In Search of the Holy Grail

In case you haven’t come across it, there is a provocative (if sometimes repetitive) recent book on the Japanese slump by Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession (Wiley).   Koo places the blame squarely on balance sheet problems.    Interestingly, the balance sheet problems he emphasises are not in the financial sector but in the corporate (and broader) private sector.  

The following passages give a flavour of the argument:

If Japan’s fundamental problem was neither structural nor banking related, was it caused by monetary policy mistakes, as so many academics have claimed?  To answer this question, one must look at a peculiar monetary phenomenon of the Japanese economy that is not discussed in any economics textbook or business book.   Some readers may think this claim is exaggerated, but Japanese firms have spent the past dozen-odd years paying down debt when interest rates were at zero. (p. 11)

. . .

In summary, the private sector felt obliged to . . . to pay down debt . . ..  Disastrous consequences were avoided only because the government took the opposite course of action.   By administering fiscal stimulus . . . the government succeeded in preventing catastrophic decline in the nation’s standard of living despite the economic crisis.  (p. 25)

Of course, it would be a mistake to exaggerate the similarities between the Japanese and Irish economies.    For one thing, the Irish fiscal situation is already dire.   But, despite the appreciated efforts to put me straight, I continue to be surprised by how little attention is being given to domestic demand.   Improving competitiveness is critical and rightly the focus of much comment, but it will be a drawn out affair.   I fear many good enterprises will be destroyed along the way as expenditure switching is dominated by expenditure reduction.   How can we avoid an obscenely excessive property boom being followed by an obscenely excessive liquidation? 

6 replies on “In Search of the Holy Grail”


I think there is widespread consensus that the government should run a sizeable deficit in order to support domestic demand. The debate is about whether deficits north of 10 percent of GDP are excessive: running a smaller deficit (but still well in excess of the Maastricht ceiling) would still be generally supportive of demand, while being more encouraging in terms of sustainability.

A correction in public sector wages is helpful in resolving the labour market problem that is currently driving up unemployment and inhibiting the export sector; it is also helpful in helping the government to make inroads on the structural component of the deficit (while still maintaining the cyclical component of the deficit).

Thanks Philip and Iulia. My apologies for pontificating from the outside.

I appreciate your points about the sustainability of the public finances and the importance of the credibility of the bank guarantee.

I still think there is a question about what is best to do at the margin–i.e. starting from the deficit of 10 percent of GDP. For example, I am more sceptical about expansionary fiscal contraction assumption that I take to be a central part of Philip’s argument in both the SBP piece and the conference paper. Having said that, putting competiveness and governement wage consumption multiplier arguments together, I have been convinced that the public sector wage cut makes sense.

I think where I differ a bit from the emerging consensus–forgive me for lumping a number of sophisticated arguments together–is in how I assess the the balance of risks. I certainly see the risks of a loss of confidence by investors in Irish debt and by Irish consumers/businesses as a result of out-of-control public fiannces. But I also worry that, just as the eocnomy overshot greatly on the upside, it will overshoot greatly on the downside, with potentially long-lasting damage.

I don’t mean to suggest that others do not share my concerns. But the debate in Ireland seems to be weighted more to the “hard money” end of the spectrum than seems to be the case elsewhere. (Of course, no other country has suffered the same degree of fiscal collapse, which surely explains much of the difference.) Some “soft money” pontification seems a worthwhile contribution–however annoying.

The Guardian’s magazine on Saturday had an article about (& interviews with) recent Chancellors of the Exchequer. Some of the issues raised (particularly runaway credit) were eerily familiar.

i think deficits need to be a huge part of the focus, unlike the US we don’t even have the benefit of a deficit creating a capital account surplus. The bond spreads alone reveal the risk which is priced into Ireland.

What will Ireland 2.0 look like? Where will the money to repay everything come from? In Japan they focused on a ‘better quality’ rather than ‘bigger is better’ focus v.s. the americans, hence Toyota and so many other brands came to dominance over GM/ford etc., but we stopped -by and large- manufacturing a long time ago in order to become a service economy and frankly we don’t have the expertise to switch back easily, Japan on the other hand never lost this ability.

now we have to rely on importing in most of the goods we buy, the skills for high end manufacturing (pharma is still here thankfully) are by and large gone or going to other countries, Dell is an instant reminder of this.

the deflation risk will remain until we export more than we import because until that happens there would be a general contraction in spending domestically.

deflation is not all bad, great depression style where it demand disappears totally due to collapse of income is of course bad, but demand still exists in the current market at some level of pricing for all products [even houses!] a lot more flat screen tv’s are being sold at 1,000 than when they cost 12,000.

In short, I would feel that spending does need to continue but only on activities that provide meaningful and lasting solutions,in that respect we don’t need to be ‘digging holes’ for the sake of it, as we all know, we’ve dug ourselves into a big enough hole already.

I see Brussels is now forecasting an 11% deficit (as a precentage of GDP) this year, and 13% in 2010.

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