Undoing lessons from Japanese crisis..

Economists never cease to surprise. You get tons of papers pointing to one set of ideas. And then comes another ton of papers which tells you what you have learnt is questionable.

For instance, we all have taken for granted that Japan made several mistakes in its 1990s crisis and US and others are doing the same. There is so much similarity between US and Japan that US is also expected to have its lost decade. Moreover, we look to Japan to make policies in US and others to revive from the crisis.

John Muellbauer and Keiko Murata dispute these well-accepted findings. They say Japan was different and so are US/UK. The current policies of lower rates might work better in US/UK but were not really effective in Japan.

Monetary transmission via Japan’s household sector is sharply different from that operating in the US and other industrial countries, and hence why monetary policy analogies with Japan should not be taken too far. In recent research with our colleagues (Muellbauer and Murata 2011 and Aron et al forthcoming), we explain why. Indeed, pushing the analogies too far probably contributed to US monetary policy errors in 2002-05, which in turn deepened the crisis that followed.

Our research focuses on the empirical analysis of Japanese consumption and household saving behaviour and explains the role of the household sector in the monetary transmission mechanism in Japan. We find two major differences in Japan compared to the US and the UK.

  • First, Japan has not experienced the kind of liberalisation of credit conditions for households seen in the US and the UK.
  • Second, the impact on consumer spending in Japan of higher house prices is negative, while in the US and UK it is positive.

Hmmm. Very interesting.

On second they say Japan is different. Unlike US and UK where consumption goes up because house prices go up, in Japan consumption declines. People instead save more to finance future homes in Japan.

in the US and UK, there is an important asset-price channel, which, according to our estimated Japanese consumption function, is not just switched off in Japan, but even works in reverse. Using data going back to 1961, we find that real land prices have a negative effect on consumption in Japan, controlling for income, financial assets and debt, interest rates, and proxies for uncertainty and for income growth expectations. Thus, when real land prices rise, young households and other renters save more, partly because larger down-payments are then needed before a mortgage can be obtained and partly because future rents will be higher. This dominates the wealth effect for older households, which we believe is small partly because of the inheritance tax advantages in Japan of leaving housing assets to their children. For shorter sub-samples in which there is less variation in real land prices, this negative land price effect is weaker than for the full period. Nevertheless, for no period can we find a remotely significant positive effect from physical assets or real land prices on consumption.

Then Japanese have high asset/income ratios. Most assets are in form of bank deposits nad Japanese draw incomes from interest from deposits. As rates declined, people lost incomes and limited consumption as well:

A second reason for the weak, or even perverse, interest-rate transmission mechanism for households in Japan comes from inter-temporal consumption theory. This says that households who are averse to fluctuations in consumption (who have a low elasticity of inter-temporal substitution) and a high asset-to-income ratio will experience positive effects on consumption from a rise in the real interest rate, while the opposite is likely to be true for households with the opposite characteristics.

Japanese households have among the highest asset-to-income ratios in the world, particularly for bank deposits. They may also be particularly cautious, so are more averse to fluctuations in consumption. Indeed, we find a very significant and robust positive real-interest-rate effect in our Japanese consumption function. Thus, the fall in short-term rates after 1993 had a negative direct effect on consumption spending in Japan. However, the later rise in real rates because of falling prices supported consumption. This contradicts the conventional Anglo-centric view that falling prices are a disaster for consumption. Figure 2 illustrates the sizable long-run effect of real interest rates on the consumption-to-income ratio in Japan. It suggests that the rise in real rates induced by price deflation after 1998 actually had a small positiveeffect on the consumption-to-income ratio

However, they add it is not as if interest rate channel has been absent in Japan or lower policy rates will not work in japan. It is just that the overall impact is going to be much weaker than US/UK.

On fiscal policy they say Japanese are more Ricardian as believe higher debts would lead to more taxes in future. Hence do not spend:

We find significant negative effects from fiscal debt-to-GDP ratios in on future growth of GDP and household income, while similar models for the US find far weaker effects. The forecasts from these models are significant in explaining consumption growth, and suggest that there is an important ‘Ricardian’ element in the behaviour of Japanese households. In other words, it appears that Japanese households have some understanding of the fact that high levels of government debt will raise future tax rates or lower future government spending which could have benefitted households.

Hmm.. Interesting pointer on typical Japanese behavior..

So basically, from their research Japan is different and hence struggling. Why are US/UK struggling despite so much policy action? The impact of interest rates etc should be greater in US/UK. They say excesses were much more in US/UK thanks to huge financial liberalisation. Hence, the positives of policy have been diminished by excesses earlier which are getting corrected now:

Credit availability for US and UK households has contracted relative to the excesses before the financial crisis, so that in this respect, differences from Japan have diminished. While this implies that the transmission, via households, to economic activity of the interest rate set by monetary policy in the US and the UK is now somewhat weaker than it was before, the differences from Japan far outweigh the similarities.

Phew…A different perspective altogether…

Based on this not much could be really done in Japan…And US/UK should not slip into Japanesse kind of lost decade trap..Time will tell what will stand true..

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