In the case of Japan, domestic observers feel little confidence that such measures will boost the economy. ZIRP and QE were not able to reverse deflation in the past, and it was exports that dragged Japan out of its recession from 2002 onwards, pushing the country to its longest post-war expansion (although at a modest annual rate of 2%).
Yet investors in the Japanese bond and stockmarkets are betting heavily that the Bank of Japan will lower its benchmark rate today, despite it already being a measly 0.3%. Interest rate sensitive bank and property stocks jumped yesterday, while bond yields also came down ahead of today's decision by the BOJ.
Akira Maekawa, chief economist at UBS, believes that a rate cut is not a foregone conclusion, given the BOJ's distaste for a policy that makes basic financial operations difficult. ôThe BOJ estimates that as interest rates move towards zero, they make money market operations difficult, since there is little point in banks lending to each other for free.ö
Is it possible that ZIRP and QE could work better in the US? The Fed certainly appears fanatically committed to preventing the kind of adjustment that normally happens after a bubble: a contraction. The US is also acting faster and with greater firepower than in Japan, where the idea of reflating the economy through large deficits and a recapitalisation of the banks took many years to gain acceptance. Jeffrey E. Garten, a Yale academic and former US government official, even called for additional expenditure of $4 trillion worldwide in a recent edition of Newsweek magazine. That is on top of up to $8 trillion spent on the bailout in the US alone, which accounts for around half of the countryÆs GDP.
Yet the experience of Japan does not give cause for optimism. UBSÆs Maekawa writes in a recent report: ôRealistically, the BOJ has no other policy options except QE, despite the potentially high cost of introducing QE and the very limited likely impact on the real economy.ö He goes on to forecast the highest negative growth in 10 years for Japan, with 2009 GDP declining by 0.9%.
Maekawa believes the pessimistic BOJ position on QE is due to the fact that it ôhelps ease stresses in financial systems, but that it would do little to help negative prices turn positive or to re-energise a waning real economy. However, there is nothing left in the face of the increasing risk that conventional liquidity provision will be insufficient to overcome the unprecedented deleveraging-induced recessionary pressure.ö
Richard Koo of the Nomura Research Institute in Japan and a leading historian of the Japanese experience, believes that QE and ZIRP didnÆt work for the simple reason that when companies and individuals are rebuilding their balance sheets, there is no demand for loans. ôWith no one borrowing money, the liquidity supplied by the BOJ will simply sit in the system and will not add to the economyÆs income stream,ö he writes in his book Balance Sheet Recession.
Koo also disagrees with 'helicopter moneyÆ for Japan û the policy related to QE where money is given directly to consumers and companies û because once they realise that everybody has received the same amount of money, itÆs clear that nothing has changed. The only consequence is that asset prices will rise to match to extra liquidity. Worse, people could lose confidence in the money and rush to change yen into a æharderÆ currency. Interestingly, the reaction to the FedÆs interest rate cut to practically zero appears to partly bear Koo out, since the dollar declined sharply against the yen and other currencies on Thursday. However, US Treasury yields paradoxically came down as investors simultaneously sought a safe haven.
One way out of this strange and unprecedented situation is to adopt good old fiscal programmes. The biggest and most effective æfiscal programmeÆ in the US was World War Two, which was several magnitudes bigger than President RooseveltÆs New Deal and finally drove the US economy out of its slump. So maybe the wars in Afghanistan and Iraq will ironically end up saving the US economy, assuming they go on long enough.
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