Lessons from the Bank of Japan
by George Hatjoullis
Guntram B. Wolff of Bruegel offers us three ” Lessons from the Bank of Japan for the euro area” (http://bit.ly/1uHyPcd). First, once deflation takes hold, breaking the deflation mindset can be difficult. Second, synchronous fiscal austerity programmes are driving much of the disinflationary impulse. In other words, the risk of deflation is self-inflicted. Finally, the politics of monetary policy is difficult in unified and largely homogenous state such as Japan. It is positively byzantine in the heterogeneous and fractured eurozone. Difficult decisions are hard to make and become bogged down in nationalist, cultural and political controversy. Mr Wolff has said nothing readers of this blog have not heard before and on more than one occasion but he has said it from a platform that has some credibility (unlike this blog) so it is worth emphasising.There is one lesson that Mr Wolff has forgotten to add: the BoJ has failed using the best available non-taboo tools.
Quantitative easing is a conventional tool. It appears in textbooks as “open market operations’. It is simply not a frequently used tool. The USA and the UK used it with some success but not entirely. Despite starting from a position of positive inflation expectations and employing aggressive reserve and QE tools, both the US and UK are failing to hold domestic inflation close to target levels. The global deflationary forces are overwhelming domestic efforts. Japan has merely stepped up conventional reserve and QE operations. If it has not been wholly effective in the US and UK, then why on earth should it be so in a Japan trying to break a deflationary mindset built up over 20 years? It should not and it will not. This point has been made in so many ways in this blog that I have become weary of repeating it.
The source of the global deflation problem is not monetary. It is fundamental to the market system. This was the whole message of the Economics series of blogs though I doubt anyone read them. Let me try to put the message in one paragraph. The problem is an insufficiency of global aggregate demand relative to potential output.The source of the insufficiency is the income inequality that arises in a successful market economy. Successful market economies achieve a rapid growth of potential output but also accumulate claims on this potential in the hands of progressively fewer people. This leads to insufficient demand arising from labour involved in producing the output. The potential can only be realised if those that have accumulated past claims on output dissave either through spending or borrowing to spend. The system appears to have exhausted the conventional avenues for dissaving and absorbing the excess potential over that purchased by the labour force. The state and pensioners (rentier) are constrained and producers are disinclined to invest given already excess capacity. The solution lies in a redistribution of income but this must be implemented in a manner that does not dim the inclination to invest and expand potential output. Historically one solution appears to have been war, which creates an effective, and helpfully unproductive, demand. Another solution is, of course, monetary financing of public sector spending. This creates demand with no corresponding liability and can be used to realise and redistribute potential output. However this is taboo at the moment. History tells us that either war or monetary financing (sometimes both) will sooner or later emerge as a ‘solution’ to the insufficiency of aggregate demand. It would nice if for once the world opted for monetary financing and eschewed the war option.
The eurozone, it seems, is determined to bring itself into the same deflation mindset in which Japan is trapped. It is doing so because it is pursuing orthodox, and somewhat unimaginative policies. Economics is a tool kit not a prescription. No tools should be excluded and each situation needs to be viewed in context. Unfortunately when the ECB was established it was designed to avoid the experience of Germany during the Weimar Republic and all that followed. Good motives, that now constrain the ECB and promise new and equally destructive outcomes. The ECB cannot act to stop deflation taking root in the eurozone. The best it can do is copy Japan and even that may be a political step too far.