September 20, 1998
Japan: Newfangled Econ 101 -- Throw Caution to the Wind
By MICHAEL M. WEINSTEIN
he Japanese are well versed in the art of fending off U.S. accusations, including the perpetual hyperventilating over Japan's protectionist trade policies. But nothing from the past could have prepared the Japanese for the latest salvo by several prominent American economists who say the Japanese government has been insufficiently reckless.
By running an overly tight monetary policy, these economists say, and by driving down inflation, the government has inadvertently contributed to a downward spiral of prices and production that has cost the Japanese nearly a decade of growth and added to economic turmoil throughout the region and beyond.
To make amends, the government must now "credibly promise to be irresponsible," says Paul Krugman, a professor of economics at the Massachusetts Institute of Technology. By that he means the central bank should embark on a crash program of printing yen -- creating not only inflation today, but also the expectation of inflation tomorrow and an indefinite number of tomorrows into the future.
Faced with a financial crisis that has swept from Asia to Russia to Latin America, President Clinton and finance officials from the major industrialized powers suggested last week a concerted effort to emphasize growth over inflation fighting, presumably by cutting interest rates. These officials do not want to spur inflation, though it might be an unintended consequence of fighting off recession with looser monetary policies.
Krugman, by contrast, embraces inflation as an economic cure for Japan's maladies. And at a moment when a quarter of the world's population is living through recession or worse, there is good reason to focus on Japan. Solving the growing financial crisis in Latin America requires resolving economic chaos in Asia. And to solve Asia's problems requires re-establishing Japan as an engine of regional growth.
Krugman's puckish prescription sounds wacky enough to Western ears, but to the decorous, orderly Japanese, it probably sounds quite mad. Professor Koiche Hamada of Yale University giggled when asked to contemplate how Krugman's formula would be received by most of the officials who run Japan's central bank.
But as Krugman points out, Japan's desperate plight cries out for unorthodox solutions. And there are signs that his ideas are making inroads: A prominent Japanese lawmaker recently embraced the notion of setting an inflation target.
Let's step back. The Japanese economy, whose rapid and noninflationary growth was the envy of the world in the 1970s and '80s, has fallen into dire straits. Industrial production has stagnated for the entire decade. Wholesale prices have fallen over the past five years, an improbably long time for prices to drop in industrialized economies. Land values have crashed, undermining the solvency of banks whose loans are tied to real estate. Stock prices have also plunged.
Deflation can be just as economically corrosive as inflation. Falling prices create an expectation of future decline, which compels consumers and investors to postpone spending, setting off a self-sustaining downward spiral of production, income, spending and prices.
So what should Japan do? There are any number of ideas, but these are the four usual suspects.
-- Japan could close down its insolvent banks and bail out the others. Only then will the normal interplay between lenders and borrowers resume. A plan along these lines was announced last week. However, such restructuring takes time and provides only a partial solution.
-- The government could try to spend its way out of recession by investing lavishly in infrastructure projects. But the government has an unenviable record of building roads and bridges that go nowhere important, tailoring projects more to the needs of political cronies than to the economy. And this, too, is only a partial answer.
-- Japan could cut taxes to boost spending. But the nation is aging quickly, and the federal deficit will balloon as the elderly retire and draw pensions. So a tax cut today will have to be offset by a tax hike in the future. Japanese taxpayers know this and can be expected to prepare for the eventual hike by stashing money they temporarily save on taxes into their bank accounts instead of spending on consumer goods.
-- The most popular way to stimulate spending -- cutting interest rates -- is impossible in Japan, because their rates are already within an eyelash of zero. The rate controlled by the central bank is already down to 0.25 percent, yet there has been no spending splurge.
Enter Krugman. He urges the central bank to drop its traditional mission of price stability and instead start printing however many yen it takes to generate lasting inflation. The goal is to turn expectations of deflation into their opposite, scaring people into buying goods now before they become more expensive. This pro-inflation policy would also spur investment by companies that could borrow yen that they know will be worth less by the time they have to repay their creditors.
Professor Allan Meltzer of Carnegie Mellon University urges the Bank of Japan to pour out however much money it takes to stop prices from falling, a less extreme goal than Krugman's. Professor Frederic Mishkin of Columbia University also wants to step on the monetary pedal, arguing that people would use the newly printed yen to buy land and other assets, thereby halting the slide in prices. He also says increasing the number of yen would drive down its value on foreign exchange markets and thereby boost exports.
These economists offer bold ideas. But, as Krugman says admiringly of his proposals, "Faced with a novel kind of economic malaise, the results of hard thinking deserve to be taken seriously."
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