Richard Koo Interview on the Causes of Economic Crises

Though the interview is a few months old, Richard Koo discusses quite a few issues here, such as Japan’s recent economic policies, the causes of the Great Recession, and balance sheet recessions.

Richard Koo on Macroeconomics and Balance Sheet Recessions

Some insightful analysis here from Richard Koo on modern macroeconomics and balance sheet recessions:

Richard Koo, “Macroeconomic Policy Debate has Lost its Way,” October 23, 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%

http://wikiposit.org/am?WB.JPN.NY.GDP.MKTP.KD.ZG=101

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.




UPDATE

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.


BIBLIOGRAPHY

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

Richard Koo on Europe, the US, and Japan

Richard Koo (Chief Economist at the Nomura Research Institute, Ltd.) gives a talk here at the Foreign Press Center (Japan) on the “Rebuilding of the European and US Economy and Japan” (January 19, 2012).

Richard Koo’s work on asset bubbles, debt deflation and balance sheet recessions is consistent with the Post Keynesian view of these problems. In many ways, his work complements that of Steve Keen.

Richard Koo in Balance Sheet Recession Debate

A BBC debate with Gillian Tett, Richard Koo and Francis Fukuyama about balance sheet recessions. One can also read Koo’s paper “The World in Balance Sheet Recession: Causes, Cure, and Politics,” Real-World Economics Review 58: 19-37.

Richard Koo on Balance Sheet Recessions

An interesting paper from Richard Koo on the state of the major economies, debt deflation, and his notion of the balance sheet recession:

Richard C. Koo, “The World in Balance Sheet Recession: Causes, Cure, and Politics,” Real-World Economics Review 58: 19-37.

This should be read with Steve Keen (2011; the PDF is also available here) and Axel Leijonhufvud (2009).

BIBLIOGRAPHY

Keen, S. 2011. “Debunking Macroeconomics,” Economic Analysis & Policy 41.3: 147-167. http://www.eap-journal.com/archive/v41_i3_01-keen.pdf

Koo, R. C. “The World in Balance Sheet Recession: Causes, Cure, and Politics,” Real-World Economics Review 58: 19-37.

Leijonhufvud, A. 2009. “Out of the Corridor: Keynes and the Crisis,” Cambridge Journal of Economics 33: 741-757.
http://cje.oxfordjournals.org/content/33/4/741.fu

Richard Koo on the Current State of the Japanese Economy

This is a very interesting, though somewhat long, talk by Richard Koo given at the Foreign Press Center Japan, on January 18, 2011, on Japan’s experience of the Great Recession. There are many good points made here, not least of all that a debt deflationary lost decade is becoming a reality for a number of Western nations. Richard Koo has a very similar view of the crisis as Steve Keen, and underlying them both is Hyman Minsky’s financial instability hypothesis, which in turn was developed from Irving Fisher’s debt deflation theory.

Richard Koo on Balance Sheet Recessions

Richard Koo is a Taiwanese economist working in Japan, and appears to be influenced by Post Keynesian economics, particularly Hyman Minsky’s financial instability hypothesis. Richard Koo’s research has focussed on balance-sheet recessions and credit cycles.

I have posted a very interesting video below where Richard Koo is essentially explaining the process of deleveraging and how to avoid debt deflation. He also explains how Japan narrowly avoided a debt deflationary disaster in the 1990s during the lost decade.

Koo makes the point that Japan and now the US are not in an inventory recession or a recession caused by a central bank trying to control inflation by monetary tightening where the underlying economy is strong: this is a balance sheet recession with excessive private debt, falling asset prices, and deleveraging.
Japan in the 1990s was prevented from a catastrophic depression and the full effects of debt deflation (e.g., the type of collapse in the US from 1929-1933) by stop-and-go use of fiscal policy: but the effectiveness of that fiscal policy was undercut by fiscal conservatives who demanded austerity and budget balancing during the lost decade, most notably in 1997-1998.

Now GDP is determined by the following:

GDP = private consumption + gross investment + government spending + (exports − imports).

In a balance sheet recession, where deleveraging is going on, households are paying down debt and reducing consumption, and business are also repaying debt and reducing gross investment.

This means that private consumption and gross investment collapse in GDP, causing a failure of aggregate demand. Unless you can massively increase exports to make up for this (impossible for most countries), then government spending must step in to fill the shortfall. But for Keynesian stimulus to work effectively, excessive and unsustainable private debt must be written off or restructured and the financial system must be cleared of bad assets and non-performing loans. In Japan, and now as we see in the US and other nations, deleveraging and the poor state of private balance sheets can cause the malaise to go on for years.

Without these measures and additional, larger fiscal stimulus, the US and possibly the UK will most likely experience a lost decade in the 2010s, and now Joseph Stiglitz thinks that the European Union itself will be in for a “lost half-decade” too. Whether the US and European nations will slip into outright deflation again as austerity is implemented is difficult to know. Possibly high energy and commodity prices will keep inflation moderate to high in coming years.

But if serious austerity takes hold in the US a lost decade for America, with a double dip recession, is a real concern. The US may well be the new Japan, so it seems.



Finally, there is further analysis of these issues here from the perspective of MMT:

Bill Mitchell, “How fiscal policy saved the world,” Billy Blog, October 9th, 2009.

Bill Mitchell, “Balance sheet recessions and democracy,” Billy Blog, July 3rd, 2009.