The U.S. Economy: Not a Repeat of Japan

by: Arnold Landy

The Federal Reserve’s program of quantitative easing (printing money by purchasing debt securities on the open market) is making waves of liquidity that are spilling over into the broader money supply. That is why the likely effect of quantitative easing in the U.S. will be much more positive than the experience of Japan.

In 2001, Japan faced declining GDP and deflation, even though the Bank of Japan had cut interest rates to near zero. In March, 2001, the Bank of Japan began its program of quantitative easing by directly purchasing on the open market financial securities, including government debt and asset-backed debt securities. This pumped up the Bank’s current-account balance (bank reserves) more than 600% . As a result, M1 (cash in circulation and some deposits), which had risen 8.2% in 2000, and 8.5% in 2001, spurted by 27.5% in 2002, its peak year of growth.

However, that creation of money did not spill over substantially into broader classes of money. M2 (which includes deposits at more banks) rose from 2.1% in 2000 to 2.8% in 2001, to only a 3.3% increase in 2002, and then grew at a lower rate thereafter, although quantitative easing continued a few more years. M3 (which includes CDs and more types of savings accounts) shows a similar pattern. Japan ended quantitative easing in 2006, calling it a success, having attained anemic economic growth with low inflation.

The Federal Reserve in 2009, after lowering the Fed Funds Rate to near zero, has begun to engage in quantitative easing, but with very different monetary effects from those in Japan. Our Fed’s quantitative easing is larger than that of Japan. The Fed has boosted bank reserves by 895.6 % (almost nine-fold) from 4/23/2008 - 4/22/2009. This growth in reserves has spilled over to a broader measures of money to a much greater extent than happened in Japan. Our Adjusted Monetary Base has risen 108.7% in the past year, M1 is up 13.5%, M2 is up 8.5 %, and MZM is up 9.9%. So, even with our financial industry contracting, our broad measures of money continue to grow at a rates that are robust, by recent historical standards. Comparisons with Japan’s economic performance simply do not hold up. In Japan, growth in bank reserves never had more than a minimal effect on M2 and M3, which is to say that little of the money created by the central bank ever made it out into the broader economy.

The Federal Reserve is supplying an abundance of money to the economy in order to block the possibility of a deflationary spiral downward to a Depression. In order for their efforts to work, the Fed, under Ben Bernanke, is “printing money” by creating new bank reserves through quantitative easing. The Fed's creative efforts through the TAF, TARP, TALF, and a myriad of other programs are proving effective in getting the growth in bank reserves to spill over into broader money, where it is liquifying our economy, sustaining the green shoots of our nascent economic recovery.