t Both Japan and parts of the European Monetary Union have experienced
boom and bust in stock and real estate markets, which have been
followed by a lasting crisis. The paper analyses the role of a high degree of
regional heterogeneity for public debt and monetary policy in the context of
crisis. It is shown for Japan that the attempts to maintain regional cohesion via
a regional transfer mechanism has contributed to the unprecedented rise in
public debt and persistent monetary expansion. Econometric estimations show
that in Japan regional redistribution of funds has ensured homogeneous living
conditions across Japanese regions pre- and post-crisis. The side condition is
monetary expansion. A similar effect could emerge in Europe, if the crisis
persists.

• Regional heterogeneity, the rise of public debt and monetary policy in post-bubble Japan: lessons for the EMU