Author: John McHale

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? 

The speed of the fiscal deterioration is truly alarming—all the more so given Ireland’s fiscal history.  But, observing from a distance, I am still surprised that the wisdom of discretionary fiscal contraction is not subject to more public debate.   (I realise I may be missing much of the actual debate.)  Ireland is now in the throes of an extreme domestic demand-deficient recession.   On its face, it is tragic to pursue a contractionary discretionary fiscal policy with such a demand collapse and no monetary policy instrument.   Of course, the fear of a large increase in the risk premium on Irish debt and associated explosive debt dynamics could validate such a tragic choice.    But is the fiscal caution being overdone given Ireland’s modest debt and ability to borrow in its own currency?  The marginal value of stimulus should be high with the economy operating well below potential.  Thus the fact that debt is being piled up at an alarming rate does not necessarily mean it is bad policy.    I would be grateful for any thoughts on the extent of the risk of explosive debt dynamics and the likely size of fiscal multipliers in the current depressed environment.