Opinion

James Saft

Shrinking Japan asks for more of the same: James Saft

November 13, 2012

Nov 13 (Reuters) – Japan is shrinking again and its
government thinks the answer lies in more of the same policy the
Bank of Japan has been unsuccessfully implementing for 17 years.

Japan’s economy contracted by 0.9 percent in the third
quarter, data showed on Monday, reversing earlier quarters of
growth and taking the country into a nosedive equating to a 3.5
percent annual decline.

Inevitably, this has economists and policy-makers fretting
over whether Japan is sinking into a recession, technically
defined as two successive quarters of economic contraction.

“I cannot deny the possibility that Japan has fallen into a
recession phase,” Japan’s economy minister Seiji Maehara said.

As if there could be a more beside-the-point question; this
is akin to an alcoholic thinking their big problem is whether
they will lose their job. Japan’s issue isn’t whether it is
sinking into its fifth recession in 15 years – as if recessions
were somehow discrete phenomena like colds – but why it is now
20 years into an economic malaise.

There are, to be sure, extenuating circumstances. A
territorial dispute with China has led to a sharp drop-off in
trade, and the recession in the euro zone is also hurting
exports and demand.

Looking at the situation Maehara called for more, in
essence, of the same; asking the BOJ for powerful easing and
suggesting it might want to buy foreign debt, a move which
presumably would weaken the yen and increase export
competitiveness. It might be best to be a bit cautious of that
last idea: governments piling pressure on their central banks
could lead onlookers to conclude the central bank is losing
independence, a notion which could weaken the yen rapidly
and disastrously.

Japan’s government has become increasingly bold in
pressuring the BOJ, with both Maehara and Finance Minister
Koriki Jojima outspokenly jawboning the bank ahead of its
October policy meeting. That led both to new easing measures, as
the bank increased its asset-buying program and unveiled a new
plan to give banks cheap long-term funds in potentially
unlimited amounts.

It also led to an unprecedented joint statement from the BOJ
and government in which each called on the other to do more. It
is unclear if this is the BOJ defending its independence or
evidence it is being co-opted. Investors and economists both
stoutly defend the importance of central bank independence, lest
monetary policy become overly easy, which may aid in re-election
but undermine a currency and lead to inflation.

NO EASY SOLUTION

Thus far, deflationary forces have been Japan’s signature
problem, with the BOJ unable to hit its quite modest 1 percent
target for annual inflation. In nominal terms Japan’s economy is
now the smallest it has been since 1993, hardly a ringing
endorsement of campaign after campaign of quantitative easing
and other extraordinary measures.

“The most important lesson of the last 20 years in Japan and
of the last four years in western economies is that monetary
policy is ineffective when there is no private demand for
funds,” Nomura economist Richard Koo wrote in a note to clients
before the data was released.

“In Japan, there has been little or no private loan demand
since 1995, when the BOJ brought interest rates down to
near-zero levels. And neither the economy nor asset prices have
recovered, even though, as BOJ Governor Masaaki Shirakawa has
noted, the BOJ embarked on quantitative easing fully eight years
before its counterparts in Europe and the U.S.”

Koo coined the phrase ‘balance-sheet recession’ to describe
a contraction driven and reinforced by the paying back of debt.
That idea has taken hold, and an appreciation of the limits of
monetary policy has spread. Koo’s prescription, for large and
decisive amounts of government stimulus and for investment and
tax incentives, is less widely accepted.

With Japan’s government debt at a huge 230 percent of GDP,
there is not sufficient political consensus there for a large
new round of stimulus, and amid debate over the timing of
elections the opposition has refused to give Prime Minister
Yoshihiko Noda’s government the right to borrow to fund this
year’s deficit.

There seem to be two easy lessons from Japan, both of which
sadly it may be too late for the West to follow. The first is
don’t allow massive amounts of debt to build up, and the second
is don’t confuse a period of growth while debt is shrinking with
a recovery.

The harder lesson, at least for Japan, is that if you find
yourself in that position, for pity’s sake don’t do anything to
give the impression you are diminishing your central bank’s
independence.

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