As Japan awakes to a new government, the question of monetary easing is certain to take center stage in policy discussion.

No less than U.S. Federal Reserve Chairman Ben Bernanke, back in 2000 when he was professor of economics at Princeton University, lectured Japan on the role of monetary policy in combating deflation and spurring growth.

Bernanke put it bluntly: Notwithstanding the zero interest rate policy, monetary authorities have the power to issue as much money as they want with such action ultimately raising price levels.

Following this logic, we would expect that opening the floodgates of monetary issuance, in conjunction with the zero interest rate policy, would engender vicious inflation. However, Bernanke never seemed to give pause to what money issued by monetary authorities would do. After all, in the United States, since the meltdown of 2008-2009, the monetary spigot was already open to the fullest. Trillions of dollars had gushed out through the bailout programs of Presidents George W. Bush and Barack Obama.

On the heels of these bailout programs came two major bouts of quantitative easing, with QE2 ending in June 2011. At present, the U.S. is in the midst of QE3.

Yet, even with the Fed promising to continue the zero interest rate policy for the next several years, no vicious inflation has materialized.

The problem is that it was always blithely assumed that monetary issuance would stimulate the real economy of production and trade. But in the U.S. since 2008, bank lending to private-sector business has shrunk considerably. The fruits of QE, instead, are sitting idle on bank balance sheets.

The evidence for this is that the monetary base — the so-called high-power money that depository institutions have with the Fed — increased exponentially between 2008 and 2012. This is more than at any time in U.S. history. The same situation of idle balances holds for the European Central Bank.

The challenge for Japan’s new government — if it is to march down the monetary easing road — is to couple monetary issuance with fiscal policy creating active money: Money in the hands of businesses, salary earners, families, pensioners that will be spent on consuming goods in ways that drive the real economy into self-sustaining growth.

Even here, the moves will have to be bold to counter decades of deflation.

richard westra

The opinions expressed in this letter to the editor are the writer’s own and do not necessarily reflect the policies of The Japan Times.

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