Richard Koo Discusses Japan's Lost Decade and the U.S.

Richard Koo, the world-renowned chief economist of Nomura Research Institute, discussed the lessons learned from Japan’s “lost decade” during a presentation at Center for Strategic and International Studies (CSIS). During his discussion, Koo suggested that government stimulus can play a key role in alleviating the problems of a balance sheet recession. Koo’s recent book, “The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession”, discusses these issues in greater detail.

Source: CSIS, October 29, 2009.

Comments

[Denis Gould:]

That is really scary. Depression or default. Without putting government debt on a path which looks like ending in default, GDP would have contracted by 50%! Or maybe a good world war will sort us out.

Nov 09 03:34 AM

[Dave Wrixon:]

What is obvious is that if the guy knows what he is talking about and the Obama strategy is indeed best the way forward, then the best scenario that anyone can hope for is an average of Zero Growth in the US for the next 15 to 20 years.

The other thing that is clear is that he advocates and the Fed Culture is lie to everyone to save the system. Whilst that may be justifiable at a Macro Level, at an individual level is pure folly to believe a single word they say.

Nov 09 03:49 AM

[Ricard:]

Given that Richard Koo is the only Japanese (Korean) economist to speak authoritatively about Japan's economy, I put more weight on his statements and theories than anyone here in the US.

As it stands, we are lucky our problems are not as severe as they are in Japan.

Nov 09 08:11 AM

[Ricard:]

1) My bad, apparently he is Taiwanese.

2) I don't think anyone has noticed that this video is already one year old (10/29/08, not 2009). He's still talking about Bernanke pondering lowering rates and the administration debating the stimulus package. Regardless, thanks for posting it.

3) His theories would also explain why China's economy is humming along, given the enormous size of their stimulus relative to their GDP. I suppose the question would then be whether or not they collapse in the future, or further their own stimulus.

Nov 09 09:49 AM

[De Graaf:]

1) Your bad is apologized and accepted (lol)

2) Yes I noticed, but that doesn't change its significance. To the contrary, they should fire Summers, Bernanke and Geithner and replace the Paul Volcker instantly...I said: INSTANTLY g@ddammit.

3) Exactly, but don't forget that China's record stimulus is sustainable as aggregate demand as long as the savings rate in China remains high.
Remember what Richard Koo said: deficit neutral spending by government fiscal policy aligned with savings rate to keep GDP at par.

Thats only applicable to avoid depression. If this isn't enough evidence that Keynesians monetary thinking is a fallacy, I don't know what is.

I think the Austrian school of economics is the prudent way to AVOID future crisis. But even the Austrians will now need to adhere to greater consensus on fiscal stimulus in times of crisis with less focus on the fiscal deficit.

The Obama team should consider to NOT create growth by additional fiscal stimulus measurements with a huge deficit in place. Savings rate is near 5%, so no room for a spending frenzy. Prudence is key...(no pun intended)

Cheers, great article btw.


On Nov 09 09:49 AM Ricard wrote:

> 1) My bad, apparently he is Taiwanese.
>
> 2) I don't think anyone has noticed that this video is already one
> year old (10/29/08, not 2009). He's still talking about Bernanke
> pondering lowering rates and the administration debating the stimulus
> package. Regardless, thanks for posting it.
>
> 3) His theories would also explain why China's economy is humming
> along, given the enormous size of their stimulus relative to their
> GDP. I suppose the question would then be whether or not they collapse
> in the future, or further their own stimulus.

Nov 09 01:06 PM

[derryl:]

Richard Koo is absolutely correct on every point. He fully understands the monetary and financial systems and how they interact with the real economy. From a macro perspective the US is back where it was in the 1930s and as Koo pointed out the only way out of that was when government borrowed and spent all the idle savings on the war effort. Koo explains how FDR's borrow and spend New Deal was working to keep GDP from tanking until 1937 when he tried to raise taxes and lower spending. And Koo observed that it took Pearl Harbor to really get the gov't borrowing and spending ramped up high enough to end the Depression.

Koo even acknowledged that borrowing and spending on the military is the most effective way to move out of a balance sheet recession, because the spending generates incomes but does not produce any consumable goods that would compete with private sector goods production. This suppresses goods supply which allows businesses to keep their prices high enough to be profitable. So "wasteful" stimulus spending actually prevents price deflation, which supports private sector businesses who need profits to pay down their debts.

The fiscal borrowing and spending merely takes savings that are not being used for consumption or investment and spends them into the economy where they become incomes in the hands of the spending recipients; and this is how you prevent GDP from contracting when businesses and households are decreasing the money supply by paying down debt.

In the coming era of balance sheet repair Koo does not see any increase in demand for manufactures and other consumables so there will be little demand for private sector investment in productive enterprises. Koo's ambition is to stabilize production and consumption at about current levels while people pay down their debts, so he doesn't think gov't borrowing will crowd out private borrowing. Koo thinks private borrowing will be "weak or nonexistent" during this deleveraging phase.

During normal times it is business borrowing and investing, and households borrowing and buying houses and cars and consumables, that puts income streams into the economy. One person's spending becomes another person's income. But during a balance sheet recession businesses and households are paying off debt to repair their balance sheets rather than borrowing and spending, so government becomes the borrower and spender of last resort. Koo even advocates what Japan is doing: gov't selling bonds to commercial banks as a way of borrowing newly created bank deposits, new money, if savers' demand for bonds is not high enough. The government has to spend ALL of the idle savings in order to maintain GDP at current levels. If gov't spending is less than idle savings GDP will contract and you get the deflationary death spiral.

Koo notes that up to 30 million US mortgages are or will be underwater, and if on average the buyers put only 10% down there could be a lot of walking away from underwater houses as, unlike Japan and Europe, the US mortgages are non-recourse. If this begins happening on a damaging enough scale then in addition to the fiscal measures Koo advocates (which include government recapitalizing all banks, not just the TBTF), the government could recapitalize Americans directly via a program of stimulus checks that would provide incomes so they can keep paying their mortgages rather than simply let house prices collapse and suffer the devastation that would bring. I have laid out a way to do the stimulus checks in several other comments so I will not repeat that explanation here.

One last problem that Koo did not address: after WWII came the baby boom and the building of suburbia and the modern US highways and other infrastructure. Rapid population growth and all the construction and other industry that that demanded provided the private sector with profitable investment opportunities. So after WWII the private sector took over from the Depression and War governments as borrower and spender, and private sector GDP growth increased tax revenues which allowed the government to slowly repay all the stimulus debt it had taken on to maintain (and even expand) GDP while the private sector was repairing its crashed balance sheets in the 1930s and early 40s.

I don't see any private sector growth opportunities on the horizon that are of the scale necessary to replace fiscal stimulus once America's private sector balance sheets have been healed. It will take 5-15 years for this healing to occur so some new technology may arise that presents opportunities as big as the postwar baby boom and reconstruction of the world. In an era of peak resources and new rising demand from massively populous emerging economies I suggest that the next economic phase in the US will have to be more labor intensive and less resource intensive. This would both increase employment opportunities for Americans and decrease dependence on imported oil and commodities. As much as I hate the green doom mongers, something like a national conversion to green energy and an environmental cleanup of the whole country might be a big enough project to provide the opportunities for businesses to once again invest, hire and earn profits.

I found listening to Koo laying out the entire macro scenario and showing a way through very calming. Our problems are fixable. I had thought a program of orderly debt paydown was not going to be realistic due to the scale of the problem and the length of time that would be required to accomplish a sufficient amount of deleveraging for the private sector to regain its feet and begin moving forward again. But Japan has done it and is doing it, without currency collapse, without GDP collapse and Depression, without any killing spikes in interest rates. Indeed, I now agree with Koo that one of our problems is that there is way too much savings and way too few profitable places to invest them, so the supply of money available to be borrowed will be high and that will keep its price (interest rates) down for the duration of the balance sheet repair process.

Nov 09 02:05 PM