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51 of 53 people found the following review helpful
5.0 out of 5 stars Brilliant attack on conventional policies, September 14, 2009
This review is from: The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession (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."
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Showing 1-7 of 7 posts in this discussion
Initial post: Feb 28, 2010 5:46:34 PM PST
[Customers don't think this post adds to the discussion. Show post anyway. Show all unhelpful posts.]

Posted on Jul 3, 2010 2:16:14 AM PDT
Kyle says:
The Great Depression was not caused by President Hoover cutting spending and Hoover did not cut spending. President Hoover was for increasing spending and FDR in fact ran against Hoover by saying he would cut down on Hoover's excessive spending. What caused the Great Depression was the Smoot-Hawley tariff which was a tax on 20,000 imports which led to a global trade war and then a massive tax increase to try and balance the budget. The unemployment rate skyrocketed. Then to top it all off, the Federal Reserve raised interest rates. You never raise interest rates during a recession and let the banking and financial system collapse, and you don't try to balance the budget via tax increases in the midst of a recession either, you have to cut spending only. As for deficit spending fixing an economy, FDR's own Treasury Secretary said that all the spending FDR was doing was not working.

Japan tried some $2 trillion in fiscal stimulus over a period of a few years, with a $5.5 trillion economy, and it did nothing. Technically, stimulus is not needed. Economists said in 1980 that if Margaret Thatcher cut spending, Britain's economy would never recover. Well she continued cutting spending and it recovered fine.

In reply to an earlier post on May 16, 2011 9:25:04 AM PDT
Yoda says:
That's a very deep and profound analysis. You should be nominated for the Nobel prize.

In reply to an earlier post on Aug 9, 2011 7:03:08 AM PDT
Ben Green says:
Your analysis would be improved if you had respected Koo's distinction of the "balance-sheet" recession as the kind he addresses. Are all of your examples aftermaths of asset bubbles?

In reply to an earlier post on Dec 28, 2011 7:40:21 AM PST
That Smoot-Hawley caused the Great Depression is rebutted in Douglas A. Irwin's book, "Peddling Protectionism"

Posted on Feb 25, 2012 7:28:19 PM PST
Last edited by the author on Feb 25, 2012 11:40:33 PM PST
Kyle's assertion about Herbert Hoover is correct. The story that Hoover was a budget slasher is not only a myth, it's the exact opposite of what really happened. Which is why Keynesians always make the assertion, but never produce the actual budget numbers for scrutiny. Well here they are.

As you can see, from Hoover's first budget in FY31 (which began in July of 1930) to his final budget ending June of 1934, nominal government spending rose 81% (3.6B to 6.5B). But more importantly, as a % of the shrinking economy he ballooned government spending by 149% (4.3% of GDP to 10.7%). Imagine exploding the government to 2-1/2 times its original size in just one term. He also took Calvin Coolidge's final budget's surplus of 0.8% of GDP and transformed it into a 6% of GDP deficit by the time he left.

The skyrocketing government spending and deficits SHOULD have been the Keynesian magic bullet that the Koos and Krugmans preach would avoid another Great Depression, but instead the USA got... well, The Great Depression.

As for the "cutting spending" myth, it is true that Hoover cut spending by $100 million (or 2%) from FY32 to FY33, but as a % of GDP he actually spent 16% more. In fact the government grew rapidly as a % of the economy in every single one of Hoover's budget years. And besides, should a 2% nominal cut really transport the economy from Keynesian recovery (which wasn't happening, to the contrary it was getting a lot worse) to spiraling out of control?

Perhaps the more logical answer (which the Keynesians never want to talk about) is that the other part of that Hoover austerity package included the largest peacetime tax hike in American history with the Revenue Act of 1932. Taxes on all incomes and capital gains were hiked dramatically with the top rate jacked up a whopping 2-1/2 times its original level from 25% to 63%.

By the way FDR raised the top rate again to 79% in 1936--the year before the "Depression within a Depression" of 1937-1938 but again the Keynesians only talk about FDR's spending cuts--not the tax hikes and Wagner Act--being the cause of that other slump.

Hoover's massive income/capital gains tax increases, massive explosion in government spending, and the Smoot-Hawley tariff which launched the trade war that sank exports by 67% contributed a lot more to the Great Depression than his measly 2% nominal spending cut which was actually a real 16% spending hike. Yet we keep hearing the myth repeated that Hoover slashed spending and that somehow that was the cause of entire calamity, with no mention whatsoever of the other much larger factors.

It's no wonder the bottom of the economy fell out the year after the tax hikes and unemployment sank to almost 25%.

BTW how does Koo explain that prior to the Great Depression, the longest American slump was the railroad debt-bubble Depression of 1893 which lasted only 4, maybe 5 years depending on how you measure it? There were no Keynesian monetary or fiscal prescriptions then, so by his logic that recession should have spiraled even further out of control with no countercyclical impediments and lasted even longer than the Great Depression. Yet in both Japan's and 1929-1946's case, the government blitzed the economy with Koo's interventionist medicine and both slumps lasted more than three times longer than what was previously America's longest recession.

In reply to an earlier post on Apr 16, 2013 9:24:24 PM PDT
Nguyen Tran says:
The spending Margaret Thatcher cut was, a great part, government subsidies on key industries. Britain was running a semi-central-planning economy; the Iron Lady threw the lot of State enterprise back into the market and let them duke it out with the private enterprises. Without loss-making factories sucking money out of the treasury, spending is reduced. With competition back into the economy, it starts getting healthier, thus the economic recovery.

Keynes fiscal policy does not mean nationalizing industries and subsidizing their losses. It means the government relieving the economy of the financial burdens it naturally has to bear, so that businesses can re-balance their budgets and has the gut to take loans and expand. At this point, government can sit back, relax and balance its own budget.
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