On Monetary Policy Outside of a Balance Sheet Recession

I can’t say that I am a huge fan of the way Japan is implementing monetary policy these days as there’s a certain level of ponzi that appears embedded in QE and its “wealth effect” transmission mechanism via the stock market.  But it does all make me wonder – since we know Japan’s balance sheet recession is over, then what if monetary policy is much more powerful outside of a BSR than we presume?  I think that once credit trends normalize within the economy that monetary policy tends to be much more effective.  We’re not quite there yet in the USA, but what if Japan is benefiting from it finally?

I’ve been particularly hard on the monetarists in recent years because I just didn’t believe their ideas would be all the impactful inside of a BSR in the USA.  But this Japanese experiment does make me wonder – could there be more to all of this than we previously believed?  And could it be implemented in a manner that doesn’t have such a stench of ponzi via the stock market?   And can it avoid the bad types of credit bubbles inside of asset markets like stocks and bonds?  I don’t know, but I am not going to lie – I am eager to analyze and judge the results in Japan at some point.

We’ll probably have to wait several years to reserve judgment on Abenomics, but I am certainly open-minded enough to admit that I could be overly skeptical about its efficacy.  But I think we should give it a lot more time and see how things play out over the next few years.  So far, I don’t think the results have been that great outside of crushing the Yen and setting the stock market on fire, but it hasn’t been very long.  So we continue to wait for the greatest experiment in modern economics to play out in real-time.



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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. My favorite part about MR is how open-minded it is to just about anything. You seem firm in your positions and opinions, but always willing to be convinced otherwise when the evidence clearly requires a change in stance. Bravo for that. Very rare especially in your business.

  2. Isn’t this the key reason why economics is so diverse and controversial? There’s no way to design experiments to test theories.

    If a sustained economic recovery occurs in Japan over the next few years can we attribute it to the monetarist policies being adopted now?… or will it simply be a coincidence?!

    On monetary policy outside of a BSR environment, of course its more potent than in a BSR. If individuals and businesses have the aggregate capacity to take on more debt, there will always be a point where the “price” of money is just too appealing. Down here in Australia (with quite a property bubble on our hands), we’re still paying around 6.5% interest on a home loan (provided you have good credit). If that were lowered to USA rates, do you think lending activity would increase??

  3. I think that you cannot judge the effects of QE even in experiments, because of the human psychology factor – i.e. you cannot say which part of the effect is due to some economic law or relationship and which part is due to sheer psychology manipulation. and then there are the constant positive feedback loops.

    To me what is new is that Japan is out of BSR. How come suddenly? More details please!

  4. “since we know Japan’s balance sheet recession is over”

    Why? Could you expand on this? I, myself, think the opposite is the case. Also, regarding “we” – have not seen anybody of any importance from any economic camp stating this.

  5. Given that QE is not “printing money”, it shouldn’t really be crushing the Yen. Something else must be going on.

  6. How do you disentangle the effect of Abenomics on Japan from the effect on the rest of world? It is clearly having a big effect everywhere, goosing stocks and state bonds in Europe and US stocks in addition to Japan.

    And when did Japan’s BSR really end?

  7. Abe is doing massive fiscal stimulus as well, so Japan is printing money. They clearly stated their intention to drive down the Yen.

  8. 8Would it be fair to say that for the policy to be effective in a manner that would satisfy your criteria, nominal GDP would have to grow faster than asset prices, debt levels and a set absolute threshold? That seems like a good yardstick to me. As you say, if debt and asset prices rise faster, then we just find ourselves back in this all too familiar position.

    I am grateful to MR and your site for showing that it is very difficult for monetary policy, as currently implemented, to drive nominal income/GDP higher without driving asset prices and debt levels even higher.

    I remain skeptical. If the US was not in a BSR in 2000-2003, then why wasn’t monetary policy more effective in stimulating GNDP growth > asset/debt growth?

  9. KB,
    Richard Koo (who is now at Nomura) has documented this and written on the subject. See his book for more on Japan. His contention is the balance sheets in Japan had been repaired by 2006.

  10. They are buying some non-Yen assets. So they are selling some Yen and buying some non-Yen.

  11. Cullen–I asked this before and didn’t get a response, and now I’m confused, because I thought you lauded Abenomics in April…

    What do you/MR suggest the Japanese should do to get their economy out of the death crawl? Something fiscal?

    With their demographics (a large retired cohort), QE/ZIRP ask that swath of Japanese savers to risk-up, which equity (risk asset) appreciation does indeed feel ponzi-like. If Abenomics can sustain the charade until demographics change, great, but someone holds the bag in the end.

  12. I did some short search, found only Koo saying “Japan near the end of BS recession”… Is it enough for “we”? I am not sure.
    You apparently agree that BS recession is ended in Japan. Do you have some concrete metrics in mind? GDP growth, consumer BS as % of GDP, consumer/business BS re-started and sustainable growth in %? Also, I assume you obviously do not count CB BS…

  13. I think the Abe government is going back to mercantilist policies and encouraging their corporations to go foreign again to generate any growth (unfortunately, the Japanese haven’t done that well in being a consumer-led economy). Also, they need to offset pressure on the Yen from rebuilding after Fukashima so the asset purchases will hopefully help monetize the fiscal impact as well as help the insurance companies to not repatriate foreign assets.

  14. PS the stock market boom will also help troubled flagship companies such as Sony, Panasonic, Nissan etc. to recapitalize.

  15. The portfolio shift effect is also very real as QE forces Japanese bond investors to look elsewhere for higher yields, i.e. outside Japan, which would necessitate selling Yen.

  16. Andrew,

    I am also asking the same question: when did Japan’s BSR end? I did not know it had ended.

    You are right that there is another problem with measuring QE effects besides psychology – the international dimension. So extremely hard to tell even if one could do experiements…

  17. Actually the definition of “BSR ending” is a bit weak: do we just need to see positive (YoY) credit growth in the troubled sector (US: HH, Japan: Corporate) to declare “victory”?

    Isn’t the reaching of a sustainable level of debt / GDP necessary? Although I note that debt service payments of US HH are at a cyclical low (after reaching an all-time high prior to 2008)

  18. He praised parts of Abenomics and criticized other parts, most notably the ponzi styled monetary policy.

  19. This is exactly my issue. And I, personally, would prefer to see not just a blip in consumer/business credit growth, but a sustainable trend. Preferably, coupled with sustainable GDP growth trend.

  20. I would be in favor of fiscal with monetary targets. What I don’t like is the explicit focus on stock prices, which I think has a distorting effect in the long-run. Abenomics has components of fiscal AND monetary, but I think the targeting of stock prices is very dangerous and could lead to asset bubbles.

    But the demographic problems are hard to overcome. I’d like to be optimistic about Japan in general, but that demographic problem is very difficult to overlook.

  21. I think we have seen an impulse in the Nikkei since December, and we should watch for signs of structural change in the Japanese economy. The markets should correct to a higher low, and then we are off to the races.

    A reminder is in order that driving up the price *does not pay* in a structural bull market, because investors can always just buy some other security. And there’s no guarantee that this is going to happen yet. I’m watching.

  22. Nice to be open minded Cullen, however I would not vindicate Monetarists on the ground that the central bank is doing fiscal policy. Maybe the current policy is not by definition fiscal policy, But I would say targeting the stock market is closer to fiscal policy then monetary because at some point the CB may buy stocks to keep up the stock market. This policy might work, however it has horrible distributional effects.

    Also I think you should remember that some people think it is important to get rid of the Washington consensus. If they are to open minded and always unsure if they or their oponents are actually correct, they would lose the debate for sure. However if you want to analyze the economy to make money in the markets then I agree you should be very open-minded.

  23. Ok, a good series to track maybe, but no answer to the conceptual part of the question…

    And what about Japan?

  24. Actually proclaimig the end of the BSR (it may be correct for a 3-6 month period of time) requires a Long-term view of:

    – how high private debt/GDP can grow further
    – total debt / GDP can grow further
    – if the end is through fiscal policy: how high government spending / GDP can grow

    (I assume that the end of the BSR will be via further growth in debt/GDP ratios like in recent history, although the latter can also stay constant)

  25. I don’t get the impression the BOJ is primarily using QE to boost the stock market in hopes of a wealth effect.

    The BOJ listed several explicit goals: 2% inflation; reduce (long term)interest rates; lower risk premia of asset prices; enhance dialog w/market participants; change inflation expectations of market participants.

    I get the impression the BOJ wants inflation, something like what Krugman describes in: “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap” – for the BOJ to “credibly promise to be irresponsible.”

    ETF purchases are only 1T yen/year, which is $10B/year. Not that much. The REIT purchases are even smaller at 30B yen/year.

    Yes, the transmission is through lower interest rates and higher asset prices, but also through enhanced dialog and inflation expectations.

    They need inflation, and the BOJ needs to be credibly irresponsible, it’s almost the opposite of 80’s Volcker.

    But I don’t see this as foremost and primarily a ponzi wealth effect via the stock market.

    But, I could be wrong.

  26. Bruce–
    Don’t have time to respond to your whole comment, but I conceded that “explicit focus on stock prices” to Cullen, mostly because I got the clarity regarding an answer to my question. As far as I know, you’re right, there is no explicit stock price target or anything like that. But there is a quota, as you say.

    Further, I think the more accurate impression is that the BOJ’s trying to buy everything in sight to boost overall asset prices and therefore increase in inflation. American QE, It can be argued, accomplishes much the same thing by creating an artificial supply squeeze and therefore boosting prices.