MAIN PAGE | EVENTS & PROGRAMS | 2001 | IGM | SPEECHES | DR. RICHARD KOO
PACIFIC BASIN ECONOMIC COUNCIL
MAIN PAGE | EVENTS & PROGRAMS | 2001 | IGM | SPEECHES | DR. RICHARD KOO
Regional Vitality in the 21st Century
April 6-10, 2001 — Tokyo, Japan
Dr. Richard Koo
The Japanese Economy in Balance Sheet Recession: The Real Culprit is Fallacy of Composition, Not Complacency Many observers both inside and outside Japan have argued that traditional economic policies have failed to revive the Japanese economy because it is suffering from structural problems. They also argue that without structural reform there will be no future for Japan. Although many structural issues undoubtedly need to be resolved, it is difficult to blame them entirely for the sudden deceleration of the Japanese economy from literally the first business day of the 1990s. This is because most structural problems date back for decades and so cannot explain why an economy that was so powerful until the very end of the 1980s suddenly lost its forward momentum from the 1990s onwards. From Profit Maximization to Debt Minimization The key to understanding the sudden change and prolonged slowdown that followed lies in the state of balance sheets of Japanese companies. For nearly half a century since the end of World War II, the Japanese economy had been running on two large wheels, the high savings rate of the household sector, and the high investment rate of the corporate sector. The ample pool of savings provided by the household sector enabled Japanese companies to borrow and invest at low interest rates, and allowed phenomenal growth of the Japanese economy and its capital stock. And it was this savings and investment combination that allowed the Japanese economy to bounce back from the ashes of the war to become the second largest economy in the world. From the first business days of the 1990s, however, asset prices in Japan began to slide. The fall in share prices was soon followed by an even more acute fall in real estate and other asset prices, which wiped Y1000 trillion, or two full year's worth of Japanese GDP, clean off the board. Some assets, such as commercial real estate have fallen to nearly 1/8th of their peak values, with devastating consequences throughout the economy (Exhibit 1). For a major industrialized nation in modern times, only the Great Depression in the US in the 1930s has seen an equivalent loss in wealth relative to the size of the economy. Since Japanese companies and households acquired those assets by borrowing money, the fall in asset prices left tens of millions of balance sheets all over the country underwater. In order to climb out of their negative equity position, they were left with no choice but to refrain from consumption and investment and redirect any cash so saved to paying down debt. In other words, millions of companies in Japan switched their highest priorities from maximizing profits to minimizing debt. Although they are all doing the right thing in view of what has happened to asset prices, the fact that they are all doing the same thing at the same time means that the economy suffers from weak consumption and weak investment. The weakness of the economy depresses asset prices even further, forcing Japanese companies and households to take even more draconian measures to repair their balance sheets. The result has been a vicious cycle brought about by the so-called fallacy of composition, i.e., everybody is doing the right thing, but the combined result of their efforts has been the opposite of their original goal. With millions of companies all over Japan trying to repair their balance sheets, the high investment rate which characterized the Japanese economy for so long has disappeared. From being a net take of funds - 10 percent of GDP in 1990 -, the corporate sector today is a net supplier of funds (i.e., debt repayment) to the tune of 4 percent of GDP, or a total change of 14 percent of GDP over the ten year period. Losing private sector demand equivalent to 14 percent of GDP is bad enough, but the matter is actually much worse because the household sector during this period did not change its savings behavior at all. In other words, the household sector continued to save nearly 10 percent of GDP as before (Exhibit 2). With the household sector saving as much as before but the corporate sector no longer borrowing to spend the saved funds, a huge deflationary gap has opened up. It is this gap which has trapped the Japanese economy in an extremely rare type of recession, called a "balance sheet recession". Loosing Monetary Policy as a Remedy This type of remedy has a number of characteristics that are not found in other recessions. First, monetary policy loses it effectiveness in this type of recession because when so many companies are minimizing debt instead of maximizing profits, central bank interest rate cuts will not increase borrowing and spending by the private sector. Indeed, even at zero interest rate, demand for funds from the private sector failed to pick up. Some have argued that by starting inflation, the central bank should be able to entice people into more spending. These people do not realize that when Japan fell into a full-fledged balance sheet recession around 1998, Japan still had a positive inflation rate. The negative inflation rate observed since 1997 is a symptom of balance sheet recession, not the cause of it. The cause of both the balance sheet recession and the subsequent deflation has been corporate and household concerns over their balance sheets that have forced them to reduce consumption and investment in order to pay down debt. Furthermore, those people who are trying to repair their balance sheets are doing the right and responsible thing. Asking them to forget their balance sheet problems and bet on future inflation is equivalent to asking to them act irresponsibly. Even though Japanese morality has fallen somewhat over the last decade, it has not fallen to anywhere near the level that will make this inflation suggestion workable. The same applies to lenders as well. Today's financial institutions are desperate for borrowers. One can only sympathize with them, given what has happened to corporate borrowings during the last ten years, as I mentioned above. For banks to lend more than they were able to do up to now, they will have to lower their lending standards substantially. But this is precisely the opposite of what everybody from bank supervisors to shareholders are telling them to do. Here again, one sees a fallacy of composition. Because everybody is doing the right thing, it is difficult to expect these people to change their behavior. Short of announcing that asset prices will go back to 1989 bubble levels and will stay there forever so that no one has to worry about their balance sheets anymore, there is really nothing the Bank of Japan can do to change people's behavior. But if potential lenders and borrowers do not change their behavior, inflation will never materialize. And even if the BOJ makes such an announcement, no one in Japan will believe it. The Japanese now realize that the Imperial Palace in the middle of Tokyo is not worth as much as the entire State of California after all, and that they were chasing the wrong asset prices in the late 1980s. When John Maynard Keynes discovered the liquidity trap in which monetary policy lost its effectiveness during the Great Depression, he was actually looking at a balance sheet recession. Unfortunately, his analysis failed to take in the concerns that people may have about their balance sheets. This crucial omission left the so-called Keynesian Revolution largely incomplete, and made it vulnerable to attacks from monetarists. Perhaps Keynes was too rich himself to worry about debt. The Japanese experience of the 90s, however, proved conclusively that balance sheet problems create both liquidity traps and deflation. The Danger of Deflationary Spiral Another key difference between the balance sheet recession and other recessions is that in the former, there is a real possibility of deflationary spiral. In an ordinary world, including an ordinary recession, a typical Japanese person may spend Y800 of this Y1000 income, and save the remaining Y200 with a bank. The Y800 portion will immediately become someone else's income, and the remaining Y200 will be lent to somebody by the bank to be spent. As a result, there will be Y800 plus Y200 worth of spending that is equal to the initial income of Y1000, and the economy can move forward. If the bank cannot find enough borrowers for the Y200, all it has to do is to lower rates as well. Under ordinary circumstances, lower rates are sufficient to entice more borrowers to come forward and all remaining funds will be borrowed and spent. During a balance sheet recession, however, the same person may still spend Y800 and save Y200. But the problem is that companies are all trying to pay down debt and nobody is borrowing the Y200. Without any borrowers, however, no financial institutions will survive. So let us assume that they desperately looked for borrowers and after lowering the rates as low as they could possible go, they found enough borrowers for Y100. That will still leave Y100 in excess reserves or with money brokers that will simply stop circulating in the income stream. This means there will be Y100 of "leakage", and only Y900 of spending to the original Y1000 of income. With only Y900 worth of income to begin with, the same rate of (0.9) of leakage the next time around will reduce the income to Y810, and the following round down to Y730 and so forth. This process will continue until the private sector as a group is so poor that they cannot save even Y1. In other words, if income drops from Y1000 to say Y500, those who were accustomed to a living standard of Y1000 will have to spend every yen in order to maintain their lifestyles. But when they spend the entire Y500, there will be no leakage. The next person who receives that income will also have to spend the entire Y500 because he too is accustomed to a living standard of Y1000 lifestyle. At this level of Y500, therefore, there will be no leakage and an equilibrium is reached. And this is exactly what happened to the US during the Great Depression, when nearly 50% of GDP was lost before a new equilibrium was reached. Japan has thus far managed to avoid the above outcome by having the government spend just enough to keep the aforementioned vicious cycle from starting. In other words, every time the Y100 demand gap has opened up, the government has come in, borrowed that amount and spent it. That is why, in spite of the massive loss in wealth I talked about earlier, the economy has managed something close to zero percent growth during the last decade. Far from being ineffective, therefore, the fiscal stimulus has been extremely effective in keeping the Japanese economy from collapsing. With many asset prices falling to one tenth of their peak values and millions of balance sheets under water, it is actually quit amazing that the Japanese economy has managed to sustain somewhere around zero percent growth through the last decade. Balance sheet recession is like radiation: it is devastating, but no one can see it. The loss of two years worth of GDP in the case of Japan is equivalent to the production of 20 million cars and 8 million houses. During the Kobe earthquake, 100 thousand homes were completely destroyed. But that was highly visible, and it was easy to obtain public consensus on what to do with the devastation. In a balance sheet recession, however, the houses are still there, and cars are all still running. But the invisible damage to the economy is no less real. This invisible nature of the damage fools novices and experts alike. For example, many so-called "studies" which indicated that Japanese fiscal stimulus was ineffective assumed unwittingly that the economy would have grown at zero percent in the absence of fiscal stimulus. In fact, without the fiscal stimulus, the economy would have fallen into negative 20 or 30 percent growth long ago. Disastrous Experience of 1997-98 Indeed we were able to have a glimpse of the above mentioned vicious cycle in the 1997-98 period when Prime Minister Hashimoto, believing that fiscal stimulus was useless as indicated by the above "studies", decided to cut spending and reduce the deficit. The result was a near meltdown of the economy, which registered five quarters of negative growth, the worst economic performance of any major industrialized state since World War II. The mistake was quickly recognized, however, and with a complete reversal in fiscal policy, the Japanese economy managed to climb out of its worse recession in the post War period. This 1997-98 episode was a complete replica of a similar mistake made by President Franklin Roosevelt exactly sixty years earlier in 1937. At that time, the US economy began to look better after nearly five years of fiscal stimulus provided by the New Deal. Thinking that the budget deficit was a bad thing, Roosevelt decided to move toward fiscal reform in 1937. This resulted in an immediate collapse of the US economy with the stock market losing half its value and industrial production falling by a third within a half year period. Even though Roosevelt immediately reversed his policy, the damage was done, and it literally took the attack of Pearl Harbor to enable the US economy to recover fully from the 1937 fiasco. In Japan's case, the economy is still recovering from the 1997-98 fiasco in the sense that even though it has improved significantly from its 1998 trough, most economic indicators today are still well below the fiscal 1996 average. Furthermore, the collapse of the economy has caused tax revenues to fall dramatically, resulting in a massive increase in the budget deficit in spite of all the efforts to raise taxes to reduce it. From this 1997-98 experience, many people in Japan realized that importance of fiscal spending in the current recession. Similarly, both the IMF and the OECD, which used to bash Japan's "ineffective" fiscal policy, are now all saying that Japan must maintain fiscal stimulus for the time being. The Price of Budget Deficit In spite of this consensus, there are people who argue that, given the size of Japan's deficit, room for fiscal policy is now very limited. The Japanese deficit is undoubtedly large. But we live in a market economy, not in a communist centrally planned economy. The key difference between communist and market economies is that in the former there are only quantities, whereas in the latter there are both quantities and prices. And we all know what happened to economies that ignored price signals and looked only at quantities. When it comes to budget deficits, however, somehow everybody becomes communist in that everybody looks at quantities and nobody looks at prices. If we are to judge whether the current budget deficit in Japan is good or bad for the economy, however, we must look at the price of the deficit in addition to its size. The price of the budget deficit is, of course, the yield on government bonds. If the public feels that the deficit is bad and no one wants to buy government bonds, the price of such bonds will be low and the yield high. If the public feels the opposite, the yield will be low and price high. Today, the Japanese government bond (JGB) is yielding 1.25 percent, which is about the lowest long-term bond yield in the history of mankind. The price of JGBs, therefore, is at a historical high. The lowest the US Treasury yield ever got during the Great Depression was said to be 1.85 percent in November 1941. At that time, the US unemployment rate was 9.9 percent whereas the Japanese unemployment rate today is 4.9 percent. This shows how low Japanese rates really are. This low rate makes perfect sense to the extent that with everybody in the private sector either saving money or paying down debt, there is only one borrower left in the market and that is the government. Thus, every fund manager in Japan is trying to lend to the government by buying JGBs. In other words, the Japanese public is fully supporting what the government is doing. Japan is not Italy five years ago or the US during the first term of President Reagan when long-term government bonds were yielding 14 percent and above. If anything, the message from the market is that Japan should do the opposite of Italy five years ago or the US 15 years ago by increasing the deficit instead of reducing it. After all, with everybody in the private sector paying down debt, there is absolutely no danger of crowding out, and even less danger of inflation. Furthermore, if there are any public works left to do in Japan, now is the historic opportunity to get those projects done at the lowest cost to the present and future taxpayers. With the alternative to fiscal spending a collapse into depression, there is even less reason not to mobilize fiscal policy now. Of course fiscal stimulus cannot be used forever. But our estimates suggest that given the progress already made over the last ten years, it should not take more than two to three years before the balance sheets of Japanese companies are restored to the pre-bubble 1970-1986 average. So we are not talking about five or ten more years. We are only talking another two to three years. Such a medical bill is not too much to ask for an economy that suffered Y1000 trillion in wealth loss and is currently in an intensive care unit. Put differently, the Japanese economy is in the doldrums not because people are complacent or lack the courage to reform. The economy is in the doldrums because everybody is trying to repair their balance sheets all at the same time. If people were indeed complacent, the Y70 trillion shift in corporate demand for funds would have never happened. Those companies should still be borrowing Y50 trillion a year investing in plant and equipment as before, instead of paying down Y20 trillion of loans a year. And if companies were still actively borrowing and investing as in the 70s or 80s, there is no reason for the economy to be in recession. The complacency argument, therefore, is not consistent with what actually happened to corporate activity during this period. Better Political Judgement is needed on Banking Crisis Of course no talk on the Japanese economy is complete without reference to the Japanese banking problems and everyone's favourite target, the Japanese construction companies. On the former, many have argued that the key to Japanese economic recovery is to remove NPLs from the Japanese banks so that they can lend again. However, as I mentioned earlier, in Japan, demand for funds has fallen far faster than supply of funds. Except for the nation wide credit crunch of 1997-98 brought about by simultaneous fall of the yen and the stock prices both of which torpedoed Japanese bank capital (which was promptly corrected by government's capital injection), even borrowers agree that bankers' willingness to lend has not been the obstacle to economic growth. In other words, even if all of banks become healthy tomorrow, until borrowers are happy with their balance sheets, there will be no demand for funds and consequently no economic recovery. Having said that, of course, repairing the banking system is important in its own right. Critics both inside and outside Japan have been saying that banks should scrutinize their borrower's prospects more thoroughly, and where necessary, move from reserving against non-performing loans for their direct removal from balance sheets, calls that have been placed under the broad category of structural reform. These calls are totally correct from a microeconomic perspective, but what these critics have failed to realize is that balance sheet problems are currently endemic in Japan and are leading to major systemic risk. The methods proposed by these critics could, and indeed should be adopted if only a small proportion of companies with borrowings are in difficulties. However, if the problem is as big as it is in Japan, using these methods would probably set off a horrendous chain reaction. Even companies and banks that everybody once regarded as safe would be caught up. After all, Japan has been in serious recession for the last ten years. Furthermore, during the last ten years, many key asset prices such as those of commercial real estate have fallen to nearly one tenth of their peak values. Under these circumstances, if the banks were forced to apply strict lending criteria, there would not be any suitable borrowers left. Already, the FSA's demands for stricter lending criteria have forced many companies, particularly smaller ones, into the arms of consumer finance companies with their high rates of interests. As a result, the flip side of ultra-low interest rates is a serious credit crunch for smaller companies who have lost access to bank loans. More Meaningful US Comparison Is Needed When the Latin American debt crisis erupted in 1982, threatening the entire US banking system, then Fed chairman Paul Volcker, far from rushing the banks into the disposal of non-performing loans, actually got them to increase lending to Latin America and to write off non-performing loans over many years so that both the borrowers and lenders would remain financially sound. If he had not done this, the whole of Latin America, including Mexico, would have ended up in the same mess as Indonesia in 1997, with infinitely worse consequences for banks not just in the US, but also throughout the world. Moreover, when the whole US banking sector faced balance sheet problems a decade later, in 1991 through 1998, Greenspan bolstered all banks, whether good or bad, by allowing them a full 3% spread between the prime rate (the rate at which banks lend), which was left at 6%, and the FF rate (the rate at which they borrow), which was cut to 3%. In other words, when the US was facing the same sort of systemic risk as Japan, it did not rush to dispose of non-performing loans, but rather dealt with its problems in a balanced fashion and with reference to the best interests of the economy as a whole. However, Japanese interest rates are so low that it is not possible to employ a policy of increasing spreads. This being so, the only way of strengthening the banks quickly is for the government to provide direct capital injections. Former US Treasury Secretary Larry Summers, who was well aware of this, said during this time in the job that Japan would have to inject Y15 trillion to Y25 trillion into the banks. Moreover, the more banks rush to dispose of non-performing loans (which will sap their strength), the larger the capital injections will have to be. However, actual capital injections have yet to total Y10 trillion, and FSA head Hakuo Yanagisawa, who is rushing to dispose of non-performing loans, has even contrarily asserted that further capital injections will no longer be needed. This is just courting disaster. At this time, what we need is not microeconomic orthodoxy, but rather better political judgement from a macroeconomic perspective. Unfortunately, the only analogy that has been drawn in the press, both inside and outside Japan, is with the disposal of the failed S&Ls in 1989, a small-scale affair that is of no relevance to the current situation in Japan, and not with the other two examples I talked about above, which are virtually unknown outside commercial banking circles. As a former economist covering the syndicated loan market to Latin America at the New York Fed when the first Mexican crisis erupted, I should be doing more to straighten the debate. Put differently, if Japan had to adopt the S&L type solution to its banking problems, the cost of the clean up would be easily ten times the $160 billion it cost US taxpayers. After all, the assets held by the S&Ls constituted only five percent of all assets in the US. This means the remaining 95 percent was in good hands, and those holding the 95 percent had the capacity to bid for the assets sold by the RTC. In the Japanese case, unfortunately, the ratios are completely reversed. Because there will be so few buyers, liquidating assets in such an environment will force asset prices to fall even faster. The fall in the price of real estate is plot A, however, will cause all collateral values in the neighbourhood of plot A to fall as well. That, in turn will cause a chain reaction of demand for more collateral by the lending financial institutions to borrowers who borrowed money against the assets in the neighbourhood. It is these kinds of chain reactions that are most dangerous in forcing through a micro economic orthodoxy during a systemic banking crisis. Although cleaning up the banking mess is important in itself, under the circumstances, a carefully balanced approach reminiscent of clean up job following the Latin American debt crisis seems to be more appropriate to the RTC approach. Allowing construction companies to fail presupposes full employment People are increasingly regarding the liquidation of (unproductive) construction companies as the first step towards structural reform in Japan. However, we should not forget that these arguments make sense only during the periods of full employment. In other words if new sectors are to expand when the economy is already in full employment, unproductive sectors will have to shrink, and there will have to be a transfer of staff and resources from them. However, Japan is currently a long way away from full employment. There are plenty of people, plenty of funds, and plenty of resources. Indeed, there are no material obstacles to starting up new businesses. The fact that the number of construction companies has increased during the last few years suggests that there is no barrier of entry either. What this means is that letting construction companies go bust in the current climate will simply swell the ranks of the unemployed and strengthen the oligopoly of the remaining companies. It will not do anything to advance the cause of structural reform. Moreover, if we assume that unemployed people are completely unproductive, then the more their numbers increase, the greater will be the fiscal burden on the government, and the more Japanese productivity will fall as a whole. Of course, decrepit companies need to be weeded out. However, that decision should be made by the private sector people on the ground, rather than accomplished through top down measures instigated by the banking authorities. People on the ground will probably know for themselves when to give up and when to attempt to revive a company's fortunes. Moreover, they will be well aware of what sort of undesirable chain reaction, if any, their decision might cause. As such, bottom-up weeding out would probably entail less nasty shocks to the economy as a whole then the top-down procedures. Before one worries about the future of construction companies, therefore, the economy must recover first so that resources released from the construction sector will be gainfully employed elsewhere. Just shutting down construction companies without doing anything to provide alternative job opportunities for the displaced workers would be a very irresponsible policy indeed. The Real Reason Structural Reform Is Needed The constant refrain of the doomsayers is that the fiscal deficit has risen so sharply that interest rates could skyrocket any minute, thereby preventing the Japanese economy from getting on its feet. However, current low interest rates derive from the fact that financial institutions and institutional investors have had to buy JGBs because the balance sheet recession has wiped out demand from private sector borrowers. Moreover, the JGB market has thus far withstood such shocks as news that the MOF's Trust Fund Bureau was to stop direct purchasing activity, the downgrading of Japan's sovereign debt, and constant talk from doomsayers. Indeed, these events have constantly affirmed that no matter how much interest rates have risen due to temporary external shocks, they have always returned to their original level in the absence of demand for funds (which is what supports interest rates in the first place). More importantly, the persistence of low interest rates suggests that the future risk for the Japanese economy might not be that interest rates will rise, but rather that they will not. To be more precise, the risk is that private sector investment (ie demand for funds) will remain lower then private sector saving over the medium-long term. Up to now, we had thought that once corporate balance sheets are restored, companies will become more upbeat, private sector demand will recover, and the economy will enter a path of self-sustaining recovery. However, if the US experience after 1929 is anything to go by, the chances of interest rates not going up are higher than the reverse. Indeed, it took US long-term interest rates full 30 years to regain their pre-1929 average. The massive fiscal stimulus of the New Deal and the mobilization of World War II and the Korean War all failed to bring interest rates back to pre-1929 levels. This was partly because the financial authorities capped rates, but there were other reasons too. US companies that had worked so hard to repair their balance sheets in the 1930s may well have subsequently developed an acute fear of borrowing due to their horrendous experiences during the 30s. It may be that they said never again to borrowing, and instead engaged in capital investment within the bounds of their cash flow. If this happens in Japan and companies fail to borrow what households have saved, then interest rates will remain low because financial institutions will have to buy JGBs in the absence of any other outlet for their funds. Already Japanese bookstores are flooded with books that recommend "cash flow management", which in a Japanese context means "managing a company without borrowing money". Indeed, most company executives today insist that any capital investment they might undertake would remain within the cash flow of their companies. Just like their counterparts in the US sixty years ago, they are fed up with borrowing after the experience of the last ten years. The failure of borrowers to return and interest rates remaining low is far worse than interest rates going up thanks to a recovery in private sector demand. This is because in the case of rising interest rates, the required policy response is very clear: cut the deficit. In the case of low or failing interest rates even after corporate balance sheets are restored, however, there are no clear cut remedies to deal with the situation. Moreover, if the private sector continues to save more than it borrows, then fiscal spending will still be needed to underpin the economy, which otherwise would shrink due to the lack of demand. For a high saving country like Japan, therefore, companies should be discouraged from operating on "cash flow management". But since the companies cannot be told NOT to operate on cash flow management, the policy makers will have to make sure that there are sufficient investment opportunities inside the country so as to entice companies to borrow funds to invest. In other words, investment opportunities created must be larger than the companies' cash flow, so that they will be forced into borrowing funds. In order to create such investment opportunities, the government will have to push strongly on deregulation and market-opening measures. Indeed it is in this context that structural reform is most needed. Unfortunately, very little progress has been made on this front because everyone is worried about interest rates going up, not going down. In reality, however, rates have been coming down continuously even though the deficit has been expanding rapidly. In order to make sure that Japan does not end up in a scenario where private sector demand for funds fail to recover, therefore, massive push on deregulation must proceed side by side with fiscal stimulus so that (1) companies with balance sheet problems will have the income to pay down debt, and (2) companies which finished cleaning up their balance sheets will have reasons to start borrowing money to invest in forward looking projects. Thus, the full recovery of Japan will require a two-pronged approach consisting of fiscal stimulus and structural reform. The two must go hand in hand in dealing with the special problems Japan is facing today. Lessons for the US Lastly, what does the Japanese experience mean for the US? If the US economy is falling into a balance sheet recession, which seems to be the case after the loss of $4 trillion in wealth following the NASDAQ collapse, all of the above discussions should be more relevant in determining the best course of action. In particular, we should be alert to the possibility that monetary policy will lose its effectiveness when companies start moving away from profit maximization to debt minimization. At the same time, the role of public spending, long forgotten since the thirties, may regain importance when everything else fails. Although tax cuts and other measures are much more desirable on efficiency grounds under ordinary circumstances, once in a balance sheet recession, such preferences could cost taxpayers dearly. The Japanese economy is in the doldrums not because people have been complacent or lacked courage for reform, but because everyone was doing the right thing trying to repair their balance sheets in the face of massive decline in asset prices. This, in turn, caused the fallacy of composition and resulted in an even weaker economy and even lower asset prices. But since it is not possible to tell the people NOT to clean up their balance sheets, the only way to keep the economy from entering a vicious cycle is for the government, which is the only entity outside the fallacy of composition, to offset demand that was lost in the above process. That is what the human race has learned in the disastrous 30s, and that has been the end result of the Japanese policies in the 90s. Let us hope that this lesson is not lost in the US policy debate in the 21st century. |
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