The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession [Paperback]

Richard C. Koo (Author)

Book Description

Publication Date: August 17, 2009 | ISBN-10: 0470824948 | ISBN-13: 978-0470824948 | Edition: Revised

The revised edition of this highly acclaimed work presents crucial lessons from Japan's recession that could aid the US and other economies as they struggle to recover from the current financial crisis.

This book is about Japan's 15-year long recession and how it affected current theoretical thinking about its causes and cures. It has a detailed explanation on what happened to Japan, but the discoveries made are so far-reaching that a large portion of economics literature will have to be modified to accommodate another half to the macroeconomic spectrum of possibilities that conventional theorists have overlooked.

The author developed the idea of yin and yang business cycles where the conventional world of profit maximization is the yang and the world of balance sheet recession, where companies are minimizing debt, is the yin. Once so divided, many varied theories developed in macro economics since the 1930s can be nicely categorized into a single comprehensive theory- The Holy Grail of Macro Economics

Editorial Reviews

Review

Reviews from the previous edition

"...provide fascinating insights into the problems of Japan...interesting thesis" (Wilmott.com/blogs, August 2009)

"…the Japanese policymakers who told everyone the US was in danger of falling into a prolonged period of economic weakness were right. To understand why this is true, you need to read a brilliant book by Richard Koo of the Nomura Research Institute." (Financial Times, January 2009)

"…the definitive book on Japan's decade-long recession in the 1990s." (USA Today, March 2009)

"Books about the current global economic crisis are being written and published by the truckload. But few – perhaps none – are worth reading… Richard Koo, chief economist at the Nomura Research Institute in Tokyo, a think tank attached to Japan's biggest investment bank, watched Japan's 'lost decade' from an excellent vantage point: he was close enough to understand the detail, data and ways in which both corporate and political decisions were made, and independent enough to be able to analyse what happened in a reasonably detached and cool way." (Survival, May 2009)

"A must-read to an understanding of what Japan went through and what the United States and Europe may experience is Koo's latest book The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession." (The Edge Financial Daily, December 2008)

From the Inside Flap

How did the great Depression of the 1930s get to be so bad for so long? That question has baffled economists for decades. Ben S. Bernanke, the current Fed Chairman, even called understanding the great Depression the as yet-unattained "holy Grail of Macroeconomics." Japan's Great recession of 1990-2005 finally gave us some vital clues as to how a post-bubble economy can plunge into prolonged recession while leaving conventional policy responses largely ineffective.

Building on the author's earlier work Balance Sheet Recession: Japan's Struggle with Uncharted Economics and its Global Implications (John Wiley, Singapore, 2003), The Holy Grail of Macroenomics: Lessons from Japan's Great Recession argues that there are actually two phases to an economy, the ordinary (or yang) phase, in which the private sector is maximizing profits, and the post-bubble (or yin) phase, in which private sector is minimizing debt, or repairing damaged balance sheets. Although conventional economics is useful in analyzing economies in the yang phase, it is less useful in explaining phenomena such as the "liquidity trap" that is typical of an economy in the yin phase. The distinction between the yin and yang phases also explains why some policies work well in some situations but not in others. Indeed, it offers the crucial foundation to macroeconomics that has been missing since the days of Keynes.

This groundbreaking book not only explains what happened to the U.S. during the Great Depression and to Japan during the Great recession, it also offers important policy recommendations for fighting post-bubble economic downturns in any country, including the current subprime crisis in the U.S. --This text refers to the Hardcover edition.

See all Editorial Reviews

Product Details

• Paperback: 352 pages
• Publisher: Wiley; Revised edition (August 17, 2009)
• Language: English
• ISBN-10: 0470824948
• ISBN-13: 978-0470824948
• Product Dimensions: 6.2 x 1.1 x 8.8 inches
• Shipping Weight: 1.2 pounds (View shipping rates and policies)
• Average Customer Review: 4.6 out of 5 stars  See all reviews (26 customer reviews)
• Amazon Best Sellers Rank: #213,532 in Books (See Top 100 in Books)

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Most Helpful Customer Reviews

45 of 47 people found the following review helpful

5.0 out of 5 stars Brilliant attack on conventional policies September 14, 2009

By William Podmore

Format:Paperback

Richard Koo, chief economist of Tokyo's Nomura Research Institute, has written a fascinating and important book. He claims that capitalist economies have two phases: the ordinary phase, in which firms aim to maximise profits, and the post-bubble phase, when they aim to pay off their debts. He believes that he has found the missing link of economics: "corporate debt minimisation, therefore, is the long-overlooked micro-foundation of Keynesian macro-economics."

It's still boom and bust. Koo claims that in the boom phase, monetary policy works, but not fiscal; in the bust phase, only fiscal policy works, not monetary. He shows how monetary policy cannot fight a slump. He contends that only huge fiscal stimuli, government actions to boost domestic demand, can prevent slumps.

Koo claims that, in the 1930s depression, in Japan's recession since 1990, and in the present crisis, the problem was the private sector's lack of demand for loans, not a lack of funds from the central banks. Contrary to the consensus, these depressions were not caused by the wrong monetary policy.

How to fight a slump? Cutting spending to reduce government debt is the road to disaster. In the 1930s, both President Hoover and Chancellor Bruning insisted on balancing the budget, which crashed the US and German economies. In 1945 the British government's debt was 250% of GDP, but the country survived. Between 1933 and 1936, President Roosevelt raised government spending by 125%, so GDP rose by 48% and tax revenues rose by 100%. But in 1937 he changed tack and cut spending: industrial output fell by 33%.

Japan's recession (caused by falls in the value of its assets - land and loans) destroyed 1500 trillion yens' worth of wealth - three years of Japan's GDP.... (The USA's depression lost it one year's GDP.) In Japan, monetary stimuli failed, so the Japanese government proposed irrelevant Thatcherite supply-side changes, like privatising the post office.

In 1997 the Hashimoto government, under IMF pressure, cut spending and raised taxes to balance the budget. As a result, output fell for five quarters, Japan's worst post-war meltdown, and the budget deficit rose from 22 trillion yen in 1996 to 38 trillion in 1999. In 2001, the Koizumi government did the same - with the same result. It also tried the monetary policy of quantitative easing. But this did not increase lending or the money supply. It was irrelevant.

Subsequently, the Japanese government adopted a policy of no fiscal consolidation without growth, i.e. no spending cuts or tax rises before private-sector demand recovered. This fiscal stimulus prevented a 1930s-style depression; by 2005, firms had started to borrow again.

Again, in Germany's balance sheet recession of 2000-05, "the Maastricht Treaty prevented it from applying the fiscal stimulus it needed. This deepened the recession", as Koo observes.

Finally, he notes the harmful effects of the free movement of capital: "in view of the explosion of cross-border capital flows during the past two decades contributing to adverse currency movements and the widening of global imbalances, some restrictions on those flows may be desirable." He also notes the damage done by free trade: "that market forces have not only failed to rectify trade imbalances but actually made them worse suggests that some kind of government action may be necessary." Read more ›

15 of 16 people found the following review helpful

5.0 out of 5 stars Every page and paragraph a gem of information August 31, 2009

By Roger

Format:Paperback|Amazon Verified Purchase

I am a neophyte in economics, I should have put my attention hear years ago -- being a "do gooder" at heart. The past three months I have delved into the dismal science. I never anticipated such divergence of opinions and theories. The Holy Grail of Macroeconomics is simply a gem of knowledge. Of the many books/texts I have aquired, this one is the best in gaining the meat. I mean by this, it is written in a dense style, reminisent of college texts years gone by -- yet each paragraph holds my attention and interest, unlike so many others. The author's analysis and view points are clearly stated with ample examples and "evidence." This fine writting is simply not of the "dismal science" but a wonder of clear analysis and clarity of writting.

10 of 10 people found the following review helpful

4.0 out of 5 stars important work on debt aversion October 22, 2009

By A. Menon

Format:Paperback|Amazon Verified Purchase

This book is a good account of the phenomenon of debt aversion. The thesis of the book is pretty straightforward and is that, after asset bubbles burst and businesses are technically insolvent through liquidation analysis, they are likely to pay down debt irrespective of monetary policy. The fact that the businesses are technically insolvent despite market prices is described as being a function of information asymmetry and bank incentives.

This realization is deemed to be the missing link to complete economist's understanding of how to bridge fiscal macroeconomic thought and monetary economic thought and the solutions required in the aftermath of a burst asset bubble. Discussing the shortfalls of Friedman's positions on the demand function for money to be a function of nominal interest rates, it is argued that when one is in the position of being insolvent yet operational, the focus shifts from using lending lines to maximise ROE to using free cashflow to minimize the debt that is causing this insolvency. When this market regime is upon us, it is the need of the government to use fiscal policy to fund the output gap.

I think this is pretty accurate as an analysis of the problems that arise in monetary policy when the world is in fear of the phenomenon that hurt them (being burdened with debt that is greater relative to the asset base one had assumed would back it) and this aversion has macroeconomic repurcussions. My only criticism is, I dont think this is as obscure a result as is described. Most ecnomists realize how output gaps can arise, how debt aversion can form. Richard Posner, who is a judge, talks about debt aversion off-hand as though its well known.... So all in all i think its a god perscriptive piece on a very real phenomenon we deal with but its not revolutionary and this phenomenon is discussed by others (though few have gone in to as much detail about it). Read more ›

32 of 42 people found the following review helpful

4.0 out of 5 stars Excellent Macro Review, but No Smoot-Hawley Tariff Act Discussion July 22, 2008

By James East VINE™ VOICE

Format:Hardcover

At the risk of getting taken to the wood shed by both Academics and Economists, I will venture out and provide a few comments from the view of an aspiring autodidact.

First, I would like to commend both the author and editor on a good job in the editing process, as this translation reads and flows like an English first edition. Second and as for the subject matter, the thesis is well documented and one would have a hard time to find fault with its premise. However, I will take issue with two minor points (A & B below) of which I hope will expose a small point for possible improvement and betterment for the "search of the holy grail" that hopefully in the end, may actually boost the thesis.

At issue, and from page 108 "we must conclude that the Great Depression was 13.6 percent a credit supply problem and 86.4 percent a credit demand problem."

A) I am very surprised that any discussion about the Great Depression would not even mention the Smoot-Hawley Tariff Act of 1930, which started moving thru congress the year before in 1929. Some have previously argued that this legislation started the intial cracks in the stock market before it eventually broke in October. In addition, and a very important consequence of this act was what subsequently happened to world trade and its subsequent higher retaliatory tariffs from around the world after it became law. As the US economy moved thru the next 2 years, many more tariffs were increased even after its original passage into law all thru and up until the 1932 elections at which point the winning candidate ran on a non-Nationalistic platform (i.e. on a reduced tariff platform). Why is this so relevant?... It is very relevant because on top of the already pre-existing war debt, even more private debt was lent to foreign entities during the boom of '21-'29. As the entire world contracted due to the reduced trade, the repayment of domestic debt by foreign entities became tough and may have contributed more than marginally to further decreased asset prices and of debt deflation? -- Which leads to my next point B.

B) Though discussed, it appears that the short discussion to dismiss Irving Fisher's debt-deflation thesis may have missed the point that Mr. Fisher was making. In the light of both the asset bubble cracking in late '29, then the subsequent reduced trade which played havoc not only on meeting interest payments, but actually principal debt repayment, placed further pressure on asset values. Toss in some increased tax rates, and the (9) point debt-deflation thesis (see below) holds up very well, at least in my view.

Assuming a state of over-indebtedness exists (meaning corporate and private), this will lead to liquidation, through the alarm either of debtors or creditors or both. Then we may deduce the following chain of consequences 1) Debt liquidation leads to distress selling, 2) Contraction of deposit currency, as bank loans are paid off which leads to the slowing of the velocity of money which precipitates more selling, 3) A fall in the level of prices, causing, 4) A still greater fall in net worths of business, precipitating bankruptcies, 5) A like fall in profits, curtails employment and production, 6) A reduction in output, trade, and employment, lead to, 7) Pessimism and loss of confidence, which in turn leads to, 8) Hoarding and slowing down more the velocity of circulation, and the above eight cause, 9) Complicated disturbances in the rates of interest, or the fall in money rates and the rise in the real, or commodity, rates of interest.

Outside the two points above (A) & (B), a highly recommended book on both the macro economy and the benefits of fiscal policy over monetary policy under certain (or specific) economic conditions. A truly worthy read for one's Macro Economic education.

Side note: If there is a 2nd Edition, note that Long-Term Capital was not a bank, but a highly leveraged US Hedge Fund. However, the reference maybe was meant to be for Long-Term Credit Bank of Japan.

Post Script: Given the recent actions by the US Government in September 2008, many policy makers appear to be aware of the dangers to which Mr. Koo warns about in his earlier book "Balance Sheet Recession" and in the updated version of "The Holy Grail of Macroeconomics". Time will tell if the US Congress will comply, or repeat some of the mistakes of the past. Read more ›