By Edward Hadas
LONDON (Reuters Breakingviews) - Richard Koo’s latest book is less ambitious than he originally planned. The chief economist of the Nomura Research Institute explains that this was supposed to be a joint project with his brother, “a well-known dermatologist”, who had “some fascinating insights” on “the evolution of religion and morality”. That collaboration was precluded by John Koo’s obligation to speak about new psoriasis drugs. However, “The Other Half of Macroeconomics and the Fate of Globalization” might still be guilty of excess ambition.
Koo is certain he has the clue that unravels most of the mysteries of modern economics. He came up with his big idea back in the 1990s, during Japan’s post-bubble financial freeze. Koo called this a balance-sheet recession. Potential borrowers were so anxious to reduce their leverage to safe levels that no policy interest rate could be low enough to change their minds.
It was a very helpful insight for that time and place. The argument that only large fiscal deficits could restore Japan’s economic momentum was probably right, and Koo deserves credit for seeing something that many economists missed.
The “Other Half” of the book’s title refers to Koo’s brainchild. For him, the first half of macroeconomics is the standard theory. Borrowers are looking for loans, and the available interest rate determines how much lenders will oblige them. The second half, hidden until Koo discovered it, is the balance-sheet recession, when borrowers reject loans regardless of whether there are willing lenders.
Koo argues in some detail that this insight illuminates the 2008 global financial meltdown and the subsequent crisis in the euro zone. Since monetary policy inevitably had little effect - or so he claims - governments should have done more borrowing and spending.
The conclusion may be right and the analysis is helpful, but it oversimplifies history. Fiscal deficits in all the crisis-affected countries did increase sharply after the crisis. The governments basically took Koo’s advice, just not unreservedly. Also, the book’s own graphs and tables suggest that the relationship between initial post-crisis national debt levels and subsequent growth has not been straightforward. A widespread fear of borrowing was not the only factor that slowed down the various recoveries.
Ambitious oversimplification is a problem throughout the book. Koo claims that balance-sheet recessions explain the Great Depression, the coming of World War Two and the current populist political revival. When he takes on topics not related to balance sheets – ranging from the phases of national economic development to the dangers of the free movement of capital – his observations border on the simplistic. They would have to be, since the book packs a great deal into its 280 chart-laden pages.
Koo’s reliance on abrupt judgments probably does not bother him. As a man who frequently refers to his own prescience and his crucial contributions to forming Japanese policy, he is confident in his wisdom. Readers, however, might be less trusting. His arguments would be more persuasive if they were buttressed with more empirical data and some references to the work of more specialised scholars.
Koo does engage in some detail in one current debate, over how banks create money. Unfortunately, his dismissal of his opponents is unduly fierce – he calls their view “complete nonsense”. It is also confused. He even admits the truth of the main contrary claim, that mandatory reserve ratios at individual banks do not constrain the quantity of money which the banking system as a whole can create.
He is equally careless in his rejection of the radical suggestion that governments could fund deficits by direct money creation, rather than by borrowing through the financial system. His position is surprising, as such immediate money creation sounds like an effective way to reduce the buildup of leverage which leads to his much-feared balance-sheet recessions.
Koo, though, seems wedded to a rather old-fashioned model of banking and finance, in which direct money printing is a strong taboo. He is sure that even the somewhat indirect process by which central banks create money, known as quantitative easing, will end in tears once economies move out of their balance-sheet recessions.
While “The Other Half” covers too much ground too hastily, it hardly mentions two issues that are highly pertinent to national balance-sheet analysis – the increasing economic role of property lending and the declining dependence of corporations on bank loans to finance investments. Also, Koo’s focus on balance sheets blinds him to the possibility that Japan’s shrinking population, rather than existing leverage, might be increasingly responsible for lowering demand for loans.
Indeed, despite his wide experience and obvious intelligence, Koo seems excessively narrow in his focus. He might be said to lack a certain sort of intellectual ambition. Rather than ponder big questions or delve into details, he seems content to apply old nostrums. Perhaps his brother’s lecture duties will end in time for them to try something really grand together.
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