Home > Bank of England, Monetary Policy > Japan Watch: Governor King Reads Governor Shirikawa’s Lines

Japan Watch: Governor King Reads Governor Shirikawa’s Lines

Oh god.  This was Governor Shirikawa of the Bank of Japan back in March 2012:

The first is the burden of balance-sheet repair. Even with monetary easing, economic entities with excess debt neither increase expenditures nor embrace more risk taking until their debts are reduced to an appropriate level. Monetary easing only mitigates pains associated with balance-sheet repair. Moreover, employing this mitigator for a prolonged time comes with costs, as it reduces incentives to lessen excess debt and causes delays in balance-sheet repair, which ultimately is necessary for economic recovery. Needless to say, the effect of low interest rates is extended to those economic entities that have not suffered any damage to their balance sheets. If they bring forward future demand to the present by taking advantage of a low interest rate environment, this leads to an increase in aggregate demand. As balance-sheet adjustment continues for a long period of time, however, the amount of future demand that could be brought forward gradually diminishes even in a low interest rate environment. The above-mentioned cost of reducing incentives to lessen excess debt is not only an issue for private economic entities but also for the government. Once the increased level of government debt is perceived to be unsustainable, this threatens both price stability and financial system stability, as in the case of the European debt problem.

My emphasis.  This is Governor Shirikawa’s good friend Governor Mervyn King in October 2012:

First, monetary policy supports demand and output by encouraging households and businesses to switch demand from tomorrow to today. But when tomorrow becomes today, an even larger stimulus is required to bring forward more spending from the future. Since the paradox of policy has been evident for almost four years, tomorrow has become not just today but yesterday. When the factors leading to a downturn are long-lasting, only continual injections of stimulus will suffice to sustain the level of real activity. Obviously, this cannot continue indefinitely. Policy can only smooth, not prevent, the ultimate adjustment. At some point the paradox of policy must be resolved.

My emphasis again.  It’s almost the same wording.  Oh god.  How did this happen?  How are the lessons of Ben Bernanke and Lars Svensson forgotten so easily?

I am short on time so cannot post more than an idle rant, but, oh god.  Please, Mr Osborne, replace this Governor now.  Get Svensson in to blow you away with New Keynesian macro done properly.  Get Scott Sumner in, or any damn fool who can print money and buy stuff;  throw the Keynesians out with the bath water; target the level of nominal GDP.   Get Gideon Gono in to show you how far you can debase the currency if you are serious about firing up the printing press.  Actually, scratch that one.  But please, no more of this.  Oh god.

  1. October 23, 2012 at 23:54

    Ok, I’d be with you in favour of a nominal GDP target. But really what we’re saying when we talk about a nominal GDP target is not “we will ensure a return to growth” but “we will tolerate inflation up to 5% in order to get all the growth we can”. I think, if you could get King off the record, he’d tell you that, for a while, he thinks you’d only get 5% inflation. I think he’d say that you’re really only shifting the burden of adjustment, but the same adjustment happens.

    That adjustment is of debtors getting their balance sheets back in shape. King’s view is that until they do that, they’ll just keep on hoarding. An NGDP mandate – as I say, I favour it – would work in part by accelerating this process, redistributing from creditors to debtors.

    As supporters of an NGDP target, you and I are saying “we’re fine with that”. But that’s a big political choice, isn’t it? And if you’re in Mervyn King’s generation, inflation was THE problem; for that reason, he probably really doesn’t want it back, leaving aside the BoE mandate. Everything he says follows from his view that:

    “The role of the Bank of England is to create the right amount of money, neither too much, nor too little, to support sustainable growth at the target rate of inflation.”

    The sentence rests on “at the target rate of inflation” – sustainable growth is only understood in that light. And from here, viewed like that, it’s difficult to see how much faster you can go than now – interest rates are near-zero, broad money rising at 3%-4% – and yet growth doesn’t pick up. He agrees with you that the BoE could create inflation – in fact, the latter part of his speech is an attack on Turner’s idea precisely because of that risk.

    Maybe he’s right, and the reason why he’s right is the reason why the mandate is wrong?

    • October 24, 2012 at 09:22

      Hi Duncan, a lot in there :)

      1) the purpose of an NGDP (level) target is not simply a way to “tolerate higher inflation”; the aim is to remove consideration of price inflation from demand management altogether, because price inflation can be driven by either demand-side or supply-side effects.

      2) under a 5% NGDP level path target a severe supply-side shock which temporarily sent inflation above 5% would be possible.

      3) The “balance sheet” argument puts the cart before the horse. Expected NGDP growth what really matters for balance sheets, for households and business and governments. The business view is the simplest: you invest based on an expected a particular path of future revenue. When there is a downwards shift in the (aggregate) expected path of future revenue, the flip side is that firms in aggregate may have “excess” capital or excess leverage.

      4) I agree with you about the way King defines “sustainable growth”. But he embraces exactly the same “self-induced paralysis” that Bernanke attacked the BoJ for; his refusal to raise expectations beyond 2% inflation forever (in the BoJ’s case that was something like 0% inflation forever, but the same principle applies).

      As we’ve seen over the last year it is possible for the BoE to tightly compress NGDP growth and still get 2% inflation. King’s quantity of money comment is much better, and it does somewhat contradict his Shirikawa-esqeue “limits” wording, since there is no limit on the amount of money the BoE can create.

  2. October 24, 2012 at 09:41

    Re (1) and (2) I think we’re on the same ground – my point about “tolerating higher inflation” is that NGDP simply reverses the conditionality, from being growth-consistent-with-inflation to inflation-consistent-with-growth. Inflation will then be a symptom of the balance of demand- and supply-side pressures; my suggestion (and I think King’s) is that there’s a lot of incipient supply-side pressure at the moment, which you would simply monetise with an NGDP target.

    Re (3), yes, and in that sense, businesses will do that – but that’s because they are reacting to the nominal variables first – sensibly, because your receipts and bills will be coming in nominal values, like it or not. It says nothing about the prospective split inflation-real growth split of the NGDP increase; that’s why it works.

    Re (4), yes.

    Agreed about policy resulting in compressed NGDP growth alongside on-track inflation; but this was hardly the intention. In NK thinking, if you keep inflation on track, giving agents a stable currency with which to operate, then growth should take care of itself. At the ZLB, it predicts a problem; he seems guilty of knowing how to deal with that problem, but not putting it into practice.

    • October 24, 2012 at 12:01

      Just thought ‘incipient’ wrong word. I meant sustained, albeit low level.

      Anyway, I see Koo again reported as saying the CB can’t raise inflation if the private sector is saving… Oh dear.

  3. October 29, 2012 at 15:07

    Great post, and some interesting references, but:

    I read the Svensson paper indirectly linked and one problem with the proposed approach (acknowledged in the paper) is that if all the major (advanced) economies are in a liquidity trap simultaneously then the method can’t work, because it relies on temporarily devaluing the currency against that of other advanced economies – a beggar-thy-neighbour approach which would be pretty unpopular right now.

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