When Japan’s finance minister says jump and the Bank of Japan responds, does that mean its independence is a sham? Or is the real show being directed by the bank itself?
Influential economist Richard Koo says that the BOJ’s recent move to double the size of its short-term financing program after Finance Minister Naoto Kan called for action against deflation was more for show than anything else.
In a refreshingly frank interview with The Diplomat, Koo excoriated the Democratic Party of Japan—and foreign media and academics—for failing to grasp certain key economic principles. He also claims that it wasn’t the Bank of Japan, but the US Federal Reserve that was panicking over the future of its independence, and suggests that Fed Chairman Ben Bernanke may have adjusted his views to fit in with Koo’s during recent congressional testimony to avoid a confrontation that might have further threatened the bank’s status.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
But first to BOJ policy specifics, and what Koo describes as the bank’s meaningless move on March 17 to boost to 20 trillion yen the reserves for three-month loans to banks.
‘With quantitative easing under the circumstances we have now, you can double and triple the liquidity in the system but there will be no takers,’ Koo says. ‘But there’ll be no harm done, and if certain parts of the political spectrum are happy as a result, then, you know, why not?’
In other words, while the Bank of Japan appears to have done something, pleasing certain sections of the DPJ in the process, it hasn’t really done anything at all.
‘If the money supply isn’t increasing, that means all the liquidity the Bank of Japan pumped into the system is stuck in the financial system,’ Koo says. ‘It's not coming out to enter the ordinary market or even the foreign exchange market for that matter. If the money comes out, that means someone borrows and spends it—then you’ll have an impact on foreign exchange, an impact on long term rates, all of that. But the fact that’s not happening means it's all basically a mirage.
‘The DPJ doesn't know that! Most academics think it's a great thing! And the foreign press, especially, think that the BOJ should be doing more. The IMF thinks the BOJ should do more.’
So why are all these people apparently missing the point?
For years Koo, now chief economist at the Nomura Research Institute, has been talking about the lessons to be learned from Japan’s ‘lost decade’—the years of recession that followed the bursting of the nation’s economic bubble of the late 1980s. In his book, The Holy Grail of Macroeconomics he argues that when an economy is pole-axed by crashing asset prices, companies no longer want to borrow money to invest because of the need to repair their weakened balance-sheets. If there are no borrowers in the market, monetary policy becomes ineffective—you can supply as much money as you want at close to zero-interest rates, but there won’t be any takers. Essentially, this suggests that there are two kinds of recession: a regular business-cycle recession, which can be tackled using monetary policy,and what Koo calls a balance-sheet recession, a far deeper kind of post-bubble recession like the Great Depression, that requires the use of fiscal policy.