrowings in Japan rose rapidly 
and then hovejed between 30 and 40 percent 
during 1979-80-significantly above corres-
ponding U.S. levels except for 1975-76. 
What were the results of this tight money/ 
easy fiscal policy mix? Japan's inflation rate 
declined sharply and steadily from 20 
percent in 1974 to below 2 percent in 1980, 
while real output recovered from its recession 
decline, and increased by more than 5 per-
cent annually throughoutthe 1976-79 period 
(see Chart 2). The output-growth rate was 
only one-half of that which prevailed prior to 
1974; still, it would be unrealistic to expect 
Japan, with its heavy dependence on oil 
imports, to maintain the same rapid growth as 
it did prior to the oil shock. 
Crowding-out? 
Some i  nd icators suggest crowd  i  ng-out du  ri ng 
this period. Gross domestic fixed-capital 
formation, as a ratio to national output, de-
clined steadily from 26 percent in 1974to 21 
percent in 1978. Butthere was no evidence of 
this from the movement of real  interest rates, 
as measured by the call-money rate deflated 
by the GNP deflator. Indeed, real interest 
rates were lower in 1977-78 than they were 
on average during the 1965-72 period, when 
the government budget was in perennial 
surplus. Apparently, there were more savings 
than government borrowings and private-in-
vestment demand could absorb. Had there 
been crowding-out, real  interest rates should 
have risen, not fallen. 
Another piece of indirect evidence is pro-
vided by changes in the nation's current-ac-
count balance, which by definition are mirror 
images of changes in the capital-account 
balance. An improvement in the current-ac-
count balance signifies a rise, and a current-Opinions expressed in this newsletter do not 
neces~_',Hilv reflect the views of the  rnana(~ernent 
of thi::'  Fecleral  Reservp Bank of San  Frandseo, 
or of the Board (y{  Covernors of the Federi11 
Re(;erve Systern. 
account deterioration a decline, in the 
nation's net investment abroad. Now, had 
crowding-out occurred, one would expect 
frustrated borrowers to seek capital from 
abroad, thus resulting in a decline in the na-
tion's net foreign investment. That situation 
then would be reflected in a deterioration in 
its current-account balance. Instead, Japan's 
current-account balance improved dramati-
cally, from a deficit of one percent of GNP in  .1 
-1974 to a surplus of nearly two percent of 
GNP in 1978. The improvement means that 
the Japanese investors as a whole were hold-
ing more foreign assets than before. Since 
investors had the alternative of holding more 
domestic assets instead, it appears rather 
unlikely that domestic business borrowers 
(and not the foreigners) were pre-empted by 
the large government borrowings. 
Admittedly, this evidence is not conclusive; 
yet it does suggest that there was probably 
little crowding-out in Japan during the 
1974-78 period. The same cannot be said of 
1979-80, when the real interest rate rose 
sharply and the current-account balance 
deteriorated. But it suffices to note that du ri ng 
a prolonged period in which rising budget 
deficits were combined with a very tight 
monetary policy little crowding-out 
occurred. 
What lessons? 
It might be argued that Japan's experience is 
hardly relevant forthe United States, because 
the two countries have very different eco-
nomic structures. Japan's personal-savings 
rate (20 percent in 1980) is several times 
larger than that of the u.s. (5% percent in 
1980), which suggests that Japan should be 
more successful than the U.S. in financing a 
larger deficit without straining the economy 
and domestic credit markets. However, a 
high savings rate necessarily implies a high 
private-investment rate, which means that a 
rise in the government deficit could just as 
easily crowd-out private investment in a 
high-savings economy as in a low-savings 
economy. The amount of crowding-out of 
private investment by government borrowing 
2 
thus does not depend on the size of the sav-
ings rate, but rather on whether desired 
. savings rises relative to desired investment. 
Japan's experience shows that, with private-
investment demand sufficiently weak, a large 
and rising government deficit need not result 
in crowding-out and an abortive economic 
recovery. On the contrary, Japan bounced 
back from the 1974 recession with a sus-
tained (albeit reduced) growth rate, and with 
a sharply falling inflation rate. 
Still, investment demand declined in Japan 
during this period, as the nation's growth 
prospects were lowered by the steep oil-price 
increases. In the face of unprecedentedly 
high and persistent unemployment, the 
monetary authorities resisted the temptation 
of stimulating demand by relaxing their tight 
rein on money growth. It was undoubtedly a 
high price to pay, but the world has not 
known a less costly way of  winding down a 
prolonged inflation spiral. Japan paid the 
price and succeeded in getting the inflation 
rate down from 20 percentto 2 percent in five 
years' time, without incurring high interest 
rates and recurrent recessions-and in spite 
of large budget deficits. The same could 
occur in the United States as well. 
In the U.S. today, crowding-out could occur 
if private investment demand bounces back 
vigorously. This need not abort the economic 
recovery, but it would imply a lowered 
growth path, with its attendant loss of output 
and employment. For that reason, policy-
makers are seeking to find ways to reduce the 
large budget deficits now facing us. And only 
in that way could the u.s. obtain a higher 
output-growth rate that is consistent with the 
objective of reducing inflation. 
Hang-Sheng Cheng Percent 
30 
20 
10 
1974 
Ch~nge(  %) 
20 
15 
10 
5 
1974 
CHART 1 
~ 
Deficit share of 
1976 
credit-market 
funds 
1978 
CHART 2 
Money supply 
1980 
.~.~  . 
.-.--~ 
P~ices  (GNP deflator)  · 
1976  1978  1980 
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BANKING DATA-TWElFfH -FEDERAL RESERVE DISTRICT 
(Dollar amounts in millions) 
Selected Assets and Liabilities 
Large Commercial Banl(S 
Loans (gross, adjusted) and investments* 
Loans (gross, adjusted) - total # 
Commercial and industrial 
Real estate 
Loans to individuals 
Securities loans 
U.s. Treasury securities* 
Other securities* 
Demand deposits - total# 
Demand c;:Ieposits - adjusted 
Savings deposits - total 
Time deposits - total# 
Individuals, part. & corp. 
(Large negotiable CD's) 
Weekly Averages 
of Daily Figures 
Member Bank Reserve Position 
Excess Reserves (+  )/Deficiency (  - ) 
Borrowings 
Net free reserves (+  )/Net borrowed( - ) 
* Excludes trading account securities. 
#  Includes items not shown separately. 
Amount 
Outstanding 
3/3/82 
157,286 
136,168 
41,968 
56,390 
23,450 
2,182 
6,228 
14,890 
40,204 
26,389-( 
30,677 
92,026 
82,220 
35,894 
Weekended 
3/3/82 
100 
14 
86 
Change 
from 
2/24/82 
- 509 
- 384 
174 
62 
- 42 
217 
100 
- 25 
2,540 
336 
604 
- 46 
- 56 
205 
-
-
-
-
Weekended 
2/24/82 
73 
155 
82 
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Change from 
year ago 
Dollar  Percent 
10,238  7.0 
11,542  9.3 
5,231  14.2 
5,194  10.1 
112  i- 0.5 
780  55.6 
470  - 7.0 
813  1- 5.2 
2,486  - 5.8 
2,985  - 10.2 
741  2.5 
15,357  20.0 
14,720  21.8 
6,445  21.9 
Comparable 
year-ago period 
104 
27 
77 
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and other Federal Reserve publications can be obtained by calling or writing the Public Infonnation Section, 
Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184. 

Crowding-out: Japanese experience

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Crowding-out: Japanese experience

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