Monday, July 4, 2011

Richard Koo on the Lessons from Japan’s Lost Decade

This is a talk by Richard Koo at a conference at the Central Bank of Argentina (June, 2011), and Steve Keen has more background on it here:
Steve Keen, “Sense on deficits & deleveraging: Koo & Varoufakis,”, July 4th, 2011.
The lessons to be learnt from Japan are stark: zombie banks must be closed down or cleaned up, and austerity is the road to disaster. The US and EU are currently on the road to disaster.


  1. What exactly is the austerity pursued in the US? Are you speaking of state governments or federal government?

  2. Yes, state and local austerity is a major problem, just as it was in the 1930s, by counteracting stimulative federal fiscal policy:

    At the federal level, the choice is between lite austerity (Obama) and savage austerity (Republicans):

    Obama is the typically evasive, chameleon-like centrist. He keeps shifting position:

    When I say "on the road to disaster", of course things could change, but I wouldn't hold my breath.

  3. From your links: "The Republican majority in the House of Representatives will this week try to pass a resolution to cut $60bn (£37.5bn) from government spending over seven months. Translating to annual cuts of $100bn or more,..."

    A resolution to cut spending is not the same thing as cutting spending. The government can't predict in advance how much it has to spend or where it will have to spend. They may easily move away from that target, if future prudence demands otherwise. Besides $100 billion of cuts in a budget much greater than $1.6 trillion is purely political posturing and not a radical move to cut the budget. It's just to make their voters happy.

    Even after those cuts happen, spending would still be higher than the previous year.

    If austerity is defined as rise in spending but not too high a rise in spending, then I don't see how austerity is any different from standard Keynesian position - that the budgets must roughly balance across the long run. How else will you obtain funds for expanding public services anyway?

  4. Note my words on "the road to diaster".

    If private sector spending and investment falls, and export-led growth can provide no balance (a rare occurrence anyway), only government can step in and fill the hole.

    Even a $100bn cuts thsi year will have an impact due to the multiplier.

    "then I don't see how austerity is any different from standard Keynesian position - that the budgets must roughly balance across the long run"

    The US will probably plunge into a lost decade. This is no time at all to cut spending.

    When the financial sector and private balance sheets are healthy again, and there is low unemployment and inflationary pressures, THEN it will be time to cut spending and balance bugdets.

    How else will you obtain funds for expanding public services anyway?

    In my opinion, the US, and other countries, should just follow Abba Lerner's functional finance model of government spending, money creation and destruction, and debt issuance, etc.

    You never run out of money because money can be created and detroyed at will by the government/central bank. If you can do QE 1 and QE 2, there is no reason why you can't do functional finance.

    The real issue is available resources, available labour, capacity utilization levels, inflation, the exchange rate etc., not fictious "financial" constraints.

  5. Prateek: "How else will you obtain funds for expanding public services anyway?"

    Isn't this one of the basic misunderstandings of consensus economics? Isn't this one of the core insights of post-Keynsiansism/MMT?

    You get the funds by typing them in.

  6. I think the key to understanding LK's argument, Prateek, is to note that state and local government budgets in the US are mostly funded by property and sales, and income taxes , which were all severely diminished by the recession and housing crash, and can't be increased without raising taxes municipalities can issue debt, but tend to be more pro-cyclical than counter-cyclical. Presently, issuance is at a ten year low.

    Anyway, in this circumstance, if the Federal government maintains its spending level, the total government sector spending falls. Most of the stimulus funds were devoted to making up for the states' shortfall in income. Now that the stimulus is spent, the states and cities have been forced to reduce spending on things like roads, police, etc.

    In a keynesian framework this local austerity is just as effective in prolonging recession as a federal one.

  7. standard Keynesian position - that the budgets must roughly balance across the long run If this is meant as a goal, it might unfortunately be correct to call it "Keynesian". But it is not at all what Keynes himself thought. Modern "Keynesians" say this all the time, without ever saying where Keynes said anything like this. The only one I've seen ask for a quote is James Galbraith, without getting a reply. Keynes did say "take care of unemployment, and the budget will take care of itself", and after a bit of struggle, was fully converted to Lerner's functional finance. Real students of Keynes like Lerner, Domar, Fullwiller, Godley etc have realized that functional finance is sounder than sound finance, that "the budget will take care of itself" - but this is an effect, not a goal.