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We examine the role of bank loans in the Japanese economy by analyzing the lending behavior of banking firms and the investment behavior of non-financial firms. As for the banks' behavior, we construct a dynamic model of lending and test a variety of behavioral hypotheses on the bank's loan supply based on the panel data set over 1976 to 1995. Our main finding is that the lending behavior is quite different by types of banks and of borrowers. For regional banks the bank loans are sensitive to deposits, indicating that they face imperfections in capital market. For major banks such as city banks, real estate plays a vital role as collateral in loan contracts. We also find that loans to small and/or non-manufacturing firms are more dependent on real estate as collateral and sensitive to the deposit growth. It is inferred that real estate functions as a device to reduce the agency cost stemming from the asymmetric information between borrowers and banks. We also find that expenditure on fixed investment is much more sensitive to bank loans for small firms than for large firms. Our simulation exercises demonstrate that cut of loan supply is largely responsible for the stagnancy of investment in the downturns after the burst of the bubble and the financial turmoil in 1997. To sum up, lending channel is indeed important in Japan in propagating the shocks in the asset markets to the real economy.

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Standard money-in-utility dynamic models assume satiable liquidity preference, and thereby prove the existence of a full-employment steady state. In the same framework, it is known that under insatiable liquidity or wealth preference there is a case where a fullemployment steady state does not exist. A liquidity trap then arises and unemployment persists in the steady state. Using both parametric and non-parametric methods, this paper empirically finds that insatiable liquidity/wealth preference is better supported. Thus, without assuming any permanent distortion, we can analyse an effective demand shortage in a dynamic optimization framework. JEL Classifications: E12, E24, E41.

We examine quantitatively the extent to which financial distress in the 1990s affected employment behavior in Japan. Based on the firm-level panel data that include small firms, we estimate dynamic labor demand function, taking the impact of financial distress on employment into consideration. We find that the firm's ratio of debt to total asset exerts a significantly negative effect on employment of small firms. We also find that employment of small firms is sensitively affected by lending attitude of financial institutions.