Ichiro Suzuki This spring marks the end of Haruhiko Kuroda’s ten-year governorship at the Bank of Japan. (He has served two five-year terms.) Governor Kuroda is forever remembered for the great experiment of extraordinary monetary easing over which he presided during his tenure. In the early 2010s, the Japanese economy was mired in mild deflation, to be the first major country to get stuck in such an economic malaise since the Depression era in the 1930s. Prices began to fall, albeit modestly, in the late 1990s after a burst of asset bubbles at the beginning of the decade and a series of banking crises that followed the bust. In response to falling prices, the Bank of Japan slashed interest rates aggressively, by the standard of the textbook at that time. Economists and scholars outside Japan, however, called the BOJ’s move too timid. Ben Bernanke, who would later become a Federal Reserve chairman, called the BOJ’s action insufficient, saying that he would even buy ketchup (in order to flood the market with liquidity). The BOJ’s version of quantitative easing did not deliver great results initially. The Japanese economy managed to avoid a deep recession amid the global economy’s setback at the turn of the 21st century, after the tech bubble’s bust. A few years later, Japanese banks were finally recapitalized, getting rid of non-performing loans though this was credited to the government, not the BOJ. This enabled the economy to grow again. Then, the subprime crisis in the U.S. dragged the global economy into the deepest recession since the 1930s. Unlike banks elsewhere, Japanese banks’ balance sheets were not contaminated with collateral debt obligations (CDOs) and other toxic securities since their balance sheets were freshly cleaned up only a few years before the global financial crisis. Nonetheless, the global economy’s severest downturn in seventy years exerted immense downward pressure on the Japanese economy as well. Having already tested an unconventional policy of quantitative easing, the BOJ was not left with a room to reduce interest rates much further upon the eruption of the crisis. Other major central banks, especially the Fed under Bernanke, embarked on a very aggressive quantitative easing to save the economy from skidding into deflation. In the absence of meaningful room for interest rates to go lower in Japan, aggressive cuts elsewhere drove international liquidity into Japanese yen assets. Japan’s interest rates adjusted for inflation, which was falling fast, turned out to be higher than those in other developed economies. What was supposed to be ultra low interest rates had proven to be insufficient relative to others. Sharp appreciation of the yen created additional downward pressure on prices in the Japanese economy. A vicious circle became pervasive at the outset of the 2010s. Ben Bernanke and the Federal Reserve Bank eventually won a battle against a risk of deflation in the U.S. The cost of the battle, however, turned out to be much greater than what chairman Bernanke expected originally. The global financial crisis made a huge dent on capital base of banks around the world. Tightened bank regulations worked against recovery of the economy, allowing banks to lend less on a given amount of capital than in years that preceded the crisis. Chairman Bernanke came to realize that it was a great deal easier said than done to revitalize the economy from the brink of deflation. Chairman Bernanke did not conceal his frustration on the progress of economic recovery and persistently weak prices. He called for a help from fiscal policy but Republican-controlled Congress did not respond to him. This experience might have made Chairman Bernanke feel somewhat sympathetic to the Bank of Japan’s Masaaki Shirakawa who was his counterpart at the BOJ for much of Bernanke’s chairmanship at the Fed. The U.S. economy at last restored growth and inflation, getting onto ‘escape velocity’ that left the threat of deflation behind, by the time of chairman Bernanke’s departure from the Fed in 2014. On the other hand, the Japanese economy had to wait until the final year of Governor Kuroda’s second five-year term to witness his original goal of 2% inflation, and it was attributed to global supply chain disruptions and a precipitous fall of the yen rather than robust demand. After ten years of a great monetary experiment in Japan, it was proved that deflation is not a monetary phenomena. Flooding the market with liquidity does not lift inflationary expectations. Much of slow growth in the Japanese economy since the 1990s can be attributed to demography, it is beginning to be believed. In fact, Japan has been doing fine in terms of productivity growth, which is a measurement of value add per person, on par with the U.S. or other major developed economies. It is shrinkage of working population to begin with and then the entire population that have been a drag on economic growth, through fewer consumers as well as workers. Weak growth feeds weak prices. In retrospect, governor Shirakawa did a fine job though he was sharply criticized for his lack of action on the Japanese economy flirting on the brink of deflation. After all, the deflation Japan had suffered, at -0.2% per annum, was hardly comparable to the one in the 1930s. As a leading scholar on the 1930s Depression era, Fed chairman Bernanke was right to fear potential consequences of deflation, and he vehemently fought to save the U.S. economy from tumbling into one. Nonetheless, Japan’s mild deflation experiences were not too terrible. It is true that the economy has been devoid of dynamism but prices were essentially very stable. It is good to have price stability. Albeit under modest growth rates, the Japanese economy posted the second longest post-WWII expansion period, just short of six years under prime minister Abe’s economic policy, Abenomics. While BOJ governor Kuroda’s aggressive monetary easing in part underwrote the expansion, it still did not lift the CPI back to 2% soon enough. After all, a goal of 2% inflation proved to be an impossible dream for an economy that is going through population decline. Even the United States, with much higher body temperature of the economy with growing population, struggled at one point to lift its inflation to 2%. Weak demand due to fewer consumers always reduces pressure on prices in Japan. In addition, demography is weighing on take-home pay of Japanese people through rising social security-related charges, at a time when salaries and wages have found it hard to rise. Such social conditions denied a chance of demand-pull inflation. True, the Japanese economy might have performed better with different policies. Instead of massive fiscal spending in the 1990s that was mocked as building bridges to nowhere, the government could have spent such financial resources on re-skilling workers in a rapidly changing world. Shinzo Abe should have pushed harder to overhaul the labor market that always ranks high on the list of obstacles for economic growth. Such policies would have pushed up growth and inflation somewhat, but probably not a great deal higher. Nonetheless, a radical monetary policy was needed to be implemented for the purpose of exhausting all possible options. Only after having tried it, we are now able to say it didn’t deliver what we had hoped. Not experimenting it would have led us to say today that we should have done it. Unlike containing inflation, monetary policy can deliver only so much when it come to lifting the economy out of the brink of deflation. While there is no ceiling on how high interest rates can rise, zero obviously is a floor on how low rates can go down. Not even quantitative easing can bring interest rates materially below zero, as it was found after a decade long experiment.
Almost ten years after Fed chairman Bernanke pleaded for fiscal policy to boost the economy, the coronavirus made very aggressive fiscal stimulus possible in order to keep the economy away from a feared depression in the developed countries in the West. Policy makers around the world at last have learned a lesson over past ten years from experiments by the Fed and the ECB as well as the BOJ.
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.