U.S. recession and Japan’s Lost Decade
U.S. recession and Japans Lost Decade
The debate rages on whether or not the U.S. should “mortgage our children’s future” by borrowing more money to spend on public projects such as infrastructure development and education Surely, the ideologues that preach about mortgaging our children’s future are the same individuals that would do away with the EPA if given the chance, and don’t believe that climate change is an issue in our world. Hypocrisy runs rampant in our political system.
In any case, the Japanese may serve as model for exactly what NOT to do when facing a banking crisis, asset price deflation, and subsequent consumer and private sector deleveraging. It appears they took a path that we may soon, and erroneously, be headed down. Recently, CNN interviewed some individuals familiar with the Japanese crisis:
Richard Koo, the chief economist for the Nomura Research Institute, a Japanese think tank, says that government spending is the key to getting the economy back on track — and that 2009’s massive stimulus package didn’t go far enough.
While Koo’s kind of thinking is decidedly unfashionable, there are good reasons to listen to him. A Japanese-born Taiwanese-American, he worked at the Federal Reserve Bank of New York in the 1980s. For the past 27 years he’s lived in Japan, studying its economy in depth and writing what many consider the definitive analysis of Japan’s “lost decade” — “The Holy Grail of Macroeconomics: Lessons From Japan’s Great Recession.”
Why do you say that this recession is different from others the U.S. has had?
Typical recessions are part of normal business cycles, when overconfident businesses overproduce and then have to cut back. This is what I call a balance-sheet recession. It’s caused by an overload of debt.
It’s a very rare type of recession that happens only after the bursting of a nationwide asset bubble, like a real estate bubble. Once the bubble bursts, the debt remains. The assets, in this case homes, are underwater; their prices are way down, but all the consumers’ original debt remains.
The Federal Reserve recently said it won’t raise interest rates for two years. Won’t that help?
No. Monetary stimulus doesn’t work until balance sheets are repaired.
Right now consumers are using their cash to pay down their debt. The economy is depressed because no one is borrowing or spending. Consumers don’t want to borrow, even at [very low] interest rates. And lenders don’t want to make loans to consumers who will struggle to pay them back. You need fiscal stimulus. That means the government should borrow and spend the money in the private sector.
When Japan fell into recession about 20 years ago, we had no idea what was happening. Interest rates were lowered to zero, but the economy still did poorly.
Every time the government stimulated the economy, it rebounded nicely. Then when they pulled back, it lost steam again.
But Japan did suffer a major recession again in 1997.
The Japanese made a horrendous mistake in 1997. The Organization for Economic Cooperation and Development and the International Monetary Fund said to Japan, “You are running a huge fiscal deficit with an aging population. You’d better reduce your deficit.”
When the government cut spending and raised taxes, the whole economy came crashing down.
I see exactly the same pattern in the U.S. today. If the government acts to cut the deficit while people are continuing to pay down their debts, then we could have a second leg of decline that could be very, very ugly.
So are you saying that the stimulus package didn’t go far enough?
Obama kept the economy from falling into a Great Depression. But you never become a hero avoiding a crisis.
The economy is still struggling, so people say that money must have been wasted. Not true. The expiration of that package is behind the economy’s weakness right now. Yes, the Bush tax cuts were extended last year, but tax cuts are the least efficient way to support the economy during a balance-sheet recession because a large portion of the cut will be saved or used to pay down consumer debt. Government spending is much more effective.
MONEY recently interviewed Carmen Reinhart, an author of what’s now thought of as the authoritative history of financial crisis. She warned that economies that build up gross deficits in excess of 90% of GDP weaken significantly. The U.S. recently passed that mark.
Before the next balance-sheet recession comes, you’ll have plenty of time to cut the deficit.
Of course, Congress recently committed to slash our deficit by $2.5 trillion as part of the agreement to avoid default.
It is good that Congress managed to avoid default. But they should keep in mind that Japan’s deficit actually increased when the government tried to cut the budget while the private sector was paying down debts. The cutback caused a second recession.
Think about the Great Depression; war spending is what finally pulled the economy out.
The Japanese government didn’t do enough spending in the early 1990s and added another 10 years to the problem. If the U.S. avoids that mistake, maybe in a couple of years you will be out of this mess.
NeilS — Pundits can talk about the necessity of fiscal austerity, but most rational economists agree that in a period of this much deleveraging, when the private sector is sitting on tons of cash and consumers are morbidly afraid to borrow, the government needs to step in to spark the engines of economic growth. Unfortunately, people like John Boehner use fear-mongering and ignorant phrases like “Giving the government more money is like giving a cocaine addict more cocaine.” Worse of all, we have a potential presidential candidate in Rick Perry that is quoted saying “Keynesian theory is now done.”
I am in complete agreement that government is inefficient at utilizing resources. I believe that a lot needs to be done in reforming entitlements and unifying the fragmented beuracratic machine that is created by conflicting local, state, and federal policies. Yet, in our current time of desperate need, where poverty levels are reaching a point not seen in 60 years, time is not on our side. Interest rates are so low that it is absolutely clear the rest of the world is begging the United States to go on a spending spree with free capital. Even after the S&P downgrade of our debt, interest rates continue to plummet. I’m sure Boehner and Perry would attribute this to the need for auditing the Federal Reserve, but the truth seems more evident that they just don’t know anything about capitalism, which they love so much, or economics in general.