Drastic easing of monetary policy urged for Japan

by Julian Ryall

With an apology for a radical — even “shocking” — approach to solving Japan’s economic problems, British economist Andrew Smithers dismissed the strategies put forward by proponents of a supply-side driven recovery as well as those advocating fiscal stimulus measures, during a recent symposium in Tokyo.

Instead of these approaches to reversing the decade-old recession, the founder of Smithers & Co. told the Nov. 10 symposium, organized by Keizai Koho Center, that Japan should dramatically ease monetary policy.

But before it can do that, Japan first needs to overcome its reluctance to face up to the problems that confront the nation, he said.

“The key problems are awkward ones,” he conceded. “The ultimate problem today is a widespread refusal to discuss the key issues and thus never to face them.”

Smithers opened the symposium, titled “Japan’s past decade — bad luck or poor policy?” by laying out the supply siders’ case, which states that inefficiencies at the micro-economic level are the problem, with supply rather than inadequate demand at the heart of the problem.

“Its proponents emphasize some key points: massive inefficiencies are supported by government regulation and ‘zombie’ companies by the banking system; inefficient ‘zombie’ companies reduce the returns on efficient ones; and privatizations, deregulations and the euthanasia of zombie companies would increase investment and growth,” he said.

This argument, however, cannot be fitted into mainstream economics as it involves a “fallacy of composition,” he said.

“At a micro-economic level the bankruptcy of a weak company reduces competition and should thus increase the profitability of the survivors,” he said. “But such bankruptcies also reduce demand, as unemployment rises, which reduces profits.”

Emphasizing Japan’s declining birth rate and the impact that will have on the labor force, productivity and profitability over the next 20 years, Smithers said the supply siders assume that Japan can grow significantly faster than, for example, the United States.

“Without a dramatic change in immigration policies, faster growth in Japan than in the U.S. require an even more dramatic gap in terms of the growth in output per head,” he said. “In short, a productivity miracle.

“That would be nice,” he added, “but it’s not a sound assumption for economic policy.”

Turning to the proponents of fiscal stimulus measures, Smithers said this group’s theory is that Japan is suffering from inadequate demand rather than inefficient supply. That problem, they claim, would be rectified by creating a larger budget deficit.

“Fiscal enthusiasts face the problem that this policy appears to have been tried — and failed to get the economy moving,” Smithers countered. And while Keynesian economic theory states that fiscal stimulus is appropriate for a cyclical recession, Japan’s problems are structural, he added.

Smithers then turned to his own “pet solution.”

“I apologize for saying that Japan needs to run a much higher current account surplus; it’s a shocking thing to say, I know,” he said. “The idea that countries should neither run large current account surpluses nor deficits is deeply ingrained in popular economics. It is, however, dangerous nonsense today.

“Demographic differences between Japan, Europe and America mean that such deficits and surpluses are the natural equilibrium position,” he pointed out, before underlining the importance of reducing the corporate sector’s debts.

“It is often remarked that inflation provides the only long-term solution to Japan’s public sector debt,” he said. “I suspect that it is also, and probably more urgently the only realistic solution to the corporate debt problem.”

“Japan needs inflation,” he added. “It shouldn’t be rapid, but the deflation problem must not get any worse. Japan needs inflation of around 3 percent a year to get the economy back in shape.”

Setting out the ways that the economy could receive that shot in the arm, Smithers suggested increasing the monetary base at an even faster rate than the present 20 percent; weakening the yen by massive market intervention — which would be “very aggressive internationally,” he admitted; or using funding policy to increase the money aggregates directly.

The most effective of these approaches would be the third proposal, he said, which would see the Finance Ministry stopping funding the deficit and borrowing short term.