Should the United States be concerned about ending up like Japan in the 1990s? There are signs that American policymakers are worried about just such a development. By this they and other economists mean the threat of an extended recessionary period of sub-par growth, and an inability to sustain a recovery, apparently because of bad assets weighing down the economy's financial system. Last week's lock-up in the US commercial paper and short-term lending markets for solid non-financial corporations, reminiscent of what preceded the real economy nose-diving in Japan in 1997-98, made the prospect all the more real.
While it is important to take the proper lessons from Japan's experience, indeed the worst seen by a rich democracy since the Great Depression, everyone should calm down.
Japan's economy stayed in a hole for a decade because repeated macroeconomic and financial policy mistakes kept slamming it back down every time the economy recovered. Monetary policy only became ineffective because the financial problems were neglected for a long period. Fiscal policy remained effective, but it was misused. After years of policy mistakes, Heizo Takenaka, minister of state for economic and fiscal policy, turned around financial and macro policy in 2001-03 in line with this analysis, and Japan went on to have its longest postwar recovery.
The US situation today is less dangerous than Japan's in 1992 or 1997 for several reasons:
- Monetary policy was eased far more aggressively by the Fed after the bubble burst than in Japan.
- Fiscal stimulus already undertaken and that underway is far larger (controlling for cyclical factors like automatic rises in unemployment insurance) in the US than it was in Japan.
- The write-off of bad debt and recapitalization of the banking system has already progressed much further, much faster than in Japan, and will be largely completed once the bailout goes through. It took Japan eight-plus years to accomplish the same thing.
- Mark to market accounting in the US has forced the banks to be more transparent and disciplined than the so-called "convoy system" in Japan, which encouraged Japanese banks' to keep their bad debt hidden.
- While the residential mortgage problem has just begun to affect commercial and consumer credit in the US in the normal transmission mechanism, in Japan structural ties between non-financial businesses and banks immediately amplified the impact and synchronicity of asset price declines.
- The US faces a somewhat inflationary environment, only now being offset by the housing bust slowdown, whereas Japan had ongoing deflationary pressures forcing down consumption.
- The US has been a capital importer, saving too little, and thus can have some benefits from an increase in savings induced by the slowdown, while Japan was already saving excessively before its recession began, making matters worse.
None of this lets US regulators and bank supervisors, including the Fed, off the hook for their failures before the bubble burst. There are uncomfortable parallels with Japan and other financial fragility episodes on that score. But this does say the impact of financial turmoil will be less here.
Japan's experience certainly reinforces for the US the message that it is better to respond to financial problems quickly than to let them mount, and that aggressive macroeconomic stimulus is worthwhile. But it denies the claims of the prophets of doom who say that if policymakers do not act within a brief window of opportunity, the situation becomes irretrievable. Even after the Great Depression was under way, once countries exited their gold standard commitments and loosened monetary policy, they began to recover. So let us be decisive and activist, but calm down. Only outright financial panic as briefly glimpsed last week presents a risk for persistent damage potentially beyond government policy's ability to fix the situation. However designed, the bailout should be able to forestall that.