| Over the last twelve years Japan has experienced a prolonged slowdown in economic activity, accompanied by a significant deterioration of the financial position of the banking sector. In this dissertation I argue that the delay in the government bailout of the financial sector has played a key role in Japan's ongoing stagnation. I construct a dynamic general equilibrium model in which the government provides deposit insurance to the financial sector. The model has the following property: the existence of non performing loans, combined with a delay in the government bailout, leads to a persistent decline in economic activity. The decline in output is caused not only by a fall in investment, but also by an endogenous decline in productivity and the number of firms. These features are consistent with Japan's experience over the last decade. Calibration results indicate that the delay in the government bailout contributes significantly to Japan's slowdown. |
