Central bankers are finding it easier to support their economies than to spur expansion as the prospect of Japanese-like lost decades looms across the developed world.
Under the Japanese model, bank book capital levels are preserved at all costs. The result is the pursuit of policies that cause incredible amounts of harm to the real economy.
Examples of these policies range from regulatory forbearance (under which the banks use 'extend and pretend' techniques to keep zombie borrowers alive - it easier for zombies to get loans than creditworthy borrowers) to quantitative easing (under which central bank intervention distorts pricing of risk assets and investors react by focusing on return of their capital and not return on their capital) to zero interest rate policies (under which individuals in or approaching retirement cut back on their consumption so as to preserve their savings).
Another round of loosely correlated global stimulus has begun after the Federal Reserve extended its Operation Twist program and counterparts from Japan to Europe consider more monetary easing of their own. The Bank of Israel today joined those injecting stimulus by reducing its benchmark interest rate for the first time in five months, in part to insulate its economy from “potential negative consequences” elsewhere.
The rub is that even as they renew their rescue efforts, policy makers are postponing forecasts for fuller recoveries and run the risk that their latest actions pack a smaller punch.
This raises the prospect of longer-term anemic expansion akin to the doldrums Japan has suffered since the early 1990s.
“Japan’s experience shows central banks can mitigate the worst effects of the current environment, but it’s going to be very hard for them to stimulate demand,” said Peter Dixon, global equities economist at Commerzbank AG in London. He predicts a lengthy period of “sluggish growth and high unemployment” in the debt-ridden industrial nations.Japan's experience shows that if the losses hidden on and off bank balance sheets are not recognized, the burden this places on the real economy requires extraordinary fiscal and monetary policy efforts to offset. Whenever there is a let up in these efforts to stimulate the economy, the burden causes the economy to contract.
The worry for international policy makers is that Japan’s recent past reflects their future.
Its economy stagnated in the early 1990s after the BOJ boosted borrowing costs to rein in a surge in inflation, real-estate and equity prices. With banks hobbled by bad debt from the bursting of the asset bubble, the BOJ lowered its main rate to near zero in 1999.
After flooding the banking system with cash from 2001 to 2006, the central bank now has deployed its second round of QE. The moves haven’t ignited growth, with GDP rising at an average rate of 0.75 percent in the past 20 years, according to IMF data.
Consumer prices fell in eight of the past 13 years, and inflation hasn’t exceeded 1 percent since 1997. Unadjusted for price changes, the size of the economy last year was the smallest since 1990 and had contracted 10 percent from its peak in 1997.Please re-read the highlighted text as it nicely summarizes what happens from pursuing the Japanese model for handling a bank solvency led financial crisis.
ECB economists say the U.S. and euro-area are “rather unlikely to tread the same path of Japan” because they had different pre-crisis debt imbalances, according to their May monthly bulletin.So far, the experience has been very similar.
This is not surprising because it is not the pre-crisis debt imbalances that shape the recovery. It is the fact that the banking systems are hiding and not recognizing their losses that shapes the recovery.
Japan’s experience nevertheless demonstrates the importance of repairing financial sectors before trying to generate a sustainable recovery and shows that delaying reforms may mean fragile economic growth, they wrote.