The Holy Grail of Macroeconomics E-Book

Richard C. Koo

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 554

Veröffentlichungsjahr: 2011

Beschreibung

The revised edition of this highly acclaimed work presents crucial lessons from Japan's recession that could aid the US and other economies as they struggle to recover from the current financial crisis. This book is about Japan's 15-year long recession and how it affected current theoretical thinking about its causes and cures. It has a detailed explanation on what happened to Japan, but the discoveries made are so far-reaching that a large portion of economics literature will have to be modified to accommodate another half to the macroeconomic spectrum of possibilities that conventional theorists have overlooked. The author developed the idea of yin and yang business cycles where the conventional world of profit maximization is the yang and the world of balance sheet recession, where companies are minimizing debt, is the yin. Once so divided, many varied theories developed in macro economics since the 1930s can be nicely categorized into a single comprehensive theory- The Holy Grail of Macro Economics

Leseprobe

Contents

Acknowledgments

Preface

Chapter 1: Japan’s Recession

1. Structural problems and banking-sector issues cannot explain Japan’s long recession

2. The bubble’s collapse triggered a balance sheet recession

3. Fiscal expenditures bolstered Japan’s economy

4. Debt minimization and monetary policy

Chapter 2: Characteristics of Balance Sheet Recessions

1. Emerging from a balance sheet recession

2. Tax receipts during a balance sheet recession

3. Interest rates after a balance sheet recession

4. Proclaiming the need for monetary easing only demonstrates a lack of understanding of the recession

Chapter 3: The Great Depression was a Balance Sheet Recession

1. Why have economists overlooked balance sheet recessions?

2. The Great Depression as a balance sheet recession

3. There is more than one kind of recession

Chapter 4: Monetary, Foreign Exchange, and Fiscal Policy During a Balance Sheet Recession

1. The problem with unorthodox monetary accommodation

2. Exchange-rate policy in a balance sheet recession

3. We must leave a healthy economy for the next generation

Chapter 5: Yin and Yang Economic Cycles and the Holy Grail of Macroeconomics

1. Bubbles, balance sheet recessions, and the economic cycle

2. The mistake of applying yang tools to a yin world

3. What Keynes and the monetarists both missed

4. Toward a synthesis of economic theory

Chapter 6: Pressure of Globalization

1. The need for real reforms in Japan and other developed countries

2. Global imbalances and liberalization of capital flows

3. Correction of global imbalance must also be gradual

Chapter 7: Ongoing Bubbles and Balance Sheet Recessions

1. America’s situation: the subprime fiasco

2. The Chinese bubble

3. Germany’s choice under Maastricht

4. Preparing the global economy for both Yin and Yang phases

Chapter 8: World in Balance Sheet Recession

1. A ray of hope from Japan

2. Awareness of the Japanese experience will make people feel better

3. The need for a new social contract

4. Current export environment much more severe

5. Financing large fiscal stimulus should pose no problems

6. Rating agencies could disrupt the corrective process

7. Financing bank rescues also no problem

8. Risk/return balance of using monetary policy to combat credit crunch

9. Credit demand will be a bigger problem than credit supply

10. New growth model needed for Asia

11. Immediate challenges for Asia

12. Long-run challenges for Asia

13. Concluding remarks

Appendix: Thoughts on Walras and Macroeconomics

References and Bibliography

Index

Copyright © 2009 by John Wiley & Sons (Asia) Pte. Ltd.

Published in 2009 by John Wiley & Sons (Asia) Pte. Ltd.

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Library of Congress Cataloging-in-Publication Data:

ISBN 978-0470-82494-8

To my mother

Amy Koo Ma

Acknowledgments

This book would not have been possible without the help of many people. In particular, clients and employees of Nomura Securities, who made me think deep and hard about the problem of the Japanese economy and what it means for the world were of immense help in shaping my ideas. The fact that they had their money in Japan meant that they never allowed me to go off on a tangent.

I have also benefited from countless discussions with Mr. Robert McCauley, a former colleague at the Federal Reserve Bank of New York who is now with the Bank for International Settlements. His extensive review of my manuscript was invaluable. Frequent exchange of ideas with Mr. Shosaku Murayama, who headed the research department of the Bank of Japan until recently and is now the president of Teikoku Seiyaku Co., was also helpful. Professor Takero Doi of Keio University also helped me understand the latest developments in academia. Professor Carl F. Christ of the John Hopkins University, my alma mater also provided me with many valuable comments. Any mistakes in the book are, of course, mine and mine alone.

In the actual preparation of the book, I benefited greatly from the support provided by Mr. Hiromi Yamaji, executive vice president of Nomura Securities.

My secretary, Ms. Yuko Terado, helped me with the preparation of the text of the manuscript. My assistant, Mr. Masaya Sasaki, not only produced the graphs and provided the numerical data but also assisted me in locating professional articles and historical materials that are used here. Their dedicated help is the only reason I was able to write this quasi-academic book while working full-time as the chief economist of Nomura Research Institute. They both worked very long hours in order to get the book out on schedule. I cannot thank them enough for their efforts.

I am also grateful to Toyo Keizai, the publisher of the initial Japanese version of this book, and Mr. Chris Green, who not only translated the Japanese original beautifully, but also added valuable nuggets to make the text easier to understand for English-speaking audiences.

Finally, I wish to thank my wife, Chyen-Mei, and our children, Jackie and Rickie, for enduring my absence on so many weekends and holidays. I am truly indebted to them.

Preface

The global financial crisis and economic meltdown have raised the fear that another Great Depression may be around the corner. Although policy makers all around the world have been throwing in everything in their toolkit to fight the recession, they have so far gained only minimal traction. Moreover, after more than seven decades, the economics profession is still without an explanation as to how the depression in the 1930s got so bad for so long.

Ben S. Bernanke, the current Federal Reserve chairman and a highly acclaimed academic economist, wrote in 1995 that “to understand the Great Depression is the Holy Grail of macroeconomics,” but that “we do not yet have our hands on the Grail by any means.” He added that “not only did the Depression give birth to macroeconomics as a distinct field of study, but... the experience of the 1930s continues to influence macroeconomists’ beliefs, policy recommendations, and research agendas.” Indeed, since the publication of Keynes’ General Theory in 1936 ushered in the era of macroeconomics, various explanations have been offered for the depression in an endeavor that, in Bernanke’s words, “remains a fascinating intellectual challenge.” It remains a fascinating challenge, because it has not been explained to this day how things had gotten so bad for so long after the October 1929 stock market crash.

With that in mind, I will argue that Japan’s “Great Recession” of the past fifteen years, to use Adam Posen’s term, has finally given us the clue, not only on how a post-bubble economy can plunge into prolonged recession while leaving many conventional policy responses largely ineffective, but also on the exact policy mix needed for an economy to pull itself out of this type of recession. Although history never exactly repeats itself, I believe that there are sufficient similarities between the two extended downturns to suggest that the forces that weakened the effectiveness of traditional macro policies, and lengthened the recessions were the same in both cases. I also believe that the same negative force has been operating in the current global crisis after the bursting of housing bubbles in so many parts of the world.

To highlight the similarities between the two prolonged recessions that happened in the U.S. and Japan more than seventy years apart, this book begins by analyzing what happened to the Japanese economy. It starts with the Japanese economy not only because the author lived through the recession, and was an active participant in the policy debate during the past fifteen years, but also because Japan offers a far more comprehensive pool of data to draw from than the Depression-era U.S. Furthermore, understanding why Japan’s economy slowed so suddenly in the 1990s after being so powerful until the very end of the 1980s is a fascinating intellectual challenge in its own right.

In doing so, I use the “balance sheet recession” concept first presented in English in my earlier book Balance Sheet Recession: Japan’s Struggle with Uncharted Economics and its Global Implications (John Wiley & Sons [Asia], 2003). It is a new concept in the sense that unlike neoclassical macro theory, which assumes that private-sector corporations are always maximizing profits, it assumes that some companies may respond to daunting balance-sheet damage by minimizing debt. After explaining the exact mechanism of the extended slowdown in Japan, I move on to see whether the same mechanism was operative in the U.S. seventy years ago. The analysis is then extended to cover the recent episodes, the global financial and economic crisis.

This book was written with two main objectives and one goal. First, it seeks to explain and analyze Japan’s Great Recession. Chapters 1 and 2 are devoted to this purpose.

My second and far more ambitious objective is to incorporate the legacy of Japan’s long recession into the body of macroeconomic theory. Chapters 3 to 5 are devoted to this objective. This section extends and generalizes the balance sheet recession theory, and compares and contrasts it with conventional economic thought. The ultimate goal of this exercise, of course, is to use the lessons learned from the Great Depression and Great Recession in fighting similar economic problems that are brought about by the bursting of asset-price bubbles, especially the current global financial crisis.

Chapters 3 and 4 delve into research on the Great Depression by academic economists over the past thirty years. It was necessary to go back to the Depression because, as Bernanke’s statement at the outset makes clear, so much of macroeconomics has been influenced by what happened during it.

In particular, economists from around the world advised the Japanese authorities to fight the recession with ever more drastic monetary accommodation. They based their recommendations on the past twenty-five years of research into the Depression, which has concluded that the Depression was caused by the failure of monetary policy and that the subsequent recovery of the U.S. economy was also made possible by a change in the policy stance of the Federal Reserve.

From my vantage point on the front lines of Japanese financial markets, these policy recommendations seemed utterly unrealistic, because the demand for funds from Japanese businesses has dried up completely even with zero interest rates. In my debates with these economists, however, I realized that no constructive discussion could occur until I proved that some of the “lessons” from the Great Depression that underpin their views are themselves wrong. If it can be shown that the Great Depression was, as was the Japanese recession, a balance sheet recession, and that this was why monetary policy was powerless to fight it, conventional economic theory will have to undergo some major changes.

To prove this, I had to venture into the tiger’s lair, and what I found there was surprising. Examining the data from the perspective of demand for funds, I discovered one indicator after another that supported the balance sheet recession hypothesis. Even the classic survey of U.S. monetary history by Anna Schwartz and Milton Friedman, who were the first to argue that the Great Depression could have been avoided through the proper application of monetary policy, and who long championed monetary policy’s primacy, contained many passages supporting the view that the Great Depression was actually a balance sheet recession.

While the readers will be the ultimate judges, I believe that America’s Great Depression, as was Japan’s Great Recession, was a balance sheet recession triggered by businesses striving to minimize debt. As in Japan, the problem lay in a lack of demand for loans in the private sector, and not in a lack of funds supplied by the monetary authorities.

Chapter 5 brings everything together and argues that there are actually two phases to an economy, the ordinary (or yang) phase where private sector is maximizing profits, and the post-bubble (or yin) phase where private sector is minimizing debt or otherwise obsessed with repairing damaged balance sheets. It goes on to argue that the two are linked in a cycle. The distinction between the yin and yang phases also explains why some policies work well in some situations but not in others. The resultant synthesis provides the crucial foundation to macroeconomics that has been missing since the days of Keynes.

Chapter 6 is about the pressure of globalization and global imbalances. Although these issues are not directly related to balance sheet recessions, they are nonetheless making the conduct of monetary policy difficult in many countries.

Chapter 7 is about ongoing bubbles and balance sheet recessions, with a special emphasis on the U.S. subprime problem. The U.S. economic downturn brought about by the subprime fiasco is a version of a balance sheet recession, with many of its unpleasant characteristics. It is also a highly dangerous recession in that so many financial institutions on both sides of the Atlantic have been badly damaged by the fiasco. Although no quick recovery is possible with so much damage to household and bank balance sheets, the lessons we learned from Japan during the past fifteen years can be put to good use to minimize the recovery time for the U.S. economy. (Originally published with seven chapters in April 2008, a new chapter (Chapter 8) was added in March 2009 to bring readers up-to-date on the latest developments. In the interest of time, no changes were made on the first seven chapters.)

The appendix is my little contribution to the debate on how best to incorporate the use of money into the conventional neoclassical framework. This section also challenges some of the fundamental notions of modern economics.

Keynes responded to the tragic events of the Great Depression by inventing the concept of aggregate demand. But even he was unable or unwilling to break away from the most basic, long-held assumption of economics: that businesses everywhere and always seek to maximize profit. The Keynesian revolution ultimately ran aground because its proponents never realized that their fiscal policy recommendations worked only in the yin phase when businesses are striving to minimize debt.

The concept of balance sheet recession crosses the line that Keynes himself was unable or unwilling to cross, and allows for the possibility that companies may sometimes seek to minimize debt. By doing so, it fully explains economic phenomena such as the liquidity trap and extended recessions for which no convincing explanation has previously existed. It also complements and augments the conventional theories by clearly indicating when monetary and fiscal policy are most effective, as well as when they are most counterproductive. The synthesis of economic theories so obtained may well be the Holy Grail of macroeconomics we have been searching for since the 1930s.

The balance sheet recession concept has been developed on the back of the Japanese people’s suffering and sacrifices during the past fifteen years. Although a high price was paid, this concept should be of great assistance to countries seeking to formulate a policy response to bubbles and their aftermath, the balance sheet recession. In the meantime, I look forward to assistance and criticism from fellow economists to refine this theory, and make it a more useful tool, so that Japan’s painful experience might be transformed into a beneficial legacy for the world.

Richard C. Koo

April 2009

CHAPTER 1

Japan’s Recession

The recovery in Japan’s economy is real, and the signs of an end to the fifteen-year recession are finally here. But it is important to remember that both fundamental and cyclical factors affect the economy. It is only in the former area—those unique problems Japan has struggled with over the past fifteen years—that a genuine recovery is evident. Cyclical or external factors, such as exchange-rate fluctuations, pressures from globalization, especially from China, and financial turmoil in the U.S., also play a role. So although recent data give cause for optimism on the fundamental side, Japan will remain subject to cyclical fluctuations and external pressures.

Chapter 1 sets out to identify the kind of recession Japan has been through, and Chapter 2 examines the ongoing recovery in detail. Global as well as cyclical economic trends are discussed in Chapters 6 and 7.

1. Structural problems and banking-sector issues cannot explain Japan’s long recession

Japan’s recovery did not happen because structural problems were fixed

Much has been said about the causes of Japan’s fifteen-year recession. Some have attributed it to structural problems or to banking-sector issues; others have argued that improper monetary policy and resultant excessively high real interest rates were to blame; and still others have pointed the finger at cultural factors unique to Japan. It is probably safe to say that among non-Japanese observers, many journalists and members of the general public subscribed to the cultural or structural deficiency argument, while academics subscribed to the failure of monetary policy argument. Meanwhile, those in the financial markets subscribed to the banking problem argument as the key reason for the Japanese slowdown.

Those in the structural camp included former Federal Reserve chairman Alan Greenspan,1 who argued that Japan’s inability to weed out zombie companies must be the root cause of the problem, and former Prime Minister Junichiro Koizumi, whose battle cry was “No recovery without structural reform.” Although the term structural reform could mean different things to different people, the reform Koizumi and his economic minister Heizo Takenaka had in mind was the Reagan–Thatcher-type supply-side reform. They pushed for supply-side reforms because the usual demand-side monetary and fiscal stimulus had apparently failed to turn the economy around. Late former Prime Minister Ryutaro Hashimoto, who resigned in August 1998, also pushed for structural reform as a means to get the economy going.

Structural problems were also blamed for the five-year German recession lasting from 2000 to 2005, the nation’s worst slump since World War II. That the German economy responded so poorly to monetary stimulus from the European Central Bank (ECB) when other eurozone economies responded favorably supported arguments in favor of structural reforms in Germany.

Among those in the academic camp, Krugman (1998) argued that deflation was the root cause of Japan’s difficulties, even adding that how Japan entered into deflation is immaterial.2 To counter the deflation, he pushed for quantitative easing and inflation targets. This approach of not dwelling on the nature of deflation and jumping right into possible remedies was followed by Bernanke (2003), who argued for the monetization of government debt, and Svensson (2003) and Eggertsson (2003), who recommended various combinations of price-level targeting and currency depreciation. These academic authors argued in favor of more active monetary policy because the past three decades of research into the Great Depression by authors such as Eichengreen (2004), Eichengreen and Sachs (1985), Bernanke (2000), Romer (1991), and Temin (1994) all suggested that the prolonged economic downturn and liquidity trap seen at that time could have been avoided if the U.S. central bank had injected reserves more aggressively.