I came across this wonderful speech by Kazuo Ueda of University of Tokyo. The speech was given in 2001 and Ueda was then a member of Policy Board of Japan.
He points Japan’s monetary policy was far more aggressive then experts think.
I left my career in academia to become a member of the Policy Board, the highest decision-making body of the Bank of Japan (BOJ), in 1998. Since then, I have received various policy recommendations from academics, which I greatly appreciated, but I must say that some of them were based on misapprehensions due to insufficient knowledge of the actual economic situation and monetary policy. On the other hand, many in the academic world are clearly discontented with the BOJ’s allegedly timid approach to monetary easing. Filling the gap between the views of the BOJ and the academic world is not easy, but I hope my speech today will contribute to better understanding between the two.
He then takes you to understand that BoJ was quite aggressive and tried all the tricks in the book to avoid deflation and liquidity trap. There are 3 policy options when interest rates are near zero.
Three options for further monetary easing can be considered when money market interest rates are near zero. First, if the short-term rate is very low but not zero percent, the rate can be lowered further to as close to zero as possible by increasing the monetary base. Second, the BOJ can influence expectations of economic entities by promising to continue monetary easing into the future. Some have called this the commitment or policy duration effect. Third, the BOJ can carry out unconventional operations by purchasing assets other than short-term Japanese government securities.
Read the speech to get some ‘from the ground’ experience in Japan. The things just did not improve in Japan and kept getting worse.The speech points that if deflation like situation happens it is very difficult to reverse it. There are policy prescriptions but getting them to work is a different challenge altogether.
And this is why this speech is a worry. Though, economists may never agree that US faces a situation like Japan but the similarity is getting closer. In Japan it started with the banking sector and went on to impact the entire economy. The banking sector had huge exposures to real estate sector and had huge NPAs. What was also seen in Japan was the huge presence of Zombie lending. The US banking sector may be far more competitive but the balance-sheet picture of both Japanese and US banks (and other developed economies) is likely to be similar – huge losses and need for substantial capital.
The positive this time is unlike Bank of Japan, Fed has reacted much faster. It did see the lessons from Japan but was never sure how bad the problem was. So, though Fed may have acted faster the overall situation in US Banks looks to be much worse than Japan. Let’s see what happens.