Last week, markets zoomed upon receiving the news that Japan was committed to "quantitative easing" or what we used to simply call inflation. What should give everyone pause is the reminder that we've been through this all before. In a very accessible article, "U.S. Recession Policies: Nothing New Under the (Rising) Sun" in the Fall 2009 issue of The Intercollegiate Review, Benjamin Powell expertly compares and contrasts the response of Japan to their earlier recession that led to the infamous "lost decade."
Powell documents that the central banks of both Japan in the late 1980s and the U.S. in the 2000s increased the money supply and greatly lowered interest rates. In both situations housing and stock bubbles were inflated and then burst leaving a plethora of economic devastation in their wake. He uses Austrian business cycle theory to rightly identify the massive capital malinvestment that is at the root of the economic problems of both Japan and the United States.
Powell notes that the response in the U.S. has been both monetary and fiscal stimulus. He does an expert job explaining why it was just this sort of monetary and fiscal intervention that prolonged Japan's recover into what became known as the lost decade. Powell's article is an excellent piece of economic history documenting how not to recover from the Great Recession.
Japan's central bank should simply have followed the Hayek-Robbins prescription of stabilizing nominal spending, which is also what the Fed failed to do both in the Great Depression and Great Recession.
ReplyDeleteAlso, Japan's central bank's statements commitments to higher inflation haven't been credible. They've recently raised interest any time inflation gets above 0%.
Stabilizing nominal spending might make sense if the problem in recession is not enough demand for too much production. The problem, however, is not that too many goods were produced, but that the wrong goods were produced. Capital must be reallocated toward its most productive uses. This problem is not solved by stabilizing spending.
ReplyDeleteIt is a good thing if Japan is not fully committed to higher inflation. Mass inflationary expectations is the first step to hyper-inflation.
But in the meantime the human costs of the deflation in Japan appear to be quite high.
ReplyDeleteHayek (1975):
"Today I believe that deflation has no recognizable function whatever, and that there is no justification for supporting or permitting a process of deflation."
I think the Austrian thought is to argue that Japan is suffering a proper hangover from its credit binge and malinvestment, correct? But it's worth noting that Hayek and others made the same argument in the 1930s and later regretted it-- and for good reason.
(Japan's central bank actually seems committed to Hayek's original stable NGDP rule, as NGDP grows by almost exactly 0% annually).
The misery and human costs you note are not the result of deflation. They are the direct result of Japan's failure to allow the liquidation process to occur. The Japanese government has kept unprofitably invested capital in place with fiscal and monetary stimulus as well as central bank policy that continues to keep bad debt frozen on the books of zombie banks.
ReplyDeleteCharacterizing a recession as a proper hangover after a binge is not the right way to view Austrian business cycle theory. Austrian business cycle theory views recessions as the necessary (as in this is the way things will be, not the way we must make them) consequence of capital consumption via malinvestment resulting from artificially low interest rates.
The problem is that,both in Japan and the US, entrepreneurs were led astray by central bank credit expansion to undertake too much investment at higher stages of production and not enough investment at lower stages. The end result is that a large number of investment projects were begun at stages farther away from the consumption that were simply not sustainable. These projects must be liquidated if we do not want to continue to consume capital and make the situation even worse over time. This is not a proper hangover after a binge, but the necessary restructuring of capital toward its most highly valued uses.
Additionally, whatever human costs that are accruing in Japan are not due to deflation. The claim that there has been a generation of deflation in Japan is simply wrong. In 1989 the annual CPI in Japan was at 91.3. In 2009, it was 100.3. There have been ups and down along the way, but prices are higher now than they were in 1989. The monetary base of Japan is now more than 244 times what it was in July of 1991. M1 in Japan almost trippled from 1990 to 2002 and then increased every year after until 2009. In no way can this be construed as deflation.
Also, liquidation does not have to cause prolonged misery. That is the lesson of the recession of 1920-21 that followed the inflation of the war years. During 1920 unemployment increased from 4% to 12% and GDP fell by 17%. Warren Harding's response was to cut government spending, cut taxes, and reduce the national debt and the Federal Reserve did not act to inflate in an attempt to forestall deflation. Unemployment was back down to 6.7 by the end of 1922 and fell to 2.4% in 1923. The reason we did not have two decades of misery following the recession of 1920-21 is that the government by-and-large allowed the malinvestment to be liquidated and for the necessary capital restructuring to commence.
Hayek's position on allowing liquidation after an inflationary boom got worse over time for no good reason that I can see.