U.S. in 2008: A Chance to Learn From Japan's Lost Decade

Excerpt from John Makin's latest commentary:

A detailed examination of Japan's lost decade may lead some to conclude that America's current problems are not that serious. The lessons for American policymakers in 2008, however, are clear, and it would be unwise to ignore them. An economic cycle driven by a collapse in the market for an asset--such as land or housing--to which the banking system is heavily exposed is a dangerous beast. One lesson that we shall probably be learning this year is that conventional measures like prompt policy interest rate reductions by the central bank and some fiscal relief for households and firms are necessary but not sufficient conditions to return the economy to health.

The banking system must move promptly (or be moved promptly) to reveal the full extent of its exposure to the depreciating asset--U.S. real estate, in this case. If market-clearing prices for financial assets tied to real estate entail substantial losses for financial institutions, those losses must be taken by shareholders. If shareholder equity is insufficient to protect depositors, then public funds must be used to provide that protection in the form of additional equity capital for banks in order to avoid a further collapse in asset values entailed by rapid withdrawal of funds from financial institutions...

There are two other important lessons from Japan's lost decade. The first is: do not allow deflation to take hold... The second additional lesson from Japan's 1990s experience is to avoid the temptation to raise taxes in the midst of a rapid economic slowdown driven by deteriorating credit conditions. While it is true that budget deficits and the national debt will be increased by stimulative fiscal measures and, more profoundly, by the loss of revenues that accompanies a sharp economic slowdown, a premature tax increase such as Japan executed in 1997 can throw a weak economy back into a more intense slowdown that only exacerbates the problems already present.

Comments

[Fat Arby:]

Hey, talk about the influence of Bernanke on japan's ministry of finance. If you havent' yet, look up Richard Duncan's text. Bailing out banks is an expensive proposition.

2008 Feb 27 03:07 PM

[Lawrence York:]

I agree with you, but want to add that Japan cut interest rates to zero to stop default--no accrued interest and everybody's current on there loans. By this action Japan sought to buy themselves time to let assets re-appreciate. They had engineered a 'kieretsu' between banks, corporations and government permitting, for example, permitting equity to be used as reserve capital thinking that inflation would always increase prices years later having observed the 'indexing to inflation' policies of the US. In the US we are now, because of our financial condition due to the excess of leverage, finding that to engineer a V-shaped recovery by accelerating the devaluation of homes is not possible because our banks would fail, pensions implode, and US Debt related to GNMA bankrupt us. So not much different than in Japan's situation you can understand the reason for the denials, back-peddling, and procrastination to act hoping for a short U-shaped recovery.

2008 Feb 28 12:00 PM

[the final h...:]

will someone please pass this onto the democrats before they raise taxes? talk about the end of days....heh heh heh

2008 Feb 29 01:10 AM