International History Book Report-The Holy Grail of Macroecnomics

The Holy Grail of Macroeconomics

Lessons from Japan’s Great Recession

Reported by Xintong Hou

Author: Richard Koo*A Doctoral Fellow of the Board of Governors of the Federal Reserve System (1979-81)

*An economist with the Federal Reserve Bank of New York (1981-84)

*Now is the Chief Economist of Nomura Research Institute, the research arm of Nomura Securities, Tokyo.

Scope*Balance Sheet Recession Chapter 1-4; Japan’s great recession; the great depression

*Yin and Yang Economic cycles Chapter 5; Monetary or Fiscal policy

*World in Balance Sheet Recession Chapter 6-8; current financial crisis & other ongoing bubbles

Main Ideas(1) Japan’s Great Recession is a Balance Sheet Recession· Other arguments about the recession*Cultural or structural deficiency (journalists and general public) *Failure of monetary policy (academics). Krugman pushed for QE and Inflation targets. Bernanke argued for monetization of government debt (i.e. Central bank prints money to buy Government debt). Svensson and Eggertsson recommended price-level targeting and currency depreciation.*Banking sector problem (Finance sector)

Main Ideas(2) The Great Depression is also a Balance Sheet Recession * Banking crisis alone cannot explain decline in deposits *“Credit crunch” alone was unable to explain decline in banking lending *Liquidity alone could not have stemmed the banking crisis or corporate-debt repayments *Those seeking a villain in the gold standard are also misguided.

Main Ideas(3) Yin and Yang Economic cycles

Yang Yin

1) Phenomenon Textbook economy Balance sheet recession

2) Fundamental driver Adam Smith’s “invisible hand”

Fallacy of composition

3) Corporate financial condition

Assets>Liabilities Assets<Liabilities

4) Behavioral principle Profit maximization Debt minimization

5) Outcome Greatest good for greatest number

Depression if left unattended

6) Monetary policy Effective Ineffective(liquidity trap)

7) Fiscal policy Counterproductive(crowding-out)

Effective

8) Prices Inflation Deflation

9) Interest rates Normal Very low

10) Savings Virtue Vice(paradox of thrift)

11) Remedy for Banking Crisis

Fast spread and quick disposal of NPLs

Capital injection and cautious disposal of NPLs

Main Ideas(4) Current financial crisis

Main Ideas(5) Other ongoing bubbles also threaten the world economy *Chinese bubble *Eurozone bubble(German) *Preparing the global economy for both Yin and Yang Phases by cooperation

Policy Relevance(1) How to deal with post-bubble crisis

Based on Koo’s yin and yang phase of economic cycle, 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. Governments should implement fiscal stimulus in a timely and seamless fashion and the stimulus should emphasize government spending rather than tax cuts.

Policy Relevance(2) Rebalancing the global tradeThe U.S. became the center of financial capitalism only because other countries—namely Japan and China—lent it the money. These inflows funded the large U.S. trade deficits. So to eradicate the roots of the current crisis will entail the elimination of global trade imbalances and thus requiring Asian countries to change their export-oriented growth model.

Summary

• The field of macroeconomics was born during the Great Depression, in an effort to explain why the world did not behave in the way that microeconomics theory predicted. Its first practitioner was John Maynard Keynes. In the 1970s, monetarism became the dominant power.

Summary

•After current financial crisis, as the world try to understand what happened and why, Richard Koo’s balance sheet recession offers an insightful new approach to understand modern recession.

Thank you!