Masaaki Shirakawa, governor of the Bank of Japan, on Thursday warned of the dangers of underestimating the force of the “vicious spiral between economic deterioration and the financial crisis”.

In a candid speech in New York on the eve of meetings at the International Monetary Fund, Mr Shirakawa said “Japan remains mired in a severe economic downturn” just as US government officials were seeing tentative signs of recovery in the US economy.

He drew parallels between the experience of Japan in the aftermath of the bubble years and what the US is going through today.

There was “a fine balancing act between facilitating financial de-leveraging on the one hand while preventing a sharp contraction in economic activity on the other”, he said.

As the debate about the health of US banks was intensifying, Mr Shirakawa noted that to separate banks’ impaired assets while reinforcing their capital base was among the most challenging tasks for policymakers. That was because the negative interaction between the economic downturn and financial instability generated fresh losses, which in turn aggravated the concern over capital adequacy.

The Bank of Japan has recently restarted its purchase of bank-held corporate shares and announced a plan to supply subordinated loans to domestic institutions. But Mr Shirakawa declined to address the question of whether the bank might be forced to inject capital into the system again.

His description of how the lack of public support could delay timely action also was relevant to the US. “Policy procrastination worsened the spiral between the economic contraction and the banking sector problems, making the disposals of bad assets even more difficult.”

The speech showed how the governor’s thinking had evolved since his days at the University of Chicago, the school most associated with the “markets know best” approach to regulation.

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