Stephen King: Our economic woes show that there is nothing unique about Japan
Economic Outlook: Economic outcomes in the Western world have, to date, been far worse than in Japan in the early years of stagnation
Monday 22 August 2011
Over the past few years, policymakers on either side of the Atlantic have repeatedly delivered the same message.
Japan's economic stagnation should be seen as a one-off. It wouldn't happen in the West because Japan was, somehow, different. Western economies were more flexible than Japan's, could restructure easily whenever necessary and thus would always avoid any kind of Japanese-style multi-year disappointment. And, even if Western economies were unable to heal on their own accord, policymakers had the cures and were not afraid to use them.
This position might best be described as "Western economic arrogance". There was no real attempt to explain why Japan had suffered so much. It was simply assumed that what happened over there couldn't happen over here.
Western economic arrogance began to be hard-wired into economic discourse. The Federal Reserve spent the years before the onset of the financial crisis explaining why Japan got it wrong and how the US couldn't possibly make the same mistakes. Indeed, Ben Bernanke gave a speech in 2002 entitled "Deflation: Making Sure 'It' Doesn't Happen Here", offering a step-by-step guide to the avoidance of economic stagnation.
A lot of those steps have now been adopted. Interest rates plunged, the Fed bought a wide range of financial assets in a bid to get prices up and yields down and, just the other day, it said it would keep short-term interest rates at zero all the way through to 2013 in a bid to eradicate any residual fears regarding a early tightening of monetary policy.
Yet, despite all this, markets have plunged and recession fears have returned. Even more galling, despite the willingness to adopt unconventional measures, economic outcomes in the Western world have, to date, been far worse than in Japan in the early yearsof stagnation.
So what's gone wrong? Part of the difficulty lies with the nature of the crisis. A standard Keynesian interpretation argues that the private sector can end up in a high-unemployment trap, where producers lay off workers because they fear a lack of demand and the resulting rise in unemployment creates that lack of demand. It is then incumbent upon the authorities to provide monetary and fiscal stimulus in order to "jump-start" the recovery.
Seen this way, economic policy is mostly designed to deal with the Roosevelt dictum that "the only thing we have to fear is fear itself". Economies typically perform perfectly well but, when everyone panics, things can go badly wrong unless the fear can be conquered.
This view suggests it's relatively easy to deliver a return to "business as usual". Yet that simply hasn't happened. Part of the reason is that, pre-crisis, people viewed the world through rose-tinted spectacles. The build up of debt, the reliance on continued gains in asset values and the boom in homebuilding were all conveniently ignored. Inflation was well-behaved so, in a world in which inflation-targeting was enshrined, what could possibly go wrong?
Sadly, this view reflected an ignorance of history or, at the very least, a desire to brush the lessons of history to one side.
Before its crisis, Japan had very little conventional inflation (even though asset prices were going through the roof). During the 1920s, the US had hardly any inflation at all, yet it still ended up with the Wall Street Crash and the subsequent Depression. The avoidance of inflation in no way guarantees a future of lasting prosperity.
The problem can be simply put. The last period of superlative economic performance in the Western world was probably in the late-1990s, when new technologies emerged at a rate of knots and we all benefited from massive productivity enhancements. Financial investors, however, over-egged the pudding, driving stock prices up to levels beyond what could be justified by future rates of growth.
The collapse that followed led Western policymakers to adopt "Japan-avoidance" strategies.
Interest rates fell, money became easy and the recession that followed in 2001 was either mild or, in the UK's case, non-existent. Stock markets began to recover. But economic growth began to rely not on the wonders of new technology but, instead, on bricks, mortar and leverage. The attempt to avoid "another Japan" led to a build up of real estate problems that, ironically, had been part of Japan's problems during its 1980s bubble.
This story, as we now know, was simply not sustainable. Policymakers had created a fool's paradise, a world in which you could have money for nothing. The following crisis was bad enough, but it also revealed the weaknesses of the earlier growth model. And it's that observation that has made life so difficult for policymakers subsequently. There are now two things to fear: fear, certainly, but also a malodorous economic reality.
This, in turn, has made policy a lot less effective. Take, for example, the process of printing money through so-called quantitative easing. This was supposed to be the answer to all our problems, even if central bankers struggled to explain precisely how it was supposed to work. Printing money certainly pushed asset prices up – stock markets rebounded strongly last year and interest rate spreads narrowed as planned – but there was no significant economic follow-through.
One obvious reason is the lack of willing borrowers: in a deleveraging world, debt repayment trumps everything. But it may also be the case that people no longer have confidence in the stock market. Pre-2000, the stock market could shrug off all manner of upsets, leaving investors almost always better off. Post-2000, that has no longer been the case. On a rolling five year basis, you've been as likely to lose money as to make it by investing on Wall Street. No amount of printing money can change this underlying corrosion of wealth. It reflects, after all, the deteriorating quality and pace of growth in the Western world at the beginning of the 21st century.
But there is also a difficult new political reality, one that wasn't around when Mr Bernanke gave his 2002 speech but one which, today, has made the economic challenge so much greater.
Mr Bernanke referred to it in 2002, but thought it was a challenge that applied uniquely to Japan: "The failure to end deflation in Japan... is a byproduct of a longstanding political debate about how best to address Japan's overall economic problems... comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficultto achieve."
People too often forget this part of Mr Bernanke's speech. It is a convenient form of economic amnesia because it turns out that, with political stasis on either side of the Atlantic, there is nothing unique about Japan's problems after all.
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