Credit: The Diplomat submits:
And does Japan's ruling party know what it's doing? A top economist raises serious concerns-and takes aim at the Fed.
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.
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.
So why are all these people apparently missing the point?
-The Holy Grail of Macroeconomics-
If Koo's right about this, then he's found a way to reconcile large parts of monetarist and Keynesian economics, a feat that could indeed be considered the Holy Grail for disciples of the dismal science.
LearningfromthePast
In his book, Koo recalls the controversial quantitative easing experience of the Bank of Japan in the early noughties. The move had little apparent impact on the economy, with some observers saying this showed the ineffectiveness of the approach, while others claimed it wasn't handled correctly.
Koo says he helped influence the debate within the LDP on such matters, partly through his proximity to former Prime Minister Taro Aso.
Koo claims that the LDP eventually came round to his way of thinking and stopped trying to meddle with monetary policy and put pressure on the BOJ.
But back to today's DPJ-led government, which is struggling to find cash for its campaign pledges by cutting waste amid nose-diving tax revenues. Financing additional measures to boost domestic demand would mean yet more public debt, which is already approaching 200 percent of GDP (way above the level of even Greece). Hence the desire for an economic tool (monetary policy), to tackle deflation that doesn't require the issuing of more bonds. And if the central bank doesn't take a 'mutually compatible' stance with government policy on this matter (as stipulated in the independence-limiting Article 4 of the Bank of Japan Act), then at least there'll be someone to blame.
But when it comes to the issue of Japan's national debt, Koo flatly rejects the notion that it presents any kind of financing problem.
As for the notion that Japan has already used fiscal policy with little effect other than to run up the huge national debt in the first place, Koo makes the point in his book that the use of fiscal policy during a balance sheet recession is absolutely vital for propping up an economy. It's the only effective way of boosting the money supply, since any extra liquidity pumped into the financial sector will have no takers.
It might not look as if fiscal policy helped Japan much after the bursting of its economic bubble, but the alternative would have been catastrophic, Koo says. He calculates that 1.5 quadrillion yen was wiped off Japanese assets in the wake of the bubble - that's 3 times the size of the nation's economy. Without fiscal stimulus, Japan's GDP should have shrunk to between a half and a third of its size, he claims. But in fact, GDP did not fall below its bubble peak, something he describes in the book as 'nothing less than a miracle.'
When fiscal consolidation was attempted in 1997 and 2001 under the Hashimoto and Koizumi governments, it came too early, according to Koo. The result was that the economy suffered, tax revenues fell and the budget deficit actually increased. Koo therefore believes that fiscal stimulus should remain in place until it's clear that companies have repaired their balance sheets and started borrowing again instead of paying down debt. That's the signal for an exit strategy to be employed.
Complicating matters, though, is the fact that the focus of the balance sheet problem now is outside Japan.
Either way, Koo suggests that the DPJ needs to learn the key lessons from Japan's recent economic past and to come up with a clearly defined exit strategy.
As for the extent to which the BOJ will be forced to take a mutually compatible stance with government policy in the meantime, Koo is sure that when it comes to matters of substance, BOJ Gov. Masaaki Shirakawa will stand his ground.
Koo says:
When asked to put some kind of figure on the level of independence he says the BOJ would be close to 90 on a scale with a base score of 100 for the old Bundesbank, Koo's model of an independent central bank.
FearattheFed
Indeed, speaking of the Fed, Koo says it has fallen well below 90 on this kind of scale. While coy about putting a figure on it, he agreed it would probably be somewhere between 50 and 90. What he sees as the Fed's disastrous handling of its duties means the extent of its freedom to operate is now very much in question.
As an indication of the pressure that's still on the Fed chairman - and the respect that his organization has lost in Congress - Koo points out that he himself was invited to testify as part of the semiannual Humphrey-Hawkins testimony in which the Federal Reserve chairman reports on monetary policy and the state of the economy.
But the session scheduled for February 10 didn't take place because of a huge snowstorm. It was rearranged again without Koo, although he had already handed in his testimony (.pdf). But it's here that Koo makes the startling implication that Bernanke 'adjusted' his comments in the rescheduled testimony from his initial position to views that he knew better fit in with Koo's.
For Koo, this is evidence that Bernanke is not beyond redemption. But he still has a huge task to restore the credibility of his organization and to maintain its relative autonomy. So from Koo's perspective, the debate on central bank independence should actually focus on the Fed.
'Compared to the BOJ,' Koo says, 'Right now the Federal Reserve is in far greater danger of losing independence.
Disclosure: N/A
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
