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Sunday, December 21, 2008

DID JAPAN BENEFIT FROM HIGH FISCAL STIMULI IN THE 1990's LOST DECADE? OR FROM EXPANDING MONETARY POLICIES EITHER?

Today's Buggy Topic

Look again at the subject-title of this post: it captures faithfully the issues that prof bug dealt with in a lengthy commentary left earlier today at the Marginal Revolution, a very good economic blog run by Professor Tyler Cowan of George Mason University . . . an unusually flexible libertarian too.  As it happens, many of his libertarian posters even regard him as a heretic --- maybe worse, an apostate . . . some sort of quasi-socialist in disguise. 

For some libertarians, you see, anything the government does beyond what Adam Smith espoused 230 years ago in the Wealth of Nations is socialism.  These guardians of what they regard as true-blue free-market economics are followers of Austrian libertarianism ---a theoretical school inspired early in the 20th by a group of talented economists in Vienna . . . most notably, in their influence, Ludwig von Mises and Friedrich Hayek (the latter a winner of a Nobel prize in economics.)  All of these economists had to flee to Britain or America in the 1930s, along with thousands of other talented Austro-Hungarian and German artists, scholars, writers, and scientists --- first Austria fell to a right-wing dictator early in the 1930s, then for the Germans after Hitler came to power in 1933, and then again when the Austrian population ecstatically united with Hitlerian Germany in 1937.  A more recent Austrian economist of note was the American Murray Rothbard. 

Inspiration, Not Nationality 

Since the 1930s, as this reference to Rothbard suggests, the Austrian school of economics refers to those who have been inspired by Hayek and von Mises . . . and not to nationality.  Even so, its influence is very limited in mainstream free-market economics . . . overwhelmed by far different free-market traditions that derive in particular from classical and neo-classical economists in Britain, America, and parts of Europe in the  19th and early 20th century, and --- more to the point --- by the enormous influence of Milton Friedman at the University of Chicago and his students and followers world-wide. 

Triumph Since the Early 1970s and Decline

The Chicago department, for instance, has won well over a dozen Nobel prizes alone since they were introduced for economics in the late 1960s, and inspired dozens of others.  This updated, Chicago-inspired theoretical school goes under the name of New Classicism.  And has seemed to come a cropper, at any rate for the time being, in the global financial meltdown, credit-crisis, and world-wide recession.

What has very recently emerged out of the shadows where it has been since the mid-1970 are various schools of Keynesian theories, all of which argue for far greater regulation of financial markets and the need for both

stimulative monetary and fiscal policies to combat the serious global recession . . . the first world-wide one for decades, and worse yet, the first since the Great Depression of the 1930s to coincide with a systemic financial crisis around the globe. 

The Buggy Commentary on Japan

No need for any lengthy introduction, just the opposite.  Just keep one point in mind --- the reason for the growing interest here and elsewhere in the collapse of the Japanese economic and financial systems of the 1990s. 

In that decade, Japan went from being what most of the media and lots of economists thought was the pre-destined new global financial and economic hegemon --- its highly regulated, half-statist economy far superior to American free-market and limited governmental roles in the economy --- only for it to vie with Germany (another highly half-statist economy, only in a different sense from Japan) to see which of them would rack up the worst economic growth-record in the industrial world since the Great Depression.  

Revealingly, both seemed to finally emerged after nearly 13 years or so of stagnation with a recovered ability in 2003 and 2004 to maintain some sustained economic growth.  Nothing impressive, mind you; but at least in the 2.0 - 2.50 range of annual growth until this year (Germany actually doing worse than Japan until 2006).  And both economics --- heavily structured to rely on export-led growth as the prime stimulus to industrial production and GDP growth, and by contrast to keep private consumption notably limited compared to the US, UK, and some other industrial economies --- benefited from the booming global economy until the start of this year. (Data for all this will be found in the buggy commentary left at the Marginal Revolution.

Oh, One More Reason Why Japan's 14 Years of Lost Economic Dynamism Is So Front-Page Relevance

Unlike Germany, Japan underwent sustained price-deflation throughout almost all of those 14 years . . . in fact, to an extent, it continued even after the recovery of economic growth in 2003 and 2004.  Until then, any serious price deflation is what the US and other capitalist countries experienced last in the Great Depression years after 1929 . . . further dislocating their economies and their chances of quick recovery.  And though deflation did end in the US when FDR came to office in 1933, it arose again in the late 1930s . . . this, astonishingly, despite a huge expansion of the money supply thanks to inflows of gold and capital from abroad as WWII loomed on the horizon.  Right now, of course, the threat of dislocating deflation has loomed again . . . not just in the US and elsewhere. 

Observe quickly.  If this were just a big slowdown in inflation owing to the collapse of the price of oil and other commodities world-wide, that would be desirable.  If it goes further and the general price level starts to fall, several bad things can happen to worsen a recession. 

To wit:  

  • Any household that owes money to lenders --- say, mortgage payments monthly, or credit-card debt run up over previous months or years, or on a loan for a car bought in the last few years --- finds that the real interest rate increases with each downward tick in price-levels.  Just as oppositely, inflation shifts the relationship in favor of borrowers and at the expense of loans set out in older dollar terms.

  • In the processes, households become wary of buying new durables and other costly goods --- especially if they have to take out loans for them.  On top of that, many prices of goods that consumers might still want --- think of the prices now of GM or Ford or Chrysler vehicles, heavily reduced for 2008 models and even 2009 ones as dealer-lots fill up --- are, so the consumers hope, likely to fall even more in the future, and so they delay buying them now.  This could go on a long time --- in Japan, for 14 years or so.

  • As consumers develop deflationary expectations, businesses --- retail, wholesale, producers --- find that their revenue is falling off.  They might not even be able to meet their payrolls (contracted in earlier dollar terms for big corporations), might not be able to pay supplier firms, might not be able to pay landlords, and hence start cutting back on their work forces.

  • As an alternative to laying off workers, business managers might be able to convince their existing workers that they will keep their jobs if they accept a wage-decline --- maybe even repeated declines --- as business revenue dries up.  Since the price-level is falling, such "nominal" or dollar-term wage-cuts might actually not lose any value in real-dollar terms --- what the cut nominal wages can actually buy in goods and services --- but many corporations have contracted with their workers, unionized or not, to pay an older wage.

  • On top of that, business managers are reluctant to undermine the morale of their workers --- especially their experienced and more high-paid ones --- by even nominal wage-cuts.  The result?  In recessions, business firms tend to lay off the younger, less senior workers first, while trying to keep the older, seasoned ones on the job . . . especially since they hope that economic recovery won't be far off and they will be able to up production or sales quickly.

  • Enter the problems of monetary policy.  For complex theoretical reasons first set out by Keynes and his followers in the 1930s, amid deflation and continued falls in the price-level of an economy, monetary policy that aims at reducing interest rates to the lowest point might soon be stymied.  The chief reason: as the Fed has just learned --- and Japan did when it introduced a zero interest-rate policy on short-term Treasury bills --- the nominal interest rate can only fall to zero.  The real interest rate, however, might be increasing if prices are continuing to fall.  And so both businesses and households won't borrow for either investment purposes or household durables --- despite falling prices for new machinery or plants for businesses or for new cars, TV sets, refrigerators, or new houses.

  • The result of all these interacting circumstances?  Pervasive uncertainty and even degrees of mistrust mark economic life, and especially in financial markets can materialize.  Banks no longer trust the balance sheets of corporate businesses; are wary of buying their corporate paper --- short-term loans, for a few days or up to nine months, to help them pay wages or their suppliers until their own profits increase; and may even, as is the case these days, not even trust the balance sheets of other banks and lend them money overnight.  Much safer to use excess bank reserves to buy US-issued Treasury bills even if the interest rate is close to zero.

All These Problems, As It Happens, Are at the Heart of Various Keynesian Theories. 

And they weren't supposed to occur again, or so New Classical economists have argued since the mid-1970s . . . Keynesianism of any sort not only restricted to the once-in-a-million chance of a renewed Great Depression on the scale of the 1930s, but --- should they occur --- you can count on various free-market interpretations and solutions.  All of this, please note, is a subject for future buggy articles here.

 In the meantime, click here, read Professor Cowen's lead post, then run a search or scroll down to the buggy professor comments.  And, of course, if you want --- it depends on what you think about their worth as you start reading --- look at the comments of the other posters in that thread.