Wednesday, May 19, 2010

R Koo, "Lessons from Japan: Fighting a Balance Sheet Recession" at #CFA2010

Lessons from Japan? What lessons can we learn from Japan? They did everything wrong, didn't they?

The questions above are the reactions that Richard Koo, chief economist of the Nomura Research Institute and author of The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession often gets when he presents on  "Lessons from Japan: Fighting a Balance Sheet Recession," as he did on May 18 at the CFA Institute's annual conference.

Koo made the case that the U.S. should continue fiscal stimulus until deleveraging by the private sector is complete. If we fail to do so, we risk a double-dip recession once people become complacent about economic recovery, he said. Meanwhile, the deleveraging is necessary because of "the bursting of a debt-financed asset price bubble that leaves many private-sector balance sheet liabilities than assets."

The U.S. recession is a lot more like Japan's than most people realize. Koo's first graph showed a striking similarity between the path of U.S. housing prices, 1992-2010, and Japanese housing prices, 1977-1995.

Japan's recession management has been more successful than you might think. This is especially true in the sense that Japan's gross domestic product (GDP) grew during the recession despite massive loss of wealth and private sector deleveraging, Koo said. 

Japan could have done even better if the government had consistently supplied fiscal stimulus until private sector deleveraging ended, Koo said. He estimated that Japan might have suffered only seven to eight years, instead of 15 years, if it hadn't tried to "pull the plug" on fiscal stimulus.

The U.S. has a tough task in front of it. Maintaining fiscal stimulus for an entire period is almost impossible during a peacetime democracy, said Koo. 

Here's a startling pronouncement: The U.S. has overtaken Japan in savings. This is the result of the recession, said Koo. This jump in the savings rate means that the U.S. could internally finance its fiscal stimulus. 

Interest rates will stay low, said Koo, because nobody is borrowing or lending. We have to get corporations to borrow money before we can even contemplate reducing the budget deficit, said Koo.

Some people think that the U.S. will be different from Japan because it cut interest rates more aggressively. But Koo countered that monetary policy doesn't have much impact in this kind of recession because you can't spur borrowing.

MAY 19 UPDATE: Here's link to Bloomberg.com interview with Richard Koo on the topic of his #CFA2010 presentation.

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