Productivity Slowdown in Japan’s Lost Decades: How Much of It is Attributed to Financial Factors?

The lost decades following the bubble burst in 1991 has been accompanied by slowdown of total factor productivity (TFP) growth in Japan. What has driven the TFP down, however, remains a puzzle. To address this question, we develop a New Keynesian sticky price model that is designed to investigate two suspects behind the TFP slowdown other than regression of technology; (i) malfunction of financial intermediation, and (ii) inter- and intra-sectoral misallocation of resources. Namely, our model consists of two goods producing sectors and financial intermediation and non-technology shocks endogenously alter the observed TFP through these channels. We use an estimated model based on the data from the 1980s to the 2010s to demonstrate that exogenous deteriorations of balance sheets of financial intermediaries and firms contributed a sizable portion of TFP decline by hampering financial intermediation. We also show that such shocks play the dominant role in generating persistent deflation during the lost decades.