Tuesday, April 06, 2010

What happened in Japan?

Japan had their credit crises 25 years ago, and has been mired in a slump ever since. The best source I've found to detailing that history is Richard Koo, but he's not great. Here's a nice article with some of this views:
'With quantitative easing under the circumstances we have now, you can double and triple the liquidity in the system but there will be no takers,’ Koo says. ‘But there’ll be no harm done, and if certain parts of the political spectrum are happy as a result, then, you know, why not?’
In fact, QE never works.
For years Koo, now chief economist at the Nomura Research Institute, has been talking about the lessons to be learned from Japan’s ‘lost decade’—the years of recession that followed the bursting of the nation’s economic bubble of the late 1980s. In his book, The Holy Grail of Macroeconomics he argues that when an economy is pole-axed by crashing asset prices, companies no longer want to borrow money to invest because of the need to repair their weakened balance-sheets. If there are no borrowers in the market, monetary policy becomes ineffective—you can supply as much money as you want at close to zero-interest rates, but there won’t be any takers. Essentially, this suggests that there are two kinds of recession: a regular business-cycle recession, which can be tackled using monetary policy, and what Koo calls a balance-sheet recession, a far deeper kind of post-bubble recession like the Great Depression, that requires the use of fiscal policy.
Koo's position is that monetary policy works in asset crashes, but not in credit (balance sheet) crashes. He does not question whether monetary policy never works, and that asset crashes are simply not that damaging and easily fixed through automatic fiscal stabilizers.
‘As I indicated in my book, it’s one of those recessions that happens once every God knows how many decades, where monetary policy is largely dead in the water,’ he says. ‘I mean there are no borrowers. And if the money multiplier is zero negative, what can monetary policy do? Those people in the financial sector in Japan are fully aware of this difficulty. But politicians, academics and media who are never faced with the real situation only remember what they are taught in universities, where neoclassical economics always assumes there are plenty of borrowers. They tend to bash the Bank of Japan for not doing more.
There is no money multiplier. Ever. Balance sheet recessions merely reveal what is always the case.
But when it comes to the issue of Japan’s national debt, Koo flatly rejects the notion that it presents any kind of financing problem.

‘At the moment, with long bond yields at 1.36 percent on the 10-year JGB, all these arguments that Japan has a financing problem are absolute nonsense. If the long bond yield is 14 percent like it was in 1997 then I know that this country has a horrendous financing problem. But at 1.3 or 1.4 percent, the market is saying “Please go on, we need the JGB.” A country with the lowest government bond yield having financing problems? I mean these people [who say that] really have nothing better to do.’
Japan will never have any issue servicing yen denominated debt, as it does not borrow. It has a fiat currency just like the US.
As for the notion that Japan has already used fiscal policy with little effect other than to run up the huge national debt in the first place, Koo makes the point in his book that the use of fiscal policy during a balance sheet recession is absolutely vital for propping up an economy. It’s the only effective way of boosting the money supply, since any extra liquidity pumped into the financial sector will have no takers.

It might not look as if fiscal policy helped Japan much after the bursting of its economic bubble, but the alternative would have been catastrophic, Koo says. He calculates that 1.5 quadrillion yen was wiped off Japanese assets in the wake of the bubble—that’s 3 times the size of the nation’s economy. Without fiscal stimulus, Japan’s GDP should have shrunk to between a half and a third of its size, he claims. But in fact, GDP did not fall below its bubble peak, something he describes in the book as ‘nothing less than a miracle.’
This is the key point. Did fiscal policy fail in Japan, or did it do its job, but it was simply too small? If the alternative was a dust bowl style recession, the fiscal policy was, perhaps, a modest success (although I'm sure it could have been implemented in a better way).

The question is, today, why does Japan bother to tax at all?


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