ECON/001

IBS Center for Management Research

Business Cycle: The US and the Japanese Experience

This case was written by Julie Issac and Abdul Khader, under the direction of Sanjib Dutta, IBS Center for Management
Research. It was compiled from published sources, and is intended to be used as a basis for class discussion rather than to
illustrate either effective or ineffective handling of a management situation.

 2004, IBS Center for Management Research. All rights reserved.

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License to Use for IBS Campuses Only. Sem II. Class of 2017-2019.
 ECON/001

Business Cycle: The US and the Japanese Experience

CASELET 1

USA faced its worst economic crisis in the 1930s. This crisis is often described as the Great
Depression. The depression lasted for a decade, and affected the entire economy. The reason for
the depression can be traced back to the 1920s, when there was great inequality in the distribution
of wealth, and heavy speculation on the stock market in USA. Though the GDP increased from
$74.3 billion in 1923 to $89 billion in 1929, the disparities between the haves and have-nots
widened, and this created instability in the economy. According to a study done by the Brookings
Institute, in 1929, the top 0.1% of Americans had a combined income equal to the income of the
bottom 42% of the population. The top 0.1% of Americans in 1929 controlled 34% of all savings,
while 80% of Americans had no savings at all. The owner of the Ford Company, Henry Ford, was
reported to have a personal income of $14 million in the same year when the average personal
income was $750. The reason for this disparity can be traced back to the wages being paid.
Though productivity increased in all the sectors of the economy, wages did not increase
proportionately. Thus the increase in profit was not shared between the employer and employees,
and meant an increase in income disparity.
There was a great increase in speculation in the late 1920s, with larger sums being invested in the
stock market than ever before. Stock prices rose at a tremendous rate and some investors became
rich overnight by buying and selling stocks. With the economy booming, goods were available on
credit, and middle class people started buying goods on credit and with installment payments. This
increased the demand for goods in the market, and producers increased production. But as wages
did not increase, the purchasing power of the people slowed down and demand began to fall. Poor
demand led to reduction in the volume of production and a number of employees were thrown out
of their jobs. This trend was widespread, and soon 25% of the population was unemployed. The
situation became worse when the prices of agricultural products went down and farmers were
unable to repay their loans. All these factors led to a fall in the stock market. The economy started
to recover during the Second World War. During that time USA supplied arms to the countries
involved in the war. Moreover, the USA had enlisted more than 10 million men and women into
the military. Many people also worked in factories to make the supplies for the war. In this way,
the economy started growing gradually, as employment was generated in the economy.

QUESTIONS FOR DISCUSSION:

1. Discuss the reasons for the Great Depression in the US in the 1930s.
2. Explain how government intervention helps an economy to recover?

CASELET 2

The Japanese economy has been in recession since the early 1990s. The economy was burdened
with bad debts and underwent a serious deflation. The monetary policy measures taken by the
central bank to boost the economy were unsuccessful. They only resulted in an increase in the
level of debt, which is now equal to almost 130% of GDP. There was a decline in consumer and

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 Business Cycle: The US and the Japanese Experience

business spending because of lack of confidence in the economy. Prices fell and the value of
assets came down. In order to increase consumer and business spending, the central bank of Japan
took action to increase the money supply by reducing the reserve requirement of commercial
banks. Lower reserve requirements enhance the commercial banks’ ability to lend. On 19th March
2001, the Japanese central bank adopted a zero interest rate policy i.e. it reduced its lending rate
from 0.15 percent to zero percent, in order to increase liquidity and help the economy to revive. In
response, commercial banks started lending at near-zero interest rates.
There is some disagreement among economists as to how effective an increase in the money
supply is, in stimulating the economy. Even with rates as low as 0.15 percent, consumers and
businesses are reluctant to borrow during a recession. Some economists feel that a decrease in
interest rates will stimulate exports as the central bank's actions push the yen lower against the
dollar. Normally, a zero interest rate monetary policy can give an inflationary boost to a depressed
economy, as consumer and investor demand leads to increased production and prices. This has not
yet happened in Japan. Prices are falling, and consumer spending is erratic.
The phenomenon of interest rates at or near zero is clearly abnormal. Hence, the Bank of Japan
feels that interest rates will have to be made positive gradually. After a long period of economic
uncertainty, Japan's economy has been showing a few signs of recovery. The general expectation is
that policy makers will react by pushing interest rates up. But the central bank has clarified that it
will keep interest rates at their current level because of continued uncertainty about employment
and wages.

QUESTIONS FOR DISCUSSION:

1. Why do you think the central bank of Japan announced a zero interest rate policy?

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