Thursday, May 24, 2012

Richard Koo on the West’s Lost Decade

Richard Koo (Nomura Research Institute) speaks at the Closing Panel “Overhangs, Uncertainty and Political Order: Where Do We Go From Here?” at the Institute for New Economic Thinking’s (INET) Paradigm Lost Conference in Berlin (April 14, 2012). He draws lessons from Japan’s lost decade, and why the West is now in the same position, owing to its private debt crisis, collapsed asset bubbles, and debt deflation.

Richard Koo’s approach is very similar to that of Steve Keen. There is a disease rotting modern neoliberal capitalism. Many countries are stricken with debt deflation, caused by excessive private debt and the collapse of asset bubbles in real estate from 2007–2009, which led to severe recessions in many nations (or what Koo calls “balance sheet recessions”). The theory required to explain what is afflicting Western economies is Hyman Minsky’s “financial instability hypothesis.”

A crucial point is that an important aspect of Japan’s lost decade was the austerity imposed on the economy in 1996 to 1997 by Prime Minister Ryutaro Hashimoto. The result was five quarters of negative growth in a terrible recession (1997–1999) and resulting banking crisis. This shows up in the annualised GDP figures, as you can see here:
Japanese Annualised Average GDP, 1994–2001
Year | GDP

1994 | 0.86%
1995 | 1.88%
1996 | 2.64%
1997 | 1.56%
1998 | -2.05%
1999 | -0.14%

2000 | 2.86%
2001 | 0.18%
A major consequence of the recession induced by fiscal contraction was that the Japanese budget deficit soared by 68%, owing to the collapse of tax revenue. This must be counted as another fundamental reason why Japanese public debt soared as well: it was not just the periods of fiscal expansion from 1993–1996 and after November 1998 (when the government started planning fiscal stimulus again).

One minor criticism I have is that Koo could benefit from using endogenous money theory. Also, Steve Keen urges a much more radical solution than Koo to the crisis of debt deflation: private debt write offs or a QE for the public, to allow them to repay debt (see the previous video I have posted). I think Steve Keen is right on this. Axel Leijonhufvud, another heterodox Keynesian, has also pointed out that debt deflation/deleveraging causes “financial sinkholes in private sector balance sheets” for fiscal policy (see Leijonhufvud 2009), which makes standard Keynesianism an incomplete tool for dealing with the present crisis.

Of course, government fiscal policy is badly needed and does help the private sector delever, but it needs to be done on a big scale. To make it effective, a more sensible policy is just massive writing-off and restructuring of private debt, and the use of monetary policy to protect depositors and keep the financial system solvent, before large-scale Keynesian stimulus.


An excellent post here from Bill Mitchell analyzing recent fiscal expansion in Japan:
Bill Mitchell, “Japan Grows – Expansionary Fiscal Policy Works!,” Billy Blog, May 24, 2012.
We are often told that Japanese government debt stands at over 200% of GDP, yet, as I have shown above, an important reason why that is so was the effect of austerity on the budget deficit from 1997 to 1999.


Leijonhufvud, A. 2009. “Out of the Corridor: Keynes and the Crisis,” Cambridge Journal of Economics 33: 741-757.

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