This paper examines the role of misdirected bank lending in prolonging Japan's macroeconomic stagnation following the asset price collapse in the early 1990s. It argues that Japanese banks continued to lend to insolvent firms, a practice known as "zombie lending," which distorted competition and hindered economic recovery. The authors propose a model where zombie firms, which are firms that receive subsidized credit, prevent healthy firms from entering the market, leading to reduced investment, employment, and productivity. They find that zombie firms depress the investment and employment growth of non-zombie firms and widen the productivity gap between them. The paper also shows that the prevalence of zombie firms is associated with lower levels of aggregate restructuring and more depressed job creation and destruction. The authors use firm-level data to confirm these findings, showing that the presence of zombies leads to significant distortions in the economy. The paper concludes that zombie lending and depressed restructuring were key factors in Japan's prolonged stagnation.This paper examines the role of misdirected bank lending in prolonging Japan's macroeconomic stagnation following the asset price collapse in the early 1990s. It argues that Japanese banks continued to lend to insolvent firms, a practice known as "zombie lending," which distorted competition and hindered economic recovery. The authors propose a model where zombie firms, which are firms that receive subsidized credit, prevent healthy firms from entering the market, leading to reduced investment, employment, and productivity. They find that zombie firms depress the investment and employment growth of non-zombie firms and widen the productivity gap between them. The paper also shows that the prevalence of zombie firms is associated with lower levels of aggregate restructuring and more depressed job creation and destruction. The authors use firm-level data to confirm these findings, showing that the presence of zombies leads to significant distortions in the economy. The paper concludes that zombie lending and depressed restructuring were key factors in Japan's prolonged stagnation.