Monday, December 12, 2011

Richard Koo on the state of the world


Koo sees the world staring into the abyss of a deflationary spiral due to a policies imposing fiscal austerity in a "balance sheet recession."

Read the whole article — PDF download
The world in balance sheet recession:  causes, cure, and politics
by Richard C. Koo  (Nomura Research Institute, Tokyo)

Koo concludes:
It is laudable for policy makers to shun fiscal profligacy and aim for self-reliance on  the part of the private sector. But every several decades, the private sector loses its self-control in a bubble and sustains heavy financial injuries when the bubble bursts. That forces  the private sector to pay down debt in spite of zero interest rates, triggering a deflationary  spiral. At such times and at such times only, the government must borrow and spend the  private sector’s excess savings, not only because monetary policy is impotent at such times  but also because the government cannot tell the private sector not to repair its balance sheet.
Although anyone can push for fiscal consolidation in the form of higher taxes and  lower spending, whether such efforts actually succeed in reducing the budget deficit is  another matter entirely. When the private sector is both willing and able to borrow money, fiscal consolidation efforts by the government will lead to a smaller deficit and higher growth  as resources are released to the more efficient private sector. But when the financial health  of the private sector is so impaired that it is forced to deleverage even with interest rates at  zero, a premature withdrawal of fiscal stimulus will both increase the deficit and weaken the  economy. Key differences between the textbook world and the world of balance sheet  recessions are summarized in Exhibit 17.  
With massive private sector deleveraging continuing in the U. S. and in many other  countries in spite of historically low interest rates, this is no time to embark on fiscal  consolidation. Such measures must wait until it is certain the private sector has finished  deleveraging and is ready to borrow and spend the savings that would be left un-borrowed by  the government under an austerity program.
There will be plenty of time to pay down the accumulated public debt because the  next balance sheet recession of this magnitude is likely to be generations away, given that  those who learned a bitter lesson in the present episode will not make the same mistake  again. The next bubble and balance sheet recession of this magnitude will happen only after  we are no longer here to remember them.
While Koo and MMT are in agreement on many points in the analysis, Koo seems to cling to the loanable funds doctrine and the intertemporal government budget constraint in thinking that the government's deficit ("public borrowing") needs to be reduced pro-cyclically to make space for private sector borrowing. According to MMT loanable funds and the IGBC are inapplicable under the existing monetary system for currency sovereigns, although currency users like the countries of the EZ are in a different situation. Lumping them together is incorrect.

Moreover, the government's fiscal deficit is automatically counter-cyclical in that tax revenue falls in recessions and the automatic stabilizers force government payments up. The opposite occurs upon recovery, bringing the deficit down as tax revenue rises and stabilization falls.

So while Koo is close to MMT, he is not there yet.

4 comments:

Matt Franko said...

Tom,

One thing I see holding prices up is the price of oil.

You have the monopolist OPEC in control for now, keeping this price up near $100 and this feeds into food and even housing imo.

Then you have the govt sector "ratifying" these high prices by just paying the price with no quibble. (govt being largest buyer of petroleum products)

There is a lot of cost in building materials due to the high cost inputs for petroleum (transportation) and energy. My architect friends are still telling me (in my area) around $100/psf. sales price for residential construction, perhaps a bit lower if you cut some corners with materials.

Perhaps if the regulators force liquidations (a la S&L industry in the 90's) on property (which they are not doing) we could get some deflation.

I have not seen any liquidations in my area, none!. It seems the regulators are letting the banks hold on to things vice liquidations, even restaurants they are letting them hold onto and having restaurant mgmt companies come in and just run them as a "breakeven" operations competing against mom and pop restaurants that have to actually make money to stay in business. This should be a crime.

So without liquidations and with OPEC in control and the govt just paying the posted OPEC prices, it is hard for me to see meaningful deflation at this point.

If we can get petro to collapse and regulators to force banks to liquidate, I can see some deflation then for sure, but I dont see how we get those 2 things to happen from here, not for a long while anyways....

It will soon be all we can do is drive to work and eat if this keeps up, peonage.

Resp,

Tom Hickey said...

Matt, energy is the fly in the ointment for sure. But we already knew that for some time.

Someone has to take a hit, Creditors are the logical choice since it was their overreach that led to the debt-deflation, But they are nixing any talk of haircuts. The Saudis aren't about to be nice guys and step up to take the hit instead.

Of course, if governments had a clue, then they could step up, but that is not about to happen due to the politics of austerity "to impose discipline" and "avoid inflation." So we are caught between a rock and hard place.

TPTB want "the little guy" — workers, students, elderly — to take the hit through imposed austerity. If there are going to be any liquidations, it's going to be foreclosures and anything that can be repossessed. The objective of this imposed austerity is to shrink "the welfare state" and to force wages down while supporting asset prices and financial markets.

This is not working politically as society becomes more dysfunctional due to a frontal assault on "the 99%." "The 99%" make up the majority, so if their anger gets focused then they can change things at the voting booth. So all the media hype is about preventing that focus from occurring and breaking it as soon as it threatens to pop up.

As a predictable result, the wheels are starting to come off.

NeilW said...

" At such times and at such times only, the government must borrow and spend the private sector’s excess savings,"

There is no 'must' about it. It is just one of the options.

The other option, within the Credit money circuit, is to confiscate these excess savings - which are essentially unearned - and give them to the people on the other side of the deal to eliminate the private debt.

And you can do that three ways - taxing the excess savings, declaring a debt jubilee, or collapsing the economy and letting the bankruptcy mechanism destroy the excess savings.

Unforgiven said...

Neil -

It seem that loans have been complicit in most economic downturns and the offending loans have enjoyed gov't support, one way or the other. I sometimes wonder if it's a "gift" from one administration to the next...

How about a national lottery instead, with large and frequent payouts, attenuating the need for loans at an opportune time?

Really, how do we get this under control? X amount of private sector loans must be accompanied by Y amount of gov't spending?