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Japan's "Great Recession" lasted from approximately 1992 - 2007 and finally provided the economics profession with the necessary background to understand what actually happened during the US recession of the 1930s. The discoveries made, however, are so far-reaching that a large portion of economics literature will have to be modified to accommodate another half to the macro economic spectrum of possibilities that conventional theorists have overlooked.
In particular, Japan's Great Recession showed that when faced with a massive fall in asset prices, companies typically jettison the conventional goal of profit maximization and move to minimize debt in order to restore their credit ratings. This shift in corporate priority, however, has huge theoretical as well as practical implications and opens up a whole new field of study. For example, the new insight can explain fully the precise mechanism of prolonged depression and liquidity trap which conventional economics - based on corporate profit maximization - has so far failed to offer as a convincing explanation.
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, i.e., the Holy Grail of macro economics
The policy implication of this new discovery is immense in that the conventional aversion to fiscal policy in favor of monetary policy will have to be completely reversed when the economy is in the yin phase.
The theoretical implications are also immense in the sense that the economics profession will no longer have to rely so much on various rigidities to explain recessions that have become the standard practice within the so-called New Keynesian economics of the last twenty years.
Chapter 1. Japan's Recession.
Chapter 2. Characteristics of Balance Sheet Recessions.
Chapter 3. The Great Depression was a Balance Sheet Recession.
Chapter 4. Monetary, Foreign Exchange, and Fiscal Policy During a Balance Sheet Recession.
Chapter 5. Yin and Yang Economic Cycles and the Holy Grail of Macroeconomics.
Chapter 6. Pressure of Globalization.
Chapter 7. Ongoing Bubbles and Balance Sheet Recessions.
Appendix. Thoughts on Walras and Macroeconomics.
Richard Koo, chief economist of Tokyo's Nomura Research Institute, has written a fascinating and important book. He claims that capitalist economies have two phases: the ordinary phase, in which firms aim to maximise profits, and the post-bubble phase, when they aim to pay off their debts. He believes that he has found the missing link of economics: "corporate debt minimisation, therefore, is the long-overlooked micro-foundation of Keynesian macro-economics."
It's still boom and bust. Koo claims that in the boom phase, monetary policy works, but not fiscal; in the bust phase, only fiscal policy works, not monetary. He shows how monetary policy cannot fight a slump. He contends that only huge fiscal stimuli, government actions to boost domestic demand, can prevent slumps.
Koo claims that, in the 1930s depression, in Japan's recession since 1990, and in the present crisis, the problem was the private sector's lack of demand for loans, not a lack of funds from the central banks. Contrary to the consensus, these depressions were not caused by the wrong monetary policy.
How to fight a slump? Cutting spending to reduce government debt is the road to disaster. In the 1930s, both President Hoover and Chancellor Bruning insisted on balancing the budget, which crashed the US and German economies. In 1945 the British government's debt was 250% of GDP, but the country survived. Between 1933 and 1936, President Roosevelt raised government spending by 125%, so GDP rose by 48% and tax revenues rose by 100%. But in 1937 he changed tack and cut spending: industrial output fell by 33%.
Japan's recession (caused by falls in the value of its assets - land and loans) destroyed 1500 trillion yens' worth of wealth - three years of Japan's GDP. (The USA's depression lost it one year's GDP.) In Japan, monetary stimuli failed, so the Japanese government proposed irrelevant Thatcherite supply-side changes, like privatising the post office.
In 1997 the Hashimoto government, under IMF pressure, cut spending and raised taxes to balance the budget. As a result, output fell for five quarters, Japan's worst post-war meltdown, and the budget deficit rose from 22 trillion yen in 1996 to 38 trillion in 1999. In 2001, the Koizumi government did the same - with the same result. It also tried the monetary policy of quantitative easing. But this did not increase lending or the money supply. It was irrelevant.
Subsequently, the Japanese government adopted a policy of no fiscal consolidation without growth, i.e. no spending cuts or tax rises before private-sector demand recovered. This fiscal stimulus prevented a 1930s-style depression; by 2005, firms had started to borrow again.
Again, in Germany's balance sheet recession of 2000-05, "the Maastricht Treaty prevented it from applying the fiscal stimulus it needed. This deepened the recession", as Koo observes.
Finally, he notes the harmful effects of the free movement of capital: "in view of the explosion of cross-border capital flows during the past two decades contributing to adverse currency movements and the widening of global imbalances, some restrictions on those flows may be desirable." He also notes the damage done by free trade: "that market forces have not only failed to rectify trade imbalances but actually made them worse suggests that some kind of government action may be necessary."
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Posted August 2, 2009
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I used this book for a class on this history of modern Japan, and can say that it was worth the time. Koo makes several great points about the economic policies in the US and in Japan, and gives a breakdown of the concept of "Balance Sheet Recessions" that I found most helpful. He makes some thought provoking comparisons between the American Great Depression and the Japanese Great Recession of the 1990's.
The once caution would be to advise that this book is VERY heavy on economics, so if you are light on the lingo, tread carefully.