Trusting in the fiscal pump

by Gregory Clark

“Learn from Japan,” they said as the U.S., British and EU economies headed for their current downturns. Well, they may have learned something. But until very recently that something clearly was not enough.

One thing they do seem to have learned early on was the extreme folly of Japan’s venture into supply-side economics at the height of its post-”bubble” downturn. So now no one is foolishly calling for governments to cut spending.

No Western financial medium seems keen to repeat those editorials from Japan’s main economic newspaper, Nihon Keizai Shimbun (Nikkei), dismissing Keynesian economics as some kind of old-hat anachronism. As someone put it, we are all Keynesians now. Everyone, even Tokyo, now realizes the need for governments to pump money into a flagging economy.

But how much money? The United States took a very long time to realize the main lesson from Japan’s “lost decade” — namely, that a deflationary slump is radically different from a recessionary slump. Recessions tend to self-correct: If asset prices fall, returns increase, investors move in and prices recover. Or as we saw in the Asian financial crisis of the late 1990s, if currencies collapse, exports expand, the economy recovers.

In short, if A goes down, B goes up. We are soon back to normal, though some fiscal pump-priming is always welcome.

But what happens when A goes down, and not only does B go down but C, D, and a host of other economic factors as well, which in turn push A further down, together with B, C, D, etc.? Then everything changes. We are in a deflationary spiral, as Japan was to some extent during the so-called structural reform era of former Prime Minister Junichiro Koizumi. Unchecked, we are soon in a 1930s’ style Great Depression.

Fortunately, U.S. policymakers have in the past week or so finally begun to realize this danger. They realize that low or even zero interest rate monetary policies are no help. You have to go fiscal — push as much money as you can into every corner of the economy that needs it. Stop the rot.

But for a long time those realizing this need were an endangered species, accused simultaneously of bankrupting the nation and encouraging red-hot inflation. As recently as early October, the ever-conservative Wall Street Journal was able to run a column entitled: “We Won’t Suffer a Japanese Deflation.” The risk here and now is inflation, wrote one David Gitlitz.

Even as late as early November, an article by Samuel Brittain in the Financial Times urging massive government spending was seen as rather iconoclastic (even if that rather conservative paper was good enough to publish an approving response from myself). The move to what we see now — what some call the “helicopter approach” of scattering money in the billions, even trillions, in every direction — was not made before U.S. authorities repeated a few other Japanese mistakes.

To begin with, the original U.S. rescue operations were far too piecemeal — a classic example of too little, too late. As in Europe, there was also too much reliance on the low interest rate approach, although British Prime Minister Gordon Brown, a rare example of an economist as prime minister, realized early on the need for more drastic moves.

Then there was the psychological damage caused by allowing Lehman Brothers to collapse, which matched the damage caused by the premature collapse of Japan’s Yamaichi Securities in 1997. The U.S. also took much too long to clamp down on “trash and cash” — the focused short-selling techniques of the hedge funds — which brought several of Japan’s banks to their knees during the Koizumi years.

And like Japan, many in the U.S. have still to realize the harm caused by mark-to-market accounting which, incidentally, caused the Yamaichi collapse, cheered on by the usual claque of free-market fundamentalists.

The one saving grace in all this is the current U.S. revulsion against the financial cowboys who caused this disaster. But will it last?

As in the U.S. after the Vietnam War, the “best and brightest” may have been discredited. But as in foreign affairs, where in the so-called war on terrorism we are seeing a repetition of the same ignorance and mistakes that led to Vietnam, it is only a matter of time before the discredited return. The textbook fundamentalists could soon be back in command. Their weapon will be the complaints I mentioned earlier — waste of public funds and the danger of inflation.

With honorable exceptions such as the Japan Economic Recovery Association people supported in the past by current U.S. Federal Reserve Chairman Ben Bernanke and several other top U.S. economists, most fail to realize that governments have every right simply to create the money needed for recoveries, either by themselves printing money or by forcing central banks to cooperate. Taxpayer funds are not needed.

And, as in Japan, funds provided may well be repaid with interest, once recovery gets under way. As for inflation, governments also have the tools to clamp down on that problem too once recovery gets under way — provided once again they do not move too little, too late.

Gregory Clark is vice president of Akita International University. A Japanese translation of this article will appear on