All posts in category Monetary policy

Clark Johnson has written what will become a Market Monetarist Classic

As I have written about in an earlier post I am reading Clash Johnson’s book on the Great Depression “Gold, France and the Great Depression”. So far it has proved to be an interesting and insightful book on what (to me) is familiar story of how especially French and US gold hoarding was a major cause for the Great Depression.

Clark Johnson’s explanation of Great Depression is similar to that of two other great historians of the Great Depression Scott Sumner and Douglas Irwin. Both are of course as you know Market Monetarists.

Given Johnson’s “international monetary disorder view” of the Great Depression I have been wondering whether he also had a Market Monetarist explanation for the Great Recession. I now have the answer to that question and it is affirmative – Clark Johnson is indeed a Market Monetarist, which becomes very clear when reading a new paper from the Milken Institute written by Johnson.

One thing I find especially interesting about Johnson’s paper is that he notes the importance of the US dollar as the global reserve currency and this mean that US monetary policy tightening has what Johnson calls “secondary effects” on the global economy. I have long argued that Market Monetarists should have less US centric and more global perspective on the global crisis. Johnson seems to share that view, which is not really surprising given Johnson’s work on the international monetary perspective on the Great Depression.

Johnson presents six myths about monetary policy and the six realities, which debunk these myths. Here are the six myths.

Myth 1: The Federal Reserve has followed a highly expansionary monetary policy since August, 2008.

Johnson argues that US monetary policy has not been expansionary despite the increase in the money base and the key reason for this is a large share of the money base increase happened in the form of a similar increase in bank reserves. This is a result of the fact that the Federal Reserve is paying positive interest rates on excess reserves. This is of course similar to the explanation by other Market Monetarists such as David Beckworth and Scott Sumner. Furthermore, Johnsons notes that the increase that we have seen in broader measure of the money supply mostly reflects increased demand for dollars rather than expansionary monetary policies.

Johnson notes in line with Market Monetarist reasoning: “Monetary policy works best by guiding expectations of growth and prices, rather than by just reacting to events by adjusting short-term interests”.

Myth 2: Recoveries from recessions triggered by financial crises are necessarily low.

Ben Bernanke’s theory of the Great Depression is a “creditist” theory that explains (or rather does not…) the Great Depression as a consequence of the breakdown of financial intermediation. This is also at the core of the present Fed-thinking and as a result the policy reaction has been directed at banking bailouts and injection of capital into the US banking sector. Johnson strongly disagrees (as do other Market Monetarists) with this creditist interpretation of the Great Recession (and the Great Depression for that matter). Johnson correctly notes that the financial markets failed to react positively to the massive US banking bailout known as TARP, but on the other hand the market turned around decisively when the Federal Reserve announced the first round of quantitative easing (QE) in March 2009. This in my view is a very insightful comment and shows some real Market Monetarist inside: This crisis should not be solved through bailouts but via monetary policy tools.

Myth 3: Monetary policy becomes ineffective when short-term interest rates fall close to zero.

If there is an issue that frustrates Market Monetarists then it is the claim that monetary policy is ineffective when short-term rates are close to zero. This is the so-called liquidity trap. Johnson obviously shares this frustration and rightly claims that monetary policy primarily does not work via interest rate changes and that especially expectations are key to the understanding of the monetary transmission mechanism.

Myth 4: The greater the indebtedness incurred during growth years, the larger the subsequent need for debt reduction and the greater the downturn.

It is a widespread view that the world is now facing a “New Normal” where growth will have to be below previous trend growth due to widespread deleveraging. Johnson quotes David Beckworth on the deleveraging issue as well site Milton Friedman’s empirical research for the fact there is no empirical justification for the “New Normal” view. In fact, the recovery after the crisis dependent on the monetary response to the crisis than on the size of the expansion prior to the crisis.

Myth 5: When money policy breaks down there is a plausible case for a fiscal response.

Recently the Keynesian giants Paul Krugman and Brad DeLong have joined the Market Monetarists in calling for nominal GDP targeting in the US. However, Krugman and DeLong continue to insist on also loosening of US fiscal policy. Market Monetarists, however, remain highly skeptical that a loosening of fiscal policy on its own will have much impact on the outlook for US growth. Clark Johnson shares this view. Johnson’s view on fiscal policy reminds me of Clark Warburton’s position on fiscal policy: fiscal policy only works if it can alter the demand for money. Hence, fiscal policy can work, but basically only through a monetary channel. I hope to do a post on Warburton’s analysis of fiscal policy at a later stage.

Myth 6: The rising prices of food and other commodities are evidence of expansionary policy and inflationary pressure.

It is often claimed that the rise in commodity prices in recent years is due to overly loose US monetary policy. Johnson refute that view and instead correctly notes that commodity price developments are related to growth on Emerging Markets in particular Asia rather than to US monetary policy.

Johnson’s answer: Rate HIKES!

Somewhat surprise after conducting an essentially Market Monetarist analysis of the causes of the Great Recession Clark Johnson comes up with a somewhat surprising policy recommendation – rate hikes! In fact he repeats Robert McKinnon’s suggestion that the four leading central banks of the world (the Federal Reserve, the ECB, the Bank of Japan and the Bank of England) jointly and coordinated increase their key policy rates to 2%.

Frankly, I have a very hard time seeing what an increase interest rates could do to ease monetary conditions in the US or anywhere else and I find it very odd that Clark Johnson is not even discussing changing the institutional set-up regarding monetary policy in the US after an essentially correct analysis of the state US monetary policy. It is especially odd, as Johnson clearly seem to acknowledge the US monetary policy is too tight. That however, does not take anything away from the fact that Clark Johnson has produced a very insightful and interesting paper on the causes for the Great Recession and monetary policy makers and students of monetary theory can learn a lot from reading Clark Johnson’s paper. In fact I think that Johnson’s paper might turnout to become an Market Monetarist classic similar to Robert Hetzel’s “Monetary Policy in the 2008-2009 Recession” and Scott Sumner’s “Real problem is nominal”.

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Update: Marcus Nunes and David Beckworth also comment on Clark Johnson’s paper. Thanks to both Benjamin “Mr. PR” Cole and Marcus Nunes for letting me know about Johnson’s great paper.

6 Comments
by Lars Christensen on October 22, 2011  •  Permalink
Posted in Economic and monetary history, MM Research agenda, Monetary policy, Reading recommendations, The Great Recession
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Posted by Lars Christensen on October 22, 2011

https://marketmonetarist.com/2011/10/22/clark-johnson-has-written-what-will-become-a-market-monetarist-classic/

“Our Monetary ills Laid to Puritanism”

Douglas Irwin has been so nice to send me an article from the New York Times from November 1 1931. It is a rather interesting article about the Swedish monetary guru Gustav Cassel’s view of monetary policy and especially how he saw puritanism among monetary policy makers as the great ill. I had not read the article when I wrote my comment on Calvinist economics, but I guess my thinking is rather Casselian.

The New York Times article is based on an article from the Swedish conservative Daily Svenska Dagbladet (the newspaper still exists).

Professor Cassel claims that overly tight US monetary policy in the early 1930s is due to two “main ills”: “deflation mania” and “liquidation fever”.

NYT quote Cassel: “The deeper psychological explanation of this whole movement..can without doubt be found in American Puritanism. This force assembled all its significant resources in what was considered a great moral attack on the diabolism of speculation. Each warning against deflation has stranded on fear on the part of Puritanism that a more liberal monetary policy might infuse new vigor in the spirit speculation.”

It isn’t it scary how much this reminds you about how today’s policy makers are scared of bubbles and inflation? I wonder what Gustav Cassel would tell the ECB to do today?

Maybe here would just say: “That the deflation has meant the ruin of one business after another and forced many banks to suspend payments is a matter that little concerns the stern Puritan”…”on the contrary, it is highly approves proper punishment of speculation and thorough cleaning out of questionable business projects. It totals disregards the fact that deflation in itself by degrees adversely affects the finances of any enterprise and forces even sound business to ruin”. 

Wouldn’t it be a blessing if Cassel was around today to advise central bankers? And that they actually would listen…but of course if you are a puritan or what I termed a believer on Calvinist economics then you don’t have to listen because all you want it just doom and pain to punish all the evil speculators.

 

 

 

17 Comments
by Lars Christensen on October 21, 2011  •  Permalink
Posted in Economic and monetary history, euro crisis, Monetary policy, New Casselian economics, The Great Depression
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Posted by Lars Christensen on October 21, 2011

https://marketmonetarist.com/2011/10/21/our-monetary-ills-laid-to-puritanism/

Please help Mr. Simor

He is a challenge for you all.

András Simor is governor of the Hungarian central bank (MNB). Next week he will meet with his colleagues in the MNB’s Monetary Council. They will make announcement on the monetary policy action. Mr. Simor needs your help because he is in a tricky situation.

The MNB’s operates an inflation-targeting regime with a 3% inflation target. It is not a 100% credible and the MNB has a rather unfortunate history of overshooting the inflation target. At the moment inflation continues to be slightly above the inflation target and most forecasts shows that even though inflation is forecasted to come down a bit it will likely stay elevated for some time to come. At the same time Hungarian growth is basically zero and the outlook for the wider European economy is not giving much hope for optimism.

With inflation likely to inch down and growth still very weak some might argue that monetary policy should be eased.

However, there is a reason why Mr. Simor is not likely to do this and that is his worries about the state of the Hungarian financial system. More than half of all household loans are in foreign currency – mostly in Swiss franc. Lately the Hungarian forint has been significantly weakened against the Swiss franc (despite the efforts of the Swiss central bank to stop the strengthening of the franc against the euro) and that is significantly increasing the funding costs for both Hungarian households and companies. Hence, for many the weakening of the forint feels like monetary tightening rather monetary easing and if Mr. Simor was to announce next week that he would be cutting interests to spur growth the funding costs for many households and companies would likely go up rather than down.

Mr. Simor is caught between a rock and a hard. Either he cuts interest rates and allows the forint to weaken further in the hope that can spur growth or he does nothing or even hike interest rates to strengthen the forint and therefore ease the pains of Swiss franc funding households and companies.

Mr. Simor does not have an easy job and unfortunately there is little he can do to make things better. Or maybe you have an idea?

PS The Hungarian government is not intent on helping out Mr. Simor in any way.

PPS When I started this blog I promised be less US centric than the other mainly US based Market Monetarist bloggers – I hope that his post is a reminder that I take that promise serious.

PPPS if you care to know the key policy rate in Hungary is 6%, but as you know interest rates are not really a good indicator of monetary policy “tightness”.

4 Comments
by Lars Christensen on October 20, 2011  •  Permalink
Posted in Central and Eastern Europe, Emerging Markets, MM Research agenda, Monetary institutions, Monetary policy, Monetary policy rules
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Posted by Lars Christensen on October 20, 2011

https://marketmonetarist.com/2011/10/20/please-help-mr-simor/

Calvinist economics – the sin of our times

A couple a days ago I had a discussion with a colleague of mine about the situation in Greece. My view is that it is pretty clear to everybody in the market that Greece is insolvent and therefore sooner or later we would have to see Greece default in some way or another and that it therefore is insane to continue to demand even more austerity measures from the Greek government, while at the same time asking the already insolvent Greek government to take on even more debt. My colleague on the other hand insisted that the Greeks “should pay back what they owe” and said “we can’t let countries default on their debt then everybody will do it”. It was a moral and not an economic argument he was making.

I am certainly not a Keynesian and I do not think that fiscal tightening necessarily is a bad thing for Greece, but I do, however, object strongly to what I would call Calvinist economic thinking, which increasingly is taking hold of our profession.

At the core of Calvinist economics is that Greece and other countries have committed a sin and therefore now have to repent and pay for these sins. It is obvious that the Greek government failed to tighten fiscal policy in time and even lied about the numbers, but its highly problematic that economic thinking should be based on some kind of quasi-religious morals. If a country is insolvent then that means that it will never be able to pay back its debt. It is therefore in the interest for both the country and its creditors that a deal on debt restructuring is reached. That’s textbook economics. There is no “right” or “wrong” about it – it is simple math. If you can’t be pay back your debts then you can’t pay. It’s pretty simple.

In another area very Calvinist economic thinking is widespread is in the conduct of monetary policy. Around the world central bankers resist easing monetary policy despite clear disinflationary or even deflationary tendencies and the main reason for this is not economic analysis of the economic situation, but rather the view that a loosening of monetary policy would be immoral. The Calvinists are screaming out “We will have another bubble if you ease monetary policy! Don’t let the speculators of the hook!”

The problem is that the Calvinists are confusing an easing of monetary policy or the default of insolvent nations with moral hazard.

If a central bank for example has a inflation target of 2% and inflation is running at below 1% and the central bank then decides to loosen monetary policy – then that might well be positive for “speculators” – such as property owners, banks or equity investors. The Calvinists see this as evil. As immoral, but the fact is that that is exactly what a central bank that is undershooting its inflation target should. Monetary policy is not about making judgements of what is “fair” or not, but rather about securing a nominal anchor in which investors, labour, companies and consumers can conduct there business in the market place.

The Calvinists are saying “It will be Japan”, “the global economy will not grow for a decade” and blah, blah…it nearly seems as if they want this to happen. We have sinned and now we need to repent. The interesting thing is that these Calvinists where not Calvinists back in 2005-6 and when some of us warned about excesses in the global economy they where all cheerleaders of the boom. They are like born-again Christian ex-alcoholics.

And finally just to get it completely clear. I am not in favour of bailing out anybody, or against fiscal austerity and I despise inflation. But my economics is back on economic reasoning and not on quasi-religious dogma.

PS anybody that studies history will note that Calvinist economics dominated economic thinking in countries which held on to the gold standard for too long. This is what Peter Temin has called the “Gold Standard mentality”. The in countries like France and Austria the gold standard mentality were widespread in the 1930s. We today know the consequences of that – Austria had major banking crisis in 1931, the country defaulted in 1938 and the same it ceased to existed as an independent nation. Good luck with your Calvinist economics. It spells ruins for nations around the world.

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UPDATE: Douglas Irwin has kindly reminded me that my post remind him of Gustav Cassel. Cassel used the term “puritans” about what I call Calvinist economics. Maybe Market Monetarists are New Casselians?

36 Comments
by Lars Christensen on October 20, 2011  •  Permalink
Posted in Economic and monetary history, General economic theory, MM Research agenda, Monetary policy, The euro, The Great Depression
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Posted by Lars Christensen on October 20, 2011

https://marketmonetarist.com/2011/10/20/calvinist-economics-the-sin-of-our-times/

Open-minded Brits – and Austrians

American Alex Salter is a good example of the open-minded Austrians who has welcomed the dialogue with Market Monetarists. In my own part of the world Austrians is also engaging us in a serious fashion. A good example is Anthony Evans – self-declared Austrian, monetary specialist and Associate Professor of Economics at London’s ESCP Europe Business School, and Fulbright Scholar-in-Residence at San Jose State University.

Anthony is endorsing a NGDP target for the Bank of England. See his latest comment from City A.M. here. See also this earlier comment.

In general it is interesting how British monetarists as well as British Austrian school economists seem to be much more open to Market Monetarist ideas than their counterparts in the US and in continental Europe. In that regard it should be noted that the Bank of England probably is the central bank in the world that is taking NGDP targeting most serious.

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by Lars Christensen on October 19, 2011  •  Permalink
Posted in Austrian economics, MM Research agenda, Monetary policy, Reading recommendations
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Posted by Lars Christensen on October 19, 2011

https://marketmonetarist.com/2011/10/19/open-minded-brits-%e2%80%93-and-austrians/

The Hottest Idea In Monetary Policy

Its pretty simple – Scott Sumner is a revolutionary with revolutionary idea and he is breaking through big time.

He is a story from businessinsider.com: “The Hottest Idea In Monetary Policy”.

I fundamentally think that if the Federal Reserve was to start listening to Scott then a whole lot of other economic and monetary problems would be a lot easy to solve – so that’s our hope in Europe.

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by Lars Christensen on October 19, 2011  •  Permalink
Posted in Monetary policy, Reading recommendations, Scott Sumner
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Posted by Lars Christensen on October 19, 2011

https://marketmonetarist.com/2011/10/19/the-hottest-idea-in-monetary-policy/

NGDP targeting is not about ”stimulus”

Market Monetarists are often misunderstood to think that monetary policy should “stimulate” growth and that monetary policy is like a joystick that can be used to fine-tune the economic development. Our view is in fact rather the opposite. Most Market Monetarists believe that the economy should be left to its own devises and that the more policy makers stay out of the “game” the better as we in general believe that the market rather than governments ensure the most efficient allocation of resources.

Exactly because we believe more in the market than in fine-tuning and government intervention we stress how important it is for monetary policy to provide a transparent, stable and predictable “nominal anchor”. A nominal GDP target could be such an anchor. A price level target could be another.

Traditional monetarists used to think that central banks should provide a stable nominal anchor through a fixed money supply growth rule. Market Monetarists do not disagree with the fundamental thinking behind this. We, however, are sceptical about money supply targeting because of technical and regulatory develops mean that velocity is not constant and because we from time to time see shocks to money demand – as for example during the Great Recession.

A way to illustrate this is the equation of exchange:

M*V=P*Y

If the traditional monetarist assumption hold and V (velocity) is constant then the traditional monetarist rule of a constant growth rate of M equals the Market Monetarist call for a constant growth rate of nominal GDP (PY). There is another crucial difference and that is that Market Monetarists are in favour of targeting the level of PY, while traditional monetarists favours a target of the growth of M. That means that a NGDP level rule has “memory” – if the target overshots one period then growth in NGDP need to be higher the following period.

In the light in the Great Recession what US based Market Monetarists like Bill Woolsey or Scott Sumner have been calling for is basically that M should be expanded to make up for the drop in V we have seen on the back of the Great Recession and bring PY back to its old level path. This is not “stimulus” in the traditional Keynesian sense. Rather it is about re-establishing the “old” monetary equilibrium.

In some way Market Monetarists are to blame for the misunderstandings themselves as they from time to time are calling for “monetary stimulus” and have supported QE1 and QE2. However, in the Market Monetarists sense “monetary stimulus” basically means to fill the whole created by the drop in velocity and while Market Monetarists have supported QE1 and QE2 they have surely been very critical about how quantitative easing has been conducted in the US by the Federal Reserve.

Another way to address the issue is to say that the task of the central bank is to ensure “monetary neutrality”. Normally economists talk about monetary neutrality in a “positive” sense meaning that monetary policy cannot affect real GDP growth and employment in the long run. However, “monetary neutrality” can also be see in a “normative” sense to mean that monetary policy should not influence the allocation of economic resource. The central bank ensures monetary neutrality in a normative sense by always ensuring that the growth of money supply equals that growth of the money demand.

George Selgin and other Free Banking theorists have shown that in a Free Banking world where the money supply has been privatised the money supply is perfectly elastic to changes in money demand. In a Free Banking world an “automatic” increase in M will compensate for any drop V and visa versa. So in that sense a NGDP level target is basically committing the central bank to emulate the Free Banking (the Free Market) outcome in monetary matters.

The believe in the market rather than in “centralized control mechanisms” is also illustrated by the fact that Market Monetarists advocate using market indicators and preferably NGDP futures in the conduct of monetary policy rather than the central bank’s own subjective forecasts. In a world where monetary policy is linked to NGDP futures (or other market prices) the central bank basically do not need a research department to make forecasts. The market will take care of that. In fact monetary policy monetary policy will be completely automatic in the same way a gold standard or a fixed exchange rate policy is “automatic”.

Therefore Market Monetarists are certainly not Keynesian interventionist, but rather Free Banking Theorists that accept that central banks do exists – for now at least. If one wants to take the argument even further one could argue that NGDP level targeting is the first step toward the total privatisation of the money supply.

 

 

 

10 Comments
by Lars Christensen on October 18, 2011  •  Permalink
Posted in MM Research agenda, Monetary institutions, Monetary policy, Monetary policy rules, NGDP Targeting
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Posted by Lars Christensen on October 18, 2011

https://marketmonetarist.com/2011/10/18/ngdp-targeting-is-not-about-%e2%80%9dstimulus%e2%80%9d/

Nick, Chuck and the central banks

Here is Nick Rowe on central banks and Chuck Norris. If you don’t understand Chuck you don’t understand central banks.

 

 

1 Comment
by Lars Christensen on October 18, 2011  •  Permalink
Posted in Chuck Norris, Monetary policy, Nick Rowe, Reading recommendations
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Posted by Lars Christensen on October 18, 2011

https://marketmonetarist.com/2011/10/18/nick-chuck-and-the-central-banks/

Sexy new model could shed light on the Great Recession

Market Monetarists like myself claim that the Great Recession mostly was caused by the fact that the Federal Reserve and other central banks failed to meet a sharp increase in the demand for dollars. Hence, what we saw is what David Beckworth has termed a “passive” tightening of monetary policy.

I have come across a (rather) new paper that might be able to shed more light on what impact the increase in money demand had in the Great Recession.

Te paper by Irina A. Telyukova and Ludo Visschers presents a rather sexy model (that’s an economic model…), but has a rather unsexy title “Precautionary Demand for Money in a Monetary Business Cycle Model”. Here is the abstract:

“We investigate quantitative implications of precautionary demand for money for business cycle dynamics of velocity and other nominal aggregates. Accounting for such dynamics is a standing challenge in monetary macroeconomics: standard business cycle models that have incorporated money have failed to generate realistic predictions in this regard. In those models, the only uncertainty affecting money demand is aggregate. We investigate a model with uninsurable idiosyncratic uncertainty about liquidity need and find that the resulting precautionary motive for holding money produces substantial qualitative and quantitative improvements in accounting for business cycle behavior of nominal variables, at no cost to real variables.”

Hence, Telyukova and Visschers incorporate shocks to money velocity from increases in what they call “precautionary demand for money” into a dynamic business cycle model. The model is yielding rather interesting results, but it is also a rather technical paper so it might be hard to understand if you are a none-technical economist.
Anyway, the conclusion is relatively clear:

“By incorporating this idiosyncratic risk into a standard monetary model with aggregate risk, and by carefully calibrating the idiosyncratic shocks to data, we find that the model matches many dynamic moments of nominal variables well, and greatly improves on the performance of existing monetary models that do not incorporate such idiosyncratic shocks. We show that our results are robust to multiple possible ways of calibrating the model. We show also that omitting precautionary demand while targeting, in calibration, data properties of money demand – a standard calibration practice produces inferior performance in terms of matching the data, potentially misleading implications for parameters of the model, and may therefore adversely affect the model’s policy implications as well.”

The paper was first written back in June 2008 (talk about good timing) and then later updated in March 2011. Oddly enough the paper does not make any reference to the Great Recession! This is typical of this kind of technical papers – even though the results are highly relevant the authors fail to notice that (or ignore it). That does not, however, change the fact that Telyukova’s and Visschers’ paper could clearly shed new light on the Great Recession.

As I see it the Telyukova-Visschers model could be used in two ways which would be directly relevant for monetary policy making. 1) Use the model to simulate the Great Recession. Can the increase in precautionary demand for money account for the Great Recession? 2) The model can be used to test how different policy rules (NGDP targeting, price level, inflation targeting, a McCallum rule, Taylor rule etc.) will work and react to shocks to money demand. I hope that is the direction that Telyukova and Visschers will take their research in the future.

4 Comments
by Lars Christensen on October 17, 2011  •  Permalink
Posted in General economic theory, MM Research agenda, Monetary policy, The Great Recession

Posted by Lars Christensen on October 17, 2011

https://marketmonetarist.com/2011/10/17/sexy-new-model-could-shed-light-on-the-great-recession/

Japan’s deflation story is not really a horror story

Many economists – including some Market Monetarists – tell the story about Japan’s economy as a true horror story and there is no doubt that Japan’s growth story for more than 15 years has not been too impressive – and it has certainly not been great to have been invested in Japanese stocks over last decade.

Some Market Monetarists are explaining Japan’s apparent weak economic performance with overly tight Japanese monetary policy, while others blame “zombie banks” and continued deleveraging after the bubble in to 1990s. I, however, increasingly think that these explanations are wrong for Japan.

Obviously, Japan has deflation because money demand growth consistently outpaces money supply growth. That’s pretty simple. That, however, does not necessarily have to be a problem in the long run if expectations have adjusted accordingly. The best indication that this has happened is that Japanese unemployment in fact is relatively low. So maybe what we are seeing in Japan is a version of George Selgin’s “productivity norm”. I am not saying Japanese monetary policy is fantastic, but it might not be worse than what we are seeing in the US and Europe.

The main reason Japan has low growth is demographics. If you adjust GDP growth for the growth (or rather the decline) in the labour force then one will see that the Japanese growth record really is not bad at all – especially taking into accord that Japan after all is a very high-income country.

Daniel Gros, whom I seldom agrees with (but do in this case), has done the math. He has looked Japanese growth over the last decade and compared to other industrialized countries. Here is Gros:

“Policymaking is often dominated by simple “lessons learned” from economic history. But the lesson learned from the case of Japan is largely a myth. The basis for the scare story about Japan is that its GDP has grown over the last decade at an average annual rate of only 0.6% compared to 1.7 % for the US. The difference is actually much smaller than often assumed, but at first sight a growth rate of 0.6 % qualifies as a lost decade…According to that standard, one could argue that a good part of Europe also “lost” the last decade, since Germany achieved about the same growth rates as Japan (0.6%) and Italy did even worse (0.2 %); only France and Spain performed somewhat better…But this picture of stagnation in many countries is misleading, because it leaves out an important factor, namely demography…How should one compare growth records among a group of similar, developed countries? The best measure is not overall GDP growth, but the growth of income per head of the working-age population (not per capita). This last element is important because only the working-age population represents an economy’s productive potential. If two countries achieve the same growth in average WAP income, one should conclude that both have been equally efficient in using their potential, even if their overall GDP growth rates differ…When one looks at GDP/WAP (defined as population aged 20-60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan’s overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population…The difference between Japan and the US is instructive here: in terms of overall GDP growth, it was about one percentage point, but larger in terms of the annual WAP growth rates – more than 1.5 percentage points, given that the US working-age population grew by 0.8%, whereas Japan’s has been shrinking at about the same rate.”

So it is correct that Japanese monetary policy was overly tight after the Japanese bubble bursted in the mid-90ties, but that is primarily a story of the 90s, while the story over the last decade is primarily a story of bad demographics.

We can learn a lot from Japan, but I think Japan is often used as an example of all kind of illnesses, but few of those people who pull “the Japan-card” really have studied Japan. Similar for me – I am not expert on the Japanese economy – but both the monetary and the deleveraging explanations for Japan’s low growth during the past decade (not the 90ties) I believe to be wrong.

The Great Depression as well as the Great Recession are terrible examples of the disasters that the wrong monetary policy can bring and so is the Japan crisis in the mid-90s, but we need to make the right arguments for the right policies based on fact and not myth.

PS in Daniel Gros’ comment on Japan he makes some comments on the effectiveness of monetary policy. He seems to think that monetary policy is impotent in the present situation. I strongly disagree with that as I believe that monetary policy is in fact very effective in increasing nominal income growth as well as inflation. The liquidity trap is a myth in the same way the Japan growth story is a myth.

9 Comments
by Lars Christensen on October 16, 2011  •  Permalink
Posted in Economic and monetary history, MM Research agenda, Monetary policy, Reading recommendations

Posted by Lars Christensen on October 16, 2011

https://marketmonetarist.com/2011/10/16/japan%e2%80%99s-deflation-story-is-not-really-a-horror-story/

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