By Paul Jackson
And does Japan’s ruling party know what it’s doing? A top economist raises serious concerns--and takes aim at the Fed.
When Japan’s finance minister says jump and the Bank of Japan responds, does that mean its independence is a sham? Or is the real show being directed by the bank itself?
Influential economist Richard Koo says that the BOJ’s recent move to double the size of its short-term financing program after Finance Minister Naoto Kan called for action against deflation was more for show than anything else.
In a refreshingly frank interview with The Diplomat, Koo excoriated the Democratic Party of Japan—and foreign media and academics—for failing to grasp certain key economic principles. He also claims that it wasn’t the Bank of Japan, but the US Federal Reserve that was panicking over the future of its independence, and suggests that Fed Chairman Ben Bernanke may have adjusted his views to fit in with Koo’s during recent congressional testimony to avoid a confrontation that might have further threatened the bank’s status.
But first to BOJ policy specifics, and what Koo describes as the bank’s meaningless move on March 17 to boost to 20 trillion yen the reserves for three-month loans to banks.
‘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 other words, while the Bank of Japan appears to have done something, pleasing certain sections of the DPJ in the process, it hasn’t really done anything at all.
‘If the money supply isn’t increasing, that means all the liquidity the Bank of Japan pumped into the system is stuck in the financial system,’ Koo says. ‘It's not coming out to enter the ordinary market or even the foreign exchange market for that matter. If the money comes out, that means someone borrows and spends it—then you’ll have an impact on foreign exchange, an impact on long term rates, all of that. But the fact that’s not happening means it's all basically a mirage.
‘The DPJ doesn't know that! Most academics think it's a great thing! And the foreign press, especially, think that the BOJ should be doing more. The IMF thinks the BOJ should do more.’
So why are all these people apparently missing the point?
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.
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Paul
Great topic and article. But money does work – suppose the BOJ “fixed” the yen at 150/$ and promised to buy all the dollars you presented at that rate. My guess is Japan would see a real burst in inflation + some decent growth for a while due to exports and import substitution. I doubt that changes much in the medium term, but money can work to generate inflation undoubtedly….
john
The entire problem with the western banking system is that the bank owns the government! It doesn’t matter who sits in the presidents seat if the central bank controls the money because if they really want to the central bank can collapse the economy and the politicians don’t get reelected! Politicians in theory at least have some responsibility to the people but not the fed or other central banks in the western banking system. It’s time the governments took back the power to issue money for the people and out of the hands of the banksters!
Dana Surmane
Watching Japan for thirty years has been troubling. I think one of the reasons that the U.S. is in so much trouble is that the stimulus money was essentially stolen — not used to get people working at all. The same sort of thing seems to always happen in democracies. As we all seem to be clumping us against the same fence, you begin to wonder what the next step really is. Anyway, thank you for giving Richard Koo a chance to air his intriguing views. Still, I think that the critical problem that he and most of the theorists have is in not being able to come to terms with the reality that no present government is capable of committing itself to an honestly administrated long-term stimulus or fiscal policy. With that much cash and/or tax benefit largesse available to politicians, it just serves to corrupt them faster. Sometimes we all seem to be heading toward the North Korean form of government and finance.
σ1
This is a great article and I will be sure to read the book. It tackles both of the great misconceptions about Japan – the relative efficacy of fiscal v monetary policy, and the “out of control” public debt.
I do have to say though that in the long run surely there is something to be said about the “quality” of fiscal policy. I understand that some “shovel ready” spending is necessary to ensure any given crisis does not spin out of control, but in spending public money the government should always be very mindful of where the long term efficiencies comes from – I think this has been the big failure of the LDP, and now the DPJ. The LDP was much more interested in the political implications of the use of public money and indulged in pork barrel politics – public benefit be damned. The DPJ does not seem so beholden – but I am not seeing any long-term, daring or coherent fiscal spending/innovation agenda just yet.
Kevin Cousins
Richard Koo’s book “The Holy Grail of Macroeconomics” is I believe the key to understanding the current environment. Read it together with McKinsey’s “Debt and deleveraging: The global credit bubble and its economic consequences” and you have an excellent framework for macro trading over the next few years.
Despite being easy to read, it may also be an important step forward in economic theory.
Agata
Thanks a lot for the advice. I will gladly read also the second book. Japan is good example that a new approach is essential. So time to get some knowledge on those new ideas which can become even more important in the future. Regards.
Agata
Very good article and really interesting point of view – nice to read something different. Now I really want to read Mr Koo’s book.
Barry Ritholtz
Fascinating article — thanks for the interview with Koo