Column : Abes monetary-policy delusions

Written by Stephen S Roach | Updated: Jan 4 2013, 06:18am hrs
In pressuring the BOJ to be more aggressive, Abe treads the erroneous path of the Fed and the ECB

The politicisation of central banking continues unabated. The resurrection of Shinzo Abe and Japans Liberal Democratic Partypillars of the political system that has left the Japanese economy mired in two lost decades and countingis just the latest case in point.

Japans recent election hinged critically on Abes views of the Bank of Japans monetary policy stance. He argued that a timid BOJ should learn from its more aggressive counterparts, the US Federal Reserve and the European Central Bank. Just as the Fed and the ECB have apparently saved the day through their unconventional and aggressive quantitative easing (QE), goes the argument, Abe believes it is now time for the BOJ to do the same. It certainly looks as if he will get his way. With BOJ Governor Masaaki Shirakawas term ending in April, Abe will be able to select a successorand two deputy governors as wellto do his bidding.

But will it work While experimental monetary policy is now widely accepted as standard operating procedure in todays post-crisis era, its efficacy is dubious. Nearly four years after the world hit bottom in the aftermath of the global financial crisis, QEs impact has been strikingly asymmetric. While massive liquidity injections were effective in unfreezing credit markets and arrested the worst of the crisiswitness the role of the Feds first round of QE in 2009-2010subsequent efforts have not sparked anything close to a normal cyclical recovery.

The reason is not hard to fathom. Hobbled by severe damage to private and public-sector balance sheets, and with policy interest rates at or near zero, post-bubble economies have been mired in a classic liquidity trap. They are more focused on paying down massive debt overhangs built up before the crisis than on assuming new debt and boosting aggregate demand.

The sad case of the American consumer is a classic example of how this plays out. In the years leading up to the crisis, two bubblesproperty and creditfuelled a record-high personal-consumption binge. When the bubbles burst, households understandably became fixated on balance-sheet repairnamely, paying down debt and rebuilding personal savings, rather than resuming excessive spending habits.

Indeed, notwithstanding an unprecedented post-crisis tripling of Fed assets to roughly $3 trillionprobably on their way to $4 trillion over the next yearUS consumers have pulled back as never before. In the 19 quarters since the start of 2008, annualised growth of inflation-adjusted consumer spending has averaged just 0.7%almost three percentage points below the 3.6% trend increases recorded in the 11 years ending in 2006.

Nor does the ECB have reason to be gratified with its strain of quantitative easing. Despite a doubling of its balance sheet, to a little more than 3 trillion euros ($4 trillion), Europe has slipped back into recession for the second time in four years.

Not only is QEs ability to jumpstart crisis-torn, balance-sheet-constrained economies limited; it also runs the important risk of blurring the distinction between monetary and fiscal policy. Central banks that buy sovereign debt issued by fiscal authorities offset market-imposed discipline on borrowing costs, effectively subsidising public-sector profligacy.

Unfortunately, it appears that Japan has forgotten many of its own lessonsespecially the BOJs disappointing experience with zero interest rates and QE in the early 2000s. But it has also lost sight of the 1990sthe first of its so-called lost decadeswhen the authorities did all they could to prolong the life of insolvent banks and many nonfinancial corporations. Zombie-like companies were kept on artificial life-support in the false hope that time alone would revive them. It was not until late in the decade, when the banking sector was reorganised and corporate restructuring was encouraged, that Japan made progress on the long, arduous road of balance-sheet repair and structural transformation.

US authorities have succumbed to the same Japanese-like temptations. From quantitative easing to record-high federal budget deficits to unprecedented bailouts, they have done everything in their power to mask the pain of balance-sheet repair and structural adjustment. As a result, America has created its own generation of zombiesin this case, zombie consumers.

Like Japan, Americas post-bubble healing has been limitedeven in the face of the Feds outsize liquidity injections. Household debt stood at 112% of income in the third quarter of 2012down from record highs in 2006, but still nearly 40 percentage points above the 75% norm of the last three decades of the 20th century. Similarly, the personal-saving rate, at just 3.5% in the four months ending in November 2012, was less than half the 7.9% average of 1970-99.

The same is true of Europe. The ECBs ber-aggressive actions have achieved little in the way of bringing about long-awaited structural transformation in the region. Crisis-torn peripheral European economies still suffer from unsustainable debt loads and serious productivity and competitiveness problems. And a fragmented European banking system remains one of the weakest links in the regional daisy chain.

Is this the cure that Abe really wants for Japan The last thing that the Japanese economy needs at this point is backsliding on structural reforms. Yet, by forcing the BOJ to follow in the misdirected footsteps of the Fed and the ECB, that is precisely the risk that Abe and Japan are facing.

Massive liquidity injections carried out by the worlds major central banksthe Fed, the ECB, and the BOJare neither achieving traction in their respective real economies, nor facilitating balance-sheet repair and structural change. That leaves a huge sum of excess liquidity sloshing around in global asset markets. Where it goes, the next crisis is inevitably doomed to follow.

Stephen S Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of The Next Asia

Copyright: Project Syndicate, 2012