JAPAN: QUANTIATIVE EASING, DID IT WORK?

A lesson from Japan

January 15, 2009 – 11:11 am

In March of 2001, to jumpstart a stagnant economy, the Bank of Japan became the first central bank to attempt "quantitative easing."  Japan, of course, suffered from the collapse of its own real estate bubble in 1990.  Did it work?  Did it revive the economy?

Taking the Nikkei stock average as a measure of real wealth creation in Japan, the economy is, today, at its lowest point in over 30 years.

Certainly you could have made money trading the volatility, but the buy-and-hold strategy for Japanese blue-chips has been dead money for a generation.

Clearly the BOJ's QE policy from 2001 to 2006 didn't rescue Japan's economy, which remains stagnant despite rock-bottom interest rates.

Below is a quote from a December op-ed in the FT by John Richards (bold mine):

About all quantitative easing did on the positive side for Japan was to help the BoJ keep its independence from the politicians by giving the appearance of action.

The costs were the shutting down of the money market, although it revived fairly quickly when QE ended, and a dangerous bond-bubble, whose popping threatened the recovery and destabilised the financial system.

One of the lessons of this episode for policymakers is that while quantitative easing may help to solve the short-run liquidity problems that arise in times of extreme financial duress, it is not a substitute for some of the harder choices governments must make.

These include underwriting of systemic financial risks, e.g. by guaranteeing bank deposits, the re-capitalisation (forced or voluntary) of the banks, regulatory pressure on banks to disclose and write down the bad assets, or the pressures on businesses directly via their banks to restructure and deleverage or shut down.

Rolfe here.  If you'll permit me a digression: I disagree with him strongly on underwriting systemic risks.  It makes all the other hard but necessary choices he outlines impossible. To wit: if the government guarantees bank deposits but doesn't actually have the cash to make good (FDIC doesn't), then it must do everything it can to prevent anything that threatens bank solvency.  This is the great conundrum of the current banking malaise we find ourselves in.

On the one hand, we're all taxpayers.  None of us likes the idea of bailing out failed banks.  We think the financial system should swallow its medicine: writing down bad assets, de-leveraging, all of the other prescriptions outlined above.

On the other hand, we're all bank depositors too.  If the banks take their medicine it threatens our deposits.  And we've decided that we like the idea of protecting bank deposits via federal insurance (FDIC).

We're like a Florida homeowner that decides to insure himself from a hurricane without putting any money aside for a rainy day!  We shop for the highest interest rates on bank CDs even though we know these are typically offered by the weakest banks, comforting ourselves that FDIC insurance will be there if our bank fails.

But FDIC is us!  As taxpayers we demand that the government spend all it collects in taxes and then some in order to support our high standard of living, putting nothing away to protect ourselves if, for instance, the banking system fails.

We can't have our cake and eat it too.  We can't NOT bail out banks and expect that our deposits will be safe.

Government deposit insurance should be abolished.

Continuing with Richards' piece:

A worst-case current scenario is that policymakers rushing to quantitative easing fail to understand [the need for structural reforms], giving us a bond-bubble but no permanent fixes of the underlying structural problems. In that case, when the bond-bubble bursts, paradoxically, quantitative easing will have increased systemic financial risks instead of decreasing them.

Our Fed is now creating its own bond bubble by printing money to buy bonds, manufacturing artificial demand for debt securities in an attempt to bail out banks and investors from poor lending decisions.  I recommend Richards' whole article.

More on this topic (What's this?)

Bernanke: U.S. Financial Crisis Worse than Japan's Lost Decade, but We'll Still Copy the Japanese... (George Washington's Blog, 1/13/09)

Hard Times Call for Creative Solutions (Financial Armageddon, 1/3/09)

Japan's Tertiary Index -0,9% in Nov. (Think! Finances, Investment and ..., 1/20/09)

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