R. Koo. The World in Balance Sheet Recession

The World in Balance Sheet Recession:What Post-2008 West Can Learn from Japan 1990-2005

Richard C. Koo

Chief Economist

Nomura Research Institute

Tokyo

April 2012

40

60

80

100

120

140

160

180

200

220

240

260

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

US: 10 Cities Composite Home Price Index

(US: Jan. 2000=100, Japan: Dec. 1985=100)

Note: per m2, 5-month moving averageSources: Bloomberg, Real Estate Economic Institute, Japan, S&P, S&P/Case-Shiller® Home Price Indices, as of Mar. 23, 2012

Composite Index

Futures

Japan: Tokyo Area Condo Price1

77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 9 7 98 99

Japan: Osaka Area Condo Price1

Futures

USJapan

Exhibit 1. US Housing Prices Are Moving along the Japanese Experience

2

20

30

40

50

60

70

80

90

100

110

01 02 03 04 05 06 07 08 09 10 11

Down42.0%

from Peak

84 85 86 87 88 89 90 91 92 93 94

(peak = 100)

Note: Peak of US Prices: Oct. 2007, Peak of Japanese Prices: Sep. 1990.Source: Nomura Research Institute, based on Moody's/Real Estate Analytics and Japan Real Estate Institute

Japan: Commercial Land Price Index in Six Major Cities

US: Commercial Property Price Index

"Pretend & Extend"

USJapan

Exhibit 2. US Commercial Real Estate Prices Also Falling to Japanese Levels

3

Exhibit 3. Drastic Rate Cuts Have Done Little to Revive Employment or House Prices

4

0

1

2

3

4

5

6

7

8

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

(%)

Sources: BOJ, FRB, ECB, BOE and RMB Australia. As of Mar. 23, 2012.

Australia

EU

US

UK

Japan

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.083

85

87

89

91

93

95

97

99

101

103

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(%, Seasonally adjusted, inverted)

Unemployment Rate(right scale)

Sources: US Department of Labor, FRB

(2007=100, Seasonally adjusted)

Last seen in 2005

Unemployment rate:Last seen in 1983

Industrial Production:Last seen in 1997

Industrial Production(left scale)

Exhibit 4. US Economy Is still a Long Way from Previous Peak

5

Exhibit 5. Euro-Zone Economy Is still a Long Way from Previous Peak

6

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.085

90

95

100

105

110

115

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Sources: Eurostat

(%, Seasonally adjusted, inverted)(Seasonally adjusted, 2005=100)

Industrial Production(left scale)

Unemployment Rate(right scale)

Last seen in 1997

Last seenin 2005

Exhibit 6. Except in Germany, Industrial Production in Europe Is still Weak

7

70

75

80

85

90

95

100

105

110

115

120

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Spain

France

Italy

Germany

(2005 = 100, Seasonally Adjusted)

Source: Eurostat

Level last seen in

2007: Germany

1997: France

1987-88: Italy

1996: Spain

Exhibit 7. Drastic Liquidity Injection Failed to Increase Money Supply (I): US

8

80

100

120

140

160

180

200

220

240

260

280

300

320

340

Monetary Base

Money Supply (M2)

Loans and Leases in Bank Credit

(Aug. 2008 =100, Seasonally Adjusted)

Down 25%

0.5

1.0

1.5

2.0

2.5

3.0

08/1 08/4 08/7 08/10 09/1 09/4 09/7 09/10 10/1 10/4 10/7 10/10 11/1 11/4 11/7 11/10 12/1

(%, yoy) Consumer SpendingDeflator (core)

Sources: Board of Governors of the Federal Reserve System, US Department of CommerceNote: Commercial bank loans and leases, adjustments for discontinuities made by Nomura Research Institute.

Exhibit 8. Drastic Liquidity Injection Failed to Increase Money Supply (II): EU

9

90

100

110

120

130

140

150

160

170

180

Base Money

Money Supply (M3)

Credit to Euro Area Residents

(Aug. 2008 =100, Seasonally Adjusted)

0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2

08/1 08/4 08/7 08/10 09/1 09/4 09/7 09/10 10/1 10/4 10/7 10/10 11/1 11/4 11/7 11/10 12/1

(%, yoy)

CPI core

Sources: ECB, EurostatNote: Base money's figures are seasonally adjusted by Nomura Research Institute.

Exhibit 9. Drastic Liquidity Injection Failed to Increase Money Supply (III): UK

10

70

100

130

160

190

220

250

280

310

340

Reserve Balances + Notes & CoinMoney Supply (M4)Bank Lending (M4)

Aug. 08'

(Aug. 2008 =100, Seasonally Adjusted)1

0123456

07/1 07/7 08/1 08/7 09/1 09/7 10/1 10/7 11/1 11/7 12/1

CPI (ex. Indirect Taxes)(%, yoy)

Down 16%

Sources: Bank of England, Office for National Statisics, UKNotes: 1. Reserve Balances data are seasonally unadjusted. 2. Money supply and bank lending data exclude intermmediate financial institutions.

Exhibit 10. Drastic Liquidity Injection Failed to Produce Drastic Increase in Money Supply (IV): Japan

11

-3-2-101234

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(y/y, %) CPI Core

50

100

150

200

250

300

350

Monetary Base

Money Supply (M2)

Bank Lending

1990/1Q

(1990/1Q = 100, Seasonally Adjusted)

Textbook Economics

(Monetary PolicyEffective)

Balance SheetRecession(Monetary Policy NOT Effective)

QuantitativeEasing

Down 41%

Note: Bank lending are seasonally adjusted by Nomura Research Institute.Source: Bank of Japan

Earthquake

Exhibit 11. Japan’s De-leveraging with Zero Interest Rates Lasted for 10 Years

12

-6

-4

-2

0

2

4

6

8

10

-15

-10

-5

0

5

10

15

20

25

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Borrowings from Financial Institutions (left scale)

Funds raised in Securities Markets (left scale)

CD 3M rate (right scale)

(% Nominal GDP, 4Q Moving Average) (%)

Sources: Bank of Japan, Cabinet Of f ice, Japan

Debt-financedbubble

(4 years)

Balance sheetrecession(16 years)

Funds Raised by Non-Financial Corporate Sector

down87%

25

40

55

70

85

100

115

130

0

20

40

60

80

100

120

140

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

(Sep.1990=100, Seasonally Adjusted)

Real GDP(Right Scale)

Land Price Index in Six Major Cities(Commercial, Left Scale)

(Sep. 1990=100)

Sources: Cabinet Of f ice, Japan Real Estate Institute

Nominal GDP (Right Scale)

Likely GDP Path w/o Government Action

Last seen in 1973

Cumulative 90-05 GDP

Supported by Government

Action: ~ ¥2000 trillion

Cumulative Loss of

Wealth on Shares and Real Estate

~ ¥1500 trillion

Exhibit 12. Japan’s GDP Grew in spite of Massive Loss of Wealth and Private Sector De-leveraging

13

overall deficit ¥460

trillion

20

30

40

50

60

70

80

90

100

110

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Source: Ministry of Finance, JapanNote: FY 2011 includes 4th supplementary budget and FY2012 is initial budget.

Government spending

Tax revenueBubble Collapse

(Tril. yen)

cumulativecyclical deficit 90-05

¥315 trillion

Exhibit 13. Japanese Government Borrowed and Spent the Unborrowed Savings of the Private Sector to Sustain GDP

14

Exhibit 14. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit

15

0

10

20

30

40

50

60

70

80

0

10

20

30

40

50

60

70

80

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Tax Revenue

Budget Deficit

Hashimotofiscal

reform Koizumi

fiscal reform

(Yen tril.) (Yen tril.)

(FY)

Global Financial

Crisis

*

Obuchi-Morifiscal

stimulus

Earthquake

Source: Ministry of Finance, JapanNotes: Latest f igures(*) are estimated by MOF. From FY2011, f igures includes reconstruction taxes and bonds.

unnecessaryincrease in

deficit:¥103.3 tril.

Exhibit 15. US in Balance Sheet Recession: US Private Sector Increased Savings Massively after the Bubble

16

Shift from 4Q 2006 in

private sector:9.00% of GDP

Corporate: 2.15%Households:

6.86%


public sector: 7.28% of GDP

-12

-10

-8

-6

-4

-2

0

2

4

6

8

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Housing Bubble

IT Bubble

(Financial Surplus)

(Financial Deficit)

(as a ratio to nominal GDP, %, quarterly)

Rest of the World

Households

General Government

Corporate Sector(Non-Financial Sector +

Financial Sector)

Financial Surplus or Deficit by Sector

Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: FRB, US Department of Commerce

Exhibit 16. UK in Balance Sheet Recession: UK Private Sector Increased Savings Massively after the Bubble

17


private sector:6.77% of GDPCorporate: 0.88%

Households: 5.90%


public sector:6.45% of GDP

-12

-9

-6

-3

0

3

6

9

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Of f ice for National Statistics, UK

(as a ratio to nominal GDP, %)

(Financial Surplus)

(Financial Deficit)

Rest of the World

Households

General Government


Financial Sector)


0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012

UKUSSwedenSwitzerlandJapan

(%)

*Note: Excluding Eurozone. As of Mar. 22, 2012.Source: Bloomberg

3%

1.3%

Exhibit 17. Global Bond Yields* Nearing Japanese Levels

18

Japanese Bond Yield

in 1997

Exhibit 18. Euro-Zone Bond Yields Are Diverging Sharply

19

0

5

10

15

20

25

30

35

40

2007 2008 2009 2010 2011 2012

Greece

Ireland

Portugal

Spain

Italy

France

Germany

(%)

Note: As of Mar. 22, 2012.Source: Bloomberg

Exhibit 19. Euro-zone in Balance Sheet Recession: Euro-zone Private Sector Increased Savings Massively after the Bubble

20

-8

-6

-4

-2

0

2

4

6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Rest of the World


Households

(Financial Surplus)

(Financial Deficit)

Corporate Sector(Non-Financial Sector + Financial Sector)

General Government

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: ECB




Corporate: 3.12%Households: 0.54%




private sector:17.65% of GDPCorporate: 12.24%Households: 5.41%



-12

-9

-6

-3

0

3

6

9

12

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Banco de España


(Financial Surplus)

(Financial Deficit)

Rest of the World


General Government

Households


Exhibit 20. Spain in Balance Sheet Recession: Spanish Private Sector Increased Savings Massively after the Bubble

21

Exhibit 21. Ireland in Balance Sheet Recession: Irish Private Sector Increased Savings Massively after the Bubble

22

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

2002 2003 2004 2005 2006 2007 2008 2009 2010

Sources: Eurostat, Central Statistics Of f ice, Ireland




(Financial Surplus)

Rest of the World

HouseholdsGeneral

Government

(Financial Deficit)

Shift from 2007in private sector:29.60% of GDPCorporate: 14.99%

Households: 14.61%

Shift from 2007 in public sector:31.20% of GDP

-12

-9

-6

-3

0

3

6

9

12

99 00 01 02 03 04 05 06 07 08 09 10 11

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Banco de Portugal

Rest of the World

(Financial Surplus)

Households


(Financial Deficit)

General Government





Households: 3.34%



Exhibit 22. Portugal in Balance Sheet Recession: Portuguese Private Sector Increased Savings Massively after the Bubble

23

Exhibit 23. Sustaining Fiscal Stimulus in Democracy during Peacetime Is Difficult

24

Authoritarian Democracies

No opposition "Bond market might rebel"

(if any, quickly suppressed) "Big Government is BAD Government"

"Monetary Policy should work better"

"Aging Population"

"Should not use grand-children's credit card"

"Structual Reform is what is needed"

"Maastricht Treaty and Fiscal Compact"

"Must Avoid Greece's Fate"

...

Exhibit 24. Balance Sheet Correction in France Was Minimal

25

-8

-6

-4

-2

0

2

4

6

8

10

99 00 01 02 03 04 05 06 07 08 09 10

Sources: ECB, Eurostat



Rest of the WorldHouseholds

General Government


(Financial Surplus)

(Financial Deficit)

Shift from 2006private sector:3.43% of GDPCorporate: 2.85%

Households: 0.57%

Shift from 2006public sector:4.71% of GDP

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

General Government


Financial Sector)

Households

Rest of the World


(Financial Surplus)

(Financial Deficit)

Note: For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Sources: Banca d'Italia, Eurostat




Households: 1.06%



Exhibit 25. Balance Sheet Correction in Italy Was Minimal

26

-15

-10

-5

0

5

10

15-15

-10

-5

0

5

10

15

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

(as a percentage of nominal GDP) (as a percentage of nominal GDP, inverted)

Financial Assetsleft scale

Financial Liabilities right scale


Exhibit 26. Italian Corporates Are Back to Normal After 2 Difficult Years

27

Exhibit 27. Italian Households Are Not Affected by Crisis

28

-16

-12

-8

-4

0

4

8-8

-4

0

4

8

12

16

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11





Exhibit 28. Greek Private Sector Is Drawing Down Savings to Survive

29

-20

-15

-10

-5

0

5

10

15

20

25

01 02 03 04 05 06 07 08 09 10 11


(Financial Surplus)

(Financial Deficit)

Rest of the World

Households

General Government


Financial Sector)

Note: For the latest f igures, 4 quarter averages ending with 2Q/11' are used.Sources: Bank of Greece, Eurostat




Households: -3.09%



Exhibit 29. Greek Corporates Are Both Drawing Down Savings and Reducing Debt

30

-15

-10

-5

0

5

10

15-15

-10

-5

0

5

10

15

00 01 02 03 04 05 06 07 08 09 10 11

Financial Assets

Financial Liabilities

left scale

right scale



Exhibit 30. Greek Households Are Both Drawing Down Savings and Reducing Debt

31

-20

-15

-10

-5

0

5

10

15-15

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11

Financial Assets


left scale

right scale



75

100

125

150

175

200

225

250

275

300

325

350

2007 2008 2009 2010 2011 2012

Eurozone

US

UK

Eurozone

US

UK

Monetary Base(=Liquidity)

Money Supply

(Aug. 2008 = 100, seasonally adjusted)

Aug. 2008

Notes: 1. UK's reserve balances data are seasonally unadjusted. 2. UK's money supply and bank lending data exclude intermmediate f inancial institutions. 3. Base money's f igures of Eurozone are seasonally adjusted by Nomura Research Institute.

Source: Nomura Research Institute, based on FRB, ECB and Bank of England data.

US-like monetary

easing would allow ECB to

supply €945.5 bil. worth of

additional liquidity.

estimates

Exhibit 31. ECB Facing Balance Sheet Recession Can Supply Large Amounts of Liquidity without Igniting Inflation

32



Corporate: 3.29%Households: 2.47%



-18

-15

-12

-9

-6

-3

0

3

6

9

12

15

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

(Financial Deficit)

(Financial Surplus)


Households

Rest of the World


Financial Sector)

General Government


Note: For the latest f igures, 4 quarter averages ending with 4Q/11' are used.Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Of f ice, National Accounts

Balance Sheet Recession Global Financial

Crisis

Exhibit 32. Exit Problem (I): Japanese Corporates Increased Savings Again After Lehman

33

Exhibit 33. Japanese Corporates Are Increasing Savings

34

-25

-20

-15

-10

-5

0

5

10

15

20

25

30-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

right scale



Financial Assets

left scale

(FY)


Exhibit 34. Japanese Households Are Both Increasing Savings and Reducing Debt

35

-21

-18

-15

-12

-9

-6

-3

0

3

6

9

12-12

-9

-6

-3

0

3

6

9

12

15

18

21

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11(FY)




(as a percentage of nominal GDP, inverted)(as a percentage of nominal GDP)

Exhibit 35. Exit Problem (II): German Private Sector Refused to Borrow Money after 1999-2000 Telecom Bubble

36

-20

-15

-10

-5

0

5

10

15

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11


(Financial Surplus)

(Financial Deficit)

Rest of the World

Households

General Government


Financial Sector)

Notes: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted. For the latest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Deutche Bundesbank

Balance Sheet

Recession

Telecom Bubble


Shift from 3Q 2000

to 1Q 2005 in private sector:12.59% of GDPCorporate: 9.98%

Households: 2.60%

Shift from 3Q 2000

to 1Q 2005 in public sector:4.91% of GDP

Exhibit 36. German Corporates Are Saving More than Borrowing

37

-20

-15

-10

-5

0

5

10

15-15

-10

-5

0

5

10

15

20

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11




Notes: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted. For thelatest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Deutche Bundesbank

Exhibit 37. German Households Are Refusing to Borrow

38

-12

-8

-4

0

4

8-8

-4

0

4

8

12

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11




Notes: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted. For thelatest f igures, 4 quarter averages ending with 3Q/11' are used.Source: Deutche Bundesbank

reason for weak German house prices despite record

low interest rate

Exhibit 38. Exit Problem (III): U.S. Took 30 Years to Normalize Interest Rate after 1929 Because of Private Sector Aversion to Debt

39

0

1

2

3

4

5

6

7

8

9

1920 21 2223 24 2526 27 2829 30 3132 33 3435 36 3738 39 4041 42 4344 45 4647 48 4950 51 5253 54 5556 57 5859 60

US government bond yieldsPrime BA, 90daysUS government bond yields 1920-29 average (4.09%, June 1959)Prime BA, 90days 1920-29 average (4.13%, September 1959)

Oct '29 NY StockMarket Crash

Jun '50 Korean War

Dec '41 PearlHarbor Attack

(%)

'33～New Deal

Source: FRB, Banking and Monetary Statistics 1914-1970 Vol.1, pp.450-451 and 468-471, Vol.2, pp.674-676 and 720-727

Exhibit 39. Japanese Money Supply Kept up by Government Borrowings

40

CreditExtended tothe Private

Sector¥601.6 tril.

CreditExtended to the

Public Sector¥247.2 tril.

(+106.8)

Foreign assets

(net)

¥74.1 tril.(+41.4)

Foreign Assets(net)

¥32.7 tril.

Credit Extendedto the Public

Sector¥140.4 tril.

Money Supply(M2+CD)

¥621.5 tril.


Sector¥501.8 tril.

(-99.8)

Other Liabilities

(net)

¥78.7 tril.(-74.5)

Other Liabilities(net)

¥153.2 tril.

Money Supply

(M2+CD)

¥744.4 tril.(+122.9)

Balance Sheets of Banks in Japan

December 2007

Total Assets ¥823.1 tril. (+48.4)Total Assets ¥774.7 tril.

December 1998Assets

Assets

Liabilities

Liabilities

Source: Bank of Japan "Monetary Survey"

Money Supply Is Kept Up by Government Borrowings (II)

Exhibit 40. US Money Supply Increased after 1933 because of Government Borrowings

41


Sector$29.63 bil.

Deposits$32.18 bil.

CreditExtended tothe Public

Sector$5.45 bil.

Other Assets$8.02 bil.

Reserves$2.36 bil.

Capital$6.35 bil.

OtherLiabilities$6.93 bil.

June 1929 Assets Liabilities

Total Assets $45.46 bil. Total Assets $33.04 bil. (-12.42) Total Assets $46.53 bil. (+13.49)

CreditExtended

to thePrivateSector

$15.71 bil.(-0.09)Credit

Extended tothe Private

Sector$15.80 bil.

(-13.83)



Deposits$23.36 bil.

(-8.82)

Deposits$34.10 bil.(+10.74)

CreditExtended

to thePublicSector

$8.63 bil.(+3.18)

CreditExtended

to thePublicSector

$16.30 bil.(+7.67)

OtherAssets

$6.37 bil.(-1.65)

OtherAssets

$8.91 bil.(+2.54)

Reserves$2.24 bil.

(-0.12)

Reserves$5.61 bil.(+3.37)

OtherLiabilities$4.84 bil.

(-2.09)

OtherLiabilities$7.19 bil.(+2.35)

Capital$4.84 bil.

(-1.51)

Capital$5.24 bil.(+0.40)

(= Money Supply)

Source: Board of Governors of the Federal Reserve System (1976) Banking and Monetary Statistics 1914-1941 pp.72-79

Balance Sheets of All Member Banks

Exhibit 41. Recovery from Lehman Shock Is NOT Recovery from Balance Sheet Recession

42

Source: Nomura Research Institute

?

Lehman Shock

Actual GDP Path

Current Location

Likely GDP Pathwithout Lehman Shock

Weaker Demand from Private Sector

De-leveraging

Stronger Demand from Government's

Fiscal Stimulus

(A)

(B)

Economic weakness from private-sector

de-leveraging

Economic weakness from policy mistake

on Lehman

BubbleBurst

Exhibit 42. Yin Yang Cycle of Bubbles and Balance Sheet Recessions

43

Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession , John Wiley & Sons, Singapore, April 2008 p.160.

(1) Monetary policy is tightened, leading the bubble to collapse.

(5) Private sector phobia towards borrowing gradually disappears,and it takes a more bullish stance towards fund raising.

(8) With the economy healthy,the private sector regains its vigour,

and confidence returns.

(9) Overconfident private sector triggers a bubble.

(7) Monetary policy becomes the maineconomic tool, while deficit reduction

becomes the top fiscal priority.

(6) Private sector fund demand recovers,and monetary policy starts working again.

Fiscal policy begins to crowd out private investment.

(4) Eventually private sector finishes its debt repayments,ending the balance sheet recession.

But it still has a phobia about borrowing which keepsinterest rates low, and the economy less than fully vibrant.

Economy prone to mini-bubbles.

(3) With everybody paying down debt,monetary policy stops working.

Fiscal policy becomes the main economic toolto maintain demand.

(2) Collapse in asset prices leaves private sectorwith excess liabilities,

forcing it into debt minimization mode.The economy falls into a balance sheet recession.

BubbleYin (=Shadow) Yang (=Light)

US

Spain

UK

Germany

Japan

Exhibit 43. Contrast Between Yin and Yang Phases of Cycle

44

Yang Yin

Textbook economy Balance sheet recession

Adam Smith's "invisible hand" Fallacy of composition

Assets > Liabilities Assets < Liabilities

Profit maximization Debt minimization

Greatest good for greatest number Depression if left unattended

Effective Ineffective (liquidity trap)

Counterproductive (crowding-out) Effective

Inflationary Deflationary

Normal Very low

Virtue Vice (paradox of thrift)

a) LocalizedQuick NPL disposal

Pursue accountabilityNormal NPL disposalPursue accountability

b) SystemicSlow NPL disposal

Fat spreadSlow NPL disposal

Capital injection

Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession , John Wiley & Sons, Singapore, 2008

5) Outcome

6) Monetary policy

7) Fiscal policy

1) Phenomenon

2) Fundamental driver

3) Corporate financial condition

4) Behavioral principle

8) Prices

9) Interest rates

10) Savings

11) Remedy forBanking Crisis

Business

R. Koo. The World in Balance Sheet Recession