Download - Macroeconomic Theory and the Current Crisis
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Macroeconomic Theory and the Current Crisis:
The World Economy’s Escape from Balance Sheet Recession
November 2013
Richard C. Koo, Chief Economist
Nomura Research Institute, Tokyo +81-3-5533-2160
US House Prices Have Been Following the Japanese Experience
Exhibit 1. Cause of Breakdown in Monetary Transmission:
Bursting of Debt-Financed Bubbles
1
40
60
80
100
120
140
160
180
200
220
240
260
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
US: 10 Cities Composite Home Price Index
(US: Jan. 2000=100, Japan: Dec. 1985=100)
Note: per m2, 5-month moving averageSources: Bloomberg, Real Estate Economic Institute, Japan, S&P, S&P/Case-Shiller® Home Price Indices, as of Oct. 31, 2013
Composite Index
FuturesJapan: Tokyo Area Condo Price1
77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 9 7 98 99
Japan: Osaka Area Condo Price1
Japan falls of f its f iscal clif f(Apr. 1997)
US
Japan
Futures
Exhibit 2. Europe also Experienced House Price Bubbles,
except Germany
2
75
100
125
150
175
200
225
250
275
300
325
350
375
400
425
450
475
500
525
550
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Ireland
Greece
Spain
Germany
(end of 1995 = 100)
Notes: Ireland's f igures before 2005 are existing house prices only. Greece's f igures are f lats' prices in Athens and Thessaloniki. Sources: Nomura Research Institute, calculated f rom BIS and Europace AG data.
90
303
342
514
a symptom of Eurozone crisis
Ireland256
Greece229
Spain214
Germany106
Exhibit 3. Challenge of Abenomics: Get Businesses to Borrow Money
3
-18
-15
-12
-9
-6
-3
0
3
6
9
12
15
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
(Financial Deficit)
(Financial Surplus)
(as a ratio to nominal GDP, %)
Households
Rest of the World
Corporate Sector(Non-Financial Sector +
Financial Sector)
General Government
Financial Surplus or Deficit by Sector
Balance Sheet Recession Global Financial
Crisis
Private
Sector Savings:
8.17% of GDP
1991-2003 shift
= 22% of GDP
Note: All entries are four-quarter moving averages. For the latest f igures, four-quarter averages ending with 2Q/'13 are used.Sources: Bank of Japan, Flow of Funds Accounts, and Government of Japan, Cabinet Of f ice, National Accounts
Exhibit 4. US in Balance Sheet Recession: US Private Sector
Increased Savings significantly after the Bubble
4
-15
-10
-5
0
5
10
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Housing Bubble
IT Bubble
(Financial Surplus)
(Financial Deficit)
(as a ratio to nominal GDP, %, quarterly)
Rest of the World
Households
General Government
Corporate Sector(Non-Financial Sector +
Financial Sector)
Financial Surplus or Deficit by Sector
Note: All entries are four-quarter moving averages. For the latest f igures, four-quarter averages ending with 2Q/'13 are used.Sources: FRB, US Department of Commerce
8.61% of GDP
Exhibit 5. Europe in Balance Sheet Recession: European Private
Sectors Increasing Savings despite record-low Interest Rates
5
-20
-15
-10
-5
0
5
10
15
20
25
30
03 04 05 06 07 08 09 10 11 12 13
UK
Spain
Ireland
Portugal
Italy
(as a ratio to nominal GDP, %)
(Financial Surplus)
(Financial Deficit)
* Private Sector = Household Sector + Non-Financial Corporate Sector + Financial SectorNote: All entries are four-quarter moving averages. For the latest f igures, four-quarter averages ending with 2Q/'13 (only Ireland and Italy,
1Q/'13) are used.
Sources: Flow of funds data f rom Off ice for National Statistics, UK, Banco de España, National Statistics Institute, Spain, The Central Bank of Ireland, Central Statistics Off ice Ireland, Banco de Portugal, Banca d'Italia and Italian National Institute of Statistics
Private Sector Savings as %
of GDP
Ireland: 6.88%
Spain: 12.41%
Portugal: 8.94%
UK: 3.49%
Italy: 1.73%
Exhibit 6. Drastic Liquidity Injections Resulted in minimal
Increases in Money Supply and Credit (I): US
6
70
100
130
160
190
220
250
280
310
340
370
400
430
Monetary Base
Money Supply (M2)
Loans and Leases in Bank Credit
(Aug. 2008 =100, Seasonally Adjusted)
0.5
1.0
1.5
2.0
2.5
3.0
07/1 07/7 08/1 08/7 09/1 09/7 10/1 10/7 11/1 11/7 12/1 12/7 13/1 13/7
(%, yoy) Consumer SpendingDeflator (core)
Sources: Board of Governors of the Federal Reserve System, US Department of CommerceNote: Commercial bank loans and leases, adjustments for discontinuities made by Nomura Research Institute.
422
141
100
+1.23%
Exhibit 7. Drastic Liquidity Injections Resulted in minimal
Increases in Money Supply and Credit (II): Eurozone
7
80
90
100
110
120
130
140
150
160
170
180
190
200
Base Money
Money Supply (M3)
Credit to Euro Area Residents
(Aug. 2008 =100, Seasonally Adjusted)
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
07/1 07/7 08/1 08/7 09/1 09/7 10/1 10/7 11/1 11/7 12/1 12/7 13/1 13/7
(%, yoy)
CPI core
Sources: ECB, EurostatNote: Base money's figures are seasonally adjusted by Nomura Research Institute.
139
108
100
+0.8%
Exhibit 8. Drastic Liquidity Injections Resulted in minimal
Increases in Money Supply and Credit (III): UK
8
50
100
150
200
250
300
350
400
450
500
Reserve Balances + Notes & Coin
Money Supply (M4)
Bank Lending (M4)
Aug. 08'
(Aug. 2008 =100, Seasonally Adjusted)
1
0
1
2
3
4
5
6
07/1 07/7 08/1 08/7 09/1 09/7 10/1 10/7 11/1 11/7 12/1 12/7 13/1 13/7
CPI (ex. Indirect Taxes)(%, yoy)
Sources: Bank of England, Of f ice for National Statistics, UKNotes: 1. Reserve Balances data are seasonally unadjusted. 2. Money supply and bank lending data exclude intermmediate f inancial institutions.
458
112
85
+2.9%
Exhibit 9. Drastic Liquidity Injections Resulted in minimal
Increases in Money Supply and Credit (IV): Japan
9
50
100
150
200
250
300
350
400
450
500
550
Monetary Base
Money Supply (M2)
Bank Lending
QuantitativeEasing
(1990/1Q = 100, Seasonally Adjusted)
Bubble Burst
Quantitative and Qualitative Easing
-3
-2
-1
0
1
2
3
4
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
(y/y, %)
CPI Core(ex. fresh food)
Note: Figures for bank lending and BOJ's targets are seasonally adjusted by Nomura Research Institute.Source: Bank of Japan
Earthquake
498
183
+0.7%
106
Exhibit 10. Japan’s GDP Grew despite major Loss of Wealth and
Private Sector De-leveraging
10
down87%
25
40
55
70
85
100
115
130
0
20
40
60
80
100
120
140
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
(Sep.1990=100, Seasonally Adjusted)
Real GDP(Right Scale)
Land Price Index in Six Major Cities(Commercial, Left Scale)
(Sep. 1990=100)
Sources: Cabinet Of f ice, Japan Real Estate Institute
Nominal GDP (Right Scale)
Likely GDP Path w/o Government Action
Last seen in 1973
Reported Fiscal Multiplier
Actual Fiscal
Multiplier
Cumulative 90-05 GDP
Supported by Government
Action: ~ ¥2000 trillion
Cumulative Loss of
Wealth on Shares and Real Estate
~ ¥1500 trillion
Exhibit 11. Japanese Government Borrowed and Spent
Unborrowed Savings of Private Sector to Sustain GDP
11
overall deficit ¥460
trillion
20
30
40
50
60
70
80
90
100
110
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Ministry of Finance, JapanNote: FY2013 is initial budget and FY2012 is supplementary budget.
Government spending
Tax revenue
Bubble Collapse
(Tril. yen)
(FY)
cumulativecyclical
deficit
90-05 ¥315 trillion
Exhibit 12. Japan’s Money Supply Has Been Kept Up by
Government Borrowings
Credit
Extended to
the Private
Sector
¥601.6 tril.
Credit
Extended to the
Public Sector
¥247.2 tril.
(+106.8)
Foreign assets
(net)
¥74.1 tril.
(+41.4)
Foreign Assets
(net)
¥32.7 tril.
Credit Extended
to the Public
Sector
¥140.4 tril.
Money Supply
(M2+CD)
¥621.5 tril.
Credit
Extended to
the Private
Sector
¥501.8 tril.
(-99.8)
Other Liabilities
(net)
¥78.7 tril.
(-74.5)
Other Liabilities
(net)
¥153.2 tril.
Money Supply
(M2+CD)
¥744.4 tril.
(+122.9)
Balance Sheets of Banks in Japan
December 2007
Total Assets ¥823.1 tril. (+48.4)Total Assets ¥774.7 tril.
December 1998Assets
Assets
Liabilities
Liabilities
Source: Bank of Japan "Monetary Survey"
Money Supply Is Kept Up by Government Borrowings (II)
12
Balance Sheets of All Member Banks
Exhibit 13. Post-1933 US Money Supply Growth Made Possible by
NEW DEAL Borrowings
Credit
Extended to
the Private
Sector
$29.63 bil.
Deposits
$32.18 bil.
Credit
Extended to
the Public
Sector
$5.45 bil.
Other Assets
$8.02 bil.
Reserves
$2.36 bil.
Capital
$6.35 bil.
Other
Liabilities
$6.93 bil.
June 1929 Assets Liabilities
Total Assets $45.46 bil. Total Assets $33.04 bil. (-12.42) Total Assets $46.53 bil. (+13.49)
Credit
Extended
to the
Private
Sector
$15.71 bil.
(-0.09)Credit
Extended to
the Private
Sector
$15.80 bil.
(-13.83)
June 1936 Assets Liabilities
June 1933 Assets Liabilities
Deposits
$23.36 bil.
(-8.82)
Deposits
$34.10 bil.
(+10.74)
Credit
Extended
to the
Public
Sector
$8.63 bil.
(+3.18)
Credit
Extended
to the
Public
Sector
$16.30 bil.
(+7.67)
Other
Assets
$6.37 bil.
(-1.65)
Other
Assets
$8.91 bil.
(+2.54)
Reserves
$2.24 bil.
(-0.12)
Reserves
$5.61 bil.
(+3.37)
Other
Liabilities
$4.84 bil.
(-2.09)
Other
Liabilities
$7.19 bil.
(+2.35)
Capital
$4.84 bil.
(-1.51)
Capital
$5.24 bil.
(+0.40)
(= Money Supply)
Source: Board of Governors of the Federal Reserve System (1976) Banking and Monetary Statistics 1914-1941 pp.72-79
13
Bank Reserves as Multiples of Required Reserves
Exhibit 14. But in terms of Potential Growth of Money Supply, Kuroda
BOJ Is in the Process of Catching up with the Fed and BOE
14
0
5
10
15
20
25
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Japan
Japan: estimate
U.S.
Eurozone
U.K.
(x)
Bank reserves ÷statutory reserves
19.5x
9.7x
2.6x
Notes: 1. Estimates are based on the assumption that required reserves will increase by 3% a year and bank reserves constitute88.8% of f inancial institution's current deposit holdings with the BOJ.
2. The BOE has suspended reserve requirement in March 2009. The post-March 2009 f igures are based on the assumption
that the original reserve requirement is still applicable.Sources: Nomura Research Institute, based on BOJ, FRB, ECB and BOE data
11.8x
18.7x
21.6x
10.3x
1
2
Exhibit 15. US May be Facing a QE “Trap” (1)
15
Images of Long-term Interest Rates with and without QE
t0 t1 t2
BubbleCollapse
(Long-term interest rate)
without QE
with QE
Economic Recovery(slower growth rate due to higher interest rate)
QE "Trap"
Economic Recovery (normal growth rate)
(Time)
Exhibit 16. US May be Facing a QE “Trap” (2)
16
Images of GDP with and without QE
(GDP)
Benefit of QE
Cost of QE
t0 t1 t2
without QE
BubbleCollapse
with QE
(Time)
Exhibit 17. Peripheral Eurozone Bond Yields Diverged
significantly from the Global Trend
17
0
2
4
6
8
10
12
14
16
18
20
2007 2008 2009 2010 2011 2012 2013
Japan
UK
US
Spain
Portugal
Italy
(%)
Note: As of Oct. 31, 2013.Source: Bloomberg
3%
Eurozone crisis
2.0%
Exhibit 18. The Collapse of Neuer Markt in 2001 Pushed German
Economy into Balance Sheet Recession
18
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
(Dec. 31, 1997 = 1000)
Source: Bloomberg As of Oct. 31, 2013
TecDAX
9694.07
306.32
-97%
1129.85
Exhibit 19. German Private Sector Refused to Borrow Money
after the Dotcom Bubble
19
-15
-12
-9
-6
-3
0
3
6
9
12
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
(as a ratio to nominal GDP, %, seasonally adjusted)
(Financial Surplus)
(Financial Deficit)
Rest of the World
Corporate Sector(Non-Financial Sector + Financial Sector)
General Government
Households
German Private Sector Savings 13.0% of GDPDotcom Bubble
Balance Sheet Recession
Notes: The assumption of Treuhand agency's debt by the Redemption Fund for Inherited Liabilities in 1995 is adjusted.All entries are four-quarter moving averages. For the latest f igures, four-quarter averages ending with 2Q/'13 are used.
Source: Nomura Research Institute, based on the data of Bundesbank and Eurostat
Financial Surplus or Deficit by Sector
Exhibit 20. ECB’s Drastic Rate Cuts to 2% in 2003 Failed to Revive
the German Economy
20
0
1
2
3
4
5
6
7
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
(%)
Sources: BOJ, FRB, ECB, and BOE. As of Oct. 31, 2013.
Eurozone
US
UK
Japan
Exhibit 21. German Households Stopped Borrowing altogether
after the Dotcom bubble
21
-12
-10
-8
-6
-4
-2
0
2
4
6
8-8
-6
-4
-2
0
2
4
6
8
10
12
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
right scale
left scale left scaleFinancial Assets Financial
Surplus/Deficit
Financial Liabilities
(as a ratio to nominal GDP, %, seasonally adjusted)
Note: Seasonal adjustments by Nomura Research Institute. Latest f igures are for 2013 Q2.Sources: Nomura Research Institute, based on f low of funds data f rom Bundesbank and Eurostat
(as a ratio to nominal GDP, %, inverted, seasonally adjusted)
Collapse of the Dotcom
Bubble
Exhibit 22. Spanish Households Increased Borrowings after the Dotcom
Bubble: Now They Are in Severe Financial Distress
22
-16
-12
-8
-4
0
4
8
12
16-16
-12
-8
-4
0
4
8
12
16
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Notes: Seasonal adjustments by Nomura Research Institute. Latest f igures are for 2013 Q2.Sources: Nomura Research Institute, based on f low of funds data f rom Banco de España and National Statistics Institute, Spain
right scale
left scale left scaleFinancial Assets Financial Surplus/Deficit
Financial Liabilities
(as a ratio to nominal GDP, %, seasonally adjusted) (as a ratio to nominal GDP, %, inverted, seasonally adjusted)
Collapse of theDotcom Bubble
Exhibit 23. Irish Households Increased Borrowings after the Dotcom
Bubble: Now They Are Deleveraging
23
-20
-15
-10
-5
0
5
10
15
20
25-25
-20
-15
-10
-5
0
5
10
15
20
02 03 04 05 06 07 08 09 10 11 12 13
right scale
left scale left scaleFinancial Assets Financial
Surplus/Deficit
Financial Liabilities
(as a ratio to nominal GDP, %, seasonally adjusted) (as a ratio to nominal GDP, %, inverted, seasonally adjusted)
Notes: Seasonal adjustments by Nomura Research Institute. Latest f igures are for 2013 Q1.Sources: Nomura Research Institute, based on f low of funds data f rom Central Bank of Ireland and Central Statistics Of f ice, Ireland
Collapse of theDotcom Bubble
Exhibit 24. German-Eurozone (ex. Germany) Competitiveness Gap
Has Macro (50.2%) and Micro (49.8%) Factors
90
100
110
120
130
140
150
160
170
180
190
200
210
220
230
00 01 02 03 04 05 06 07 08 09 10 11 12
Eurozone ULC (ex. Germany) based on German M3 Growth*
Eurozone ULC (ex. Germany)
129.9
German ULCGerman M3
115.2
156.0
100.6
(1Q 2000 = 100, Seasonally Adjusted)
50.2%: Macro-Monetary Effect
49.8%: German Labor Reform Effect
(ULC = Unit Labor Cost)
Eurozone M3 (ex. Germany)
217.0
MonetarySource of
Competitiveness Gap
Note: * Parameters obtained f rom the regression result on Eurozone ULC (ex. Germany) on Eurozone M3 (ex. Germany),log(Eurozone ULC (ex.Germany)) = 3.155506 + log(Eurozone M3 (ex.Germany)) x 0.318227, applied to German M3data indexed to 1Q 2000 = 100.
Sources: Nomura Research Institute, based on ECB, Eurostat and Deutsche Bundesbank data
24
Exhibit 25. Germany Recovered from Post-Dotcom Balance Sheet
Recession by Exporting to other Eurozone Countries
25
-6000
-4000
-2000
0
2000
4000
6000
8000
10000
12000
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Deutsche Bundesbank
(€mn, seasonally adjusted)
Eurozone
Asia
US
German Balance of Trade
driven by Eurozone housing bubble
driven by weaker Euro
Exhibit 26. Two Structural Deficiencies of Eurozone
26
Maastricht Treaty restricted
fiscal stimulus needed to fight balance sheet recessions
Procyclical and destabilizing
capital flows between gov. bond markets of member
countries
Countries suffering from
balance sheet recessions fall into deflationary spirals, while
excessive easings by the ECB end up creating bubbles
elsewhere
Excessively low gov. bond
yields during bubbles
Excessively high gov. bond
yields during balance sheet
recessions
Require countries in balance
sheet recessions to implement sufficient fiscal stimulus with
blessings from the Troika in order to protect the ECB
Introduce different risk weights
for holdings of domestic vs foreign gov. bonds to keep
domestic savings at home
(1) (2)
Problem
Solution
Exhibit 27. Yin Yang Cycle of Bubbles and Balance Sheet Recessions
27
Notes 1. Recovering from 1990 Heisei bubble.
2. Recovering from 2000 IT bubble
3. Recovering from 2008 housing bubble
Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession , John Wiley & Sons, Singapore, April 2008 p.160.
(1) Monetary policy is tightened, leading the bubble to collapse.
(5) Private sector phobia towards borrowing gradually disappears, and it takes a more bullish stance towards fund raising.
(8) With the economy healthy, the private sector regains its vigour,
and confidence returns.
(9) Overconfident private sector triggers a bubble.
(7) Monetary policy becomes the main economic tool, while deficit reduction becomes the top
fiscal priority.
(6) Private sector fund demand recovers, and monetary policy starts working again.
Fiscal policy begins to crowd out private investment.
(4) Eventually private sector finishes its debt repayments, ending the balance sheet recession.
But it still has a phobia about borrowing which keeps interest rates low, and the economy less than fully vibrant.
Economy prone to mini-bubbles.
(3) With everybody paying down debt,monetary policy stops working.
Fiscal policy becomes the main economic tool to maintain demand.
(2) Collapse in asset prices leaves private sector with excess liabilities,
forcing it into debt minimization mode. The economy falls into a balance sheet recession.
BubbleYin (=Balance Sheet Recession) Yang (=Textbook Economy)
US3
Spain3
UK3
Japan1
Germany2
Exhibit 28. Contrast Between Yin and Yang Phases of Cycle
28
Yang Yin
Textbook economy Balance sheet recession
Adam Smith's "invisible hand" Fallacy of composition
Assets > Liabilities Assets < Liabilities
Profit maximization Debt minimization
Greatest good for greatest number Depression if left unattended
Effective Ineffective (liquidity trap)
Counterproductive (crowding-out) Effective
Inflationary Deflationary
Normal Very low
Virtue Vice (paradox of thrift)
a) LocalizedQuick NPL disposal
Pursue accountability
Normal NPL disposal
Pursue accountability
b) SystemicSlow NPL disposal
Fat spread
Slow NPL disposal
Gov. capital injection
Source: Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession ,
John Wiley & Sons, Singapore, 2008
1) Phenomenon
2) Fundamental driver
3) Corporate financial condition
4) Behavioral principle
8) Prices
9) Interest rates
10) Savings
11) Remedy for
Banking Crisis
5) Outcome
6) Monetary policy
7) Fiscal policy