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How did the great Depression of the 1930s get to be so bad for solong? That question has baffled economists for decades. Ben S.Bernanke, the current Fed Chairman, even called understanding thegreat Depression the as yet-unattained "holy Grail ofMacroeconomics." Japan's Great recession of 1990-2005 finally gaveus some vital clues as to how a post-bubble economy can plunge intoprolonged recession while leaving conventional policy responseslargely ineffective.
Building on the author's earlier work Balance Sheet Recession:Japan's Struggle with Uncharted Economics and its GlobalImplications (John Wiley, Singapore, 2003), The Holy Grail ofMacroenomics: Lessons from Japan's Great Recession argues thatthere are actually two phases to an economy, the ordinary (or yang)phase, in which the private sector is maximizing profits, and thepost-bubble (or yin) phase, in which private sector is minimizingdebt, or repairing damaged balance sheets. Although conventionaleconomics is useful in analyzing economies in the yang phase, it isless useful in explaining phenomena such as the "liquidity trap"that is typical of an economy in the yin phase. The distinctionbetween the yin and yang phases also explains why some policieswork well in some situations but not in others. Indeed, it offersthe crucial foundation to macroeconomics that has been missingsince the days of Keynes.
This groundbreaking book not only explains what happened to theU.S. during the Great Depression and to Japan during the Greatrecession, it also offers important policy recommendations forfighting post-bubble economic downturns in any country, includingthe current subprime crisis in the U.S.
Chapter 1. Japan's Recession.
Chapter 2. Characteristics of Balance Sheet Recessions.
Chapter 3. The Great Depression was a Balance SheetRecession.
Chapter 4. Monetary, Foreign Exchange, and Fiscal Policy Duringa Balance Sheet Recession.
Chapter 5. Yin and Yang Economic Cycles and the Holy Grail ofMacroeconomics.
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.