KRUGMAN: Japan heads for the edge
world's second-biggest economy is facing a needless slump because of the
passivity of its monetary authorities
have long been pessimistic about Japan's near-term prospects, believing
that its economy requires a more aggressive and less conventional stimulus
plan than the government has so far been willing to contemplate.
now, however, the situation seemed depressing but not alarming, with the
main risk being stagnation rather than collapse. Surely, I imagined, so
wealthy and sophisticated a nation will always be able and willing to do
whatever is necessary to avoid disaster.
in the past month or so the near-passivity of Japanese authorities in the
face of slumping bond prices and a sky-high yen has made me wonder. It
is starting to look entirely possible that the managers of the world's
second-largest economy will simply stand by, paralyzed by an odd mixture
of pride and intellectual confusion, as their nation goes into a deflationary
why the yen has risen by 25 per cent since early October, and the yield
on Japanese government bonds risen so sharply, can be disputed. Surely
neither reflects a sudden surge of optimism about the future of the Japanese
economy. The most likely explanation is that special events - the collapse
of Russia, the announcement that some public agencies will not buy as many
bonds as expected - started a sort of cascade of margin calls, in which
highly indebted holders of both yen and dollar bonds were forced to sell
their assets, driving prices down and thereby leading to further margin
calls. If true, this story suggests that markets are a lot less liquid
and efficient than economists like to believe.
whatever the reasons for these market moves, their effect is clear: they
impose new deflationary pressures on an economy that was already looking
dangerously weak. And that means that the case for a radically expansionary
monetary policy, always strong, has now become over- whelming.
or nine months ago, when I and others were arguing that Japan should engage
in aggressive monetary expansion and even deliberately target a positive
rate of inflation, the main objections were that such a policy would be
ineffective (although in that case what harm in trying?) and that it would
risk an excessive depreciation of the yen. Bet ter, went the conventional
view, to rely on fiscal expansion plus bank reform to get the economy moving.
look at the situation now. If nothing else, the rise in bond yields, the
awesome size of prospective deficits, and the realisation by rating agencies
that Japan's debt already exceeds its gross domestic product mean that
fiscal expansion has reached a limit. If the current push is not enough
- and it is not - there will not be another.
claim that bank recapitalisation will unleash massive new lending has always
been a questionable proposition, and looks no more convincing now. Anyway,
the contractionary effect of the strong yen and higher interest rates will
probably swamp the effects of the government's stimulus plan; and falling
bond and dollar prices will wipe out bank capital even as the government
tries to put more in. Surely at this point the risks of printing more money
are far outweighed by the risks of not doing so.
is truly puzzling is why Japan's financial authorities have not regarded
these market events as a call to action. Why did the Bank of Japan wait
until the yen had risen to Y110 to the dollar before intervening, and then
do so only on a small scale - rather than buying dollars aggressively months
ago? Why hasn't it bought enough Japanese government bonds to keep yields
ask where the money would come from: it could and should simply be created.
There would be no reason at all to "sterilise" these operations by selling
other assets. On the contrary, the situation offers a perfect opportunity
to effect a salutary expansion of the monetary base.
can only guess why none of this is happening. Is Japan's Ministry of Finance
so committed to promoting the yen's role as an international currency that
it does not care if that currency is backed by an imploding real economy?
Does it still fear, after eight years of slump, that expanding the monetary
base will reinflate the asset market bubble? Has it developed some novel
economic theory under which a strong yen and high interest rates are expansionary?
the reasons for inaction, the story is starting to look like a tragedy.
A great economy, which does not deserve or need to be in a slump at all,
is heading for the edge of the cliff - and its drivers refuse to turn the
author is professor of economics at the Massachusetts Institute of Technology