The lessons of Japan’s lost decades

13 October, 2012 at 15:15 | Posted in Economics | Leave a comment

European policy makers are dispensing the wrong medicine by tackling the euro-area’s fiscal ills with austerity, according to Richard Koo, chief economist of Nomura Research Institute.

The budget cuts and structural reforms prescribed to nations such as Spain by German Chancellor Angela Merkel and European Central Bank President Mario Draghi are in Koo’s eyes akin to the treatment of diabetes sufferers, who must eat carefully and exercise to improve their long-term health.

The trouble is Europe’s cash-strapped peripheral countries have the economic equivalent of pneumonia, which is more deadly and is best beaten by ensuring ample nourishment, said Koo. To the 58-year-old former Federal Reserve economist that means greater fiscal stimulus if the euro crisis is to end soon.

“The patient can have both, but doctor has to cure the pneumonia first even if the treatments contradict those required for the diabetes,” Koo said in an interview in Tokyo yesterday. “In Europe, austerity is the only game in town.”

The advice goes to the heart of Koo’s theory that like their Japanese counterparts in the 1990s, policy makers in Europe are failing to see that their region is suffering from a “balance-sheet recession.” …

Koo uses Japan’s experience to demonstrate the errors he sees being repeated in Europe. In 1997, Prime Minister Ryutaro Hashimoto’s government increased taxes and cut spending, while pushing structural reforms to offset the pain. The problem was the private sector was trying to lower debt and already failing to respond to zero interest rates … The result was five consecutive quarters of contraction and falling tax revenues, provoking a 68 percent increase in Japan’s fiscal deficit. Even though Hashimoto reversed course, it took Japan a decade to haul back its budget deficit, Koo said.

Europe can avoid a similar trap if the ECB and IMF agree Spain and other crisis-torn countries can revive stimulus and nations in better shape such as the U.S. and Germany spend the capital flooding their economies, said Koo. He also proposes a rule prohibiting euro-area governments from selling debt to the citizens of another country, limiting the ability of private savings to move abroad and hurt yields.

Bloomberg

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