Richard Koo: Japanese Economic Déjà Vu

How the West is Falling Into the Same Trap as Japan in the 1990s of Failing to Understand the Strangeness of a “Balance Sheet Recession”

The world has witnessed an economic experiment since the global crash of 2008 and the ensuing Great Recession. China immediately provided a massive and sustained fiscal stimulus. The Western countries also initially provided a stimulus, but relatively quickly shifted to austerity and deficit reduction. The result: China is back booming, and the Western economies are struggling, with those cutting deeper faring worse.

INET advisory board member Richard Koo - says that the reason is that we are in a "Balance Sheet Recession," a very rare situation in the wake of bubbles that leave businesses and individuals underwater so they spend all available income paying down debt and do not invest for new growth.

Koo argues that this is almost exactly what happened in Japan after the collapse of their bubble economy in 1990, and that country spent 15 years of trial and error policies before they finally got back to private sector growth. The only thing that solved the problem was massive and sustained government investment to fill the void left by the private sector. Monetary policy did not work since businesses could not be lured back to invest with lower interest rates.

Koo is one of the world's leading authorities on this subject. He is Chief Economist of Nomura Research Institute with responsibilities to provide independent economic and market analysis to Nomura Securities, the leading securities house in Japan. He advised the Japanese government during their difficult era, and he now is doing all he can to help the West understand his point of view.



This is a great analogy (déjà vu, indeed) and we can extract lots of important lessons from it. But I am afraid that it only applies to a relatively small number of large nations with big and deeper internal markets.

Here is the tale of the actual Great Recession case that developed recently in a small nation:

Suppose you are a small (e.g. Baltic) economy with your hands tied on the monetary policy lever because you have earlier adopted a currency board, CB, (not a classical central bank) and your currency is hard fixed to euro; morever, because of CB you could not oversee the credit channel before or do any strerilizing in the run-up to the hot capital flows in and out.

Suppose that you want to apply the lessons flowing from Japan’s “lost two decades” and the Japan-China juxtaposition of cases. So, when faced with imported Great Recession (channeled via foreign trade/investment), you try to rescue your economy from total collapse by adopting a strong fiscal stimulation (you emulate China), really the only thing you can do as the government. Suppose your ten times bigger neighbor (with practically no economic border because it was dismantled as part of the EU integration processes) is also mortally afraid of the imported Great Recession. Suppose that your bigger neighbor has a classical central bank (not currency board) and is able to conduct a monetary policy as it sees appropriate. Looking at the rapidly worsening economic situation in the region, your neighbor jumps to a radical Great Depression era “beggar-thy-neighbor” approach and devalues its currency close to 50% overnight! What happens next morning is that buyers from your small country flood the markets of your neighbor buying everything from A to Z (everything is so affordable to them as opposed to their home country) and your economy suddenly grinds to a halt under the collapse of demand; then in the matter of months your GDP drops 20%!

So, if you followed the Japanese/Chinese lessons, you ended up with big deficit/suddenly increased debt due to your strongly stimulatory policy and your economy collapsed: the worst of both worlds!


Val Samonis





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