Ideas@TheCentre
Milton Friedman was right about Japan
Surveying Japan at the end of 1997, Milton Friedman didn’t like what he saw. Writing in the Wall Street Journal , Friedman said Japan was ‘an eerie, if less dramatic, replay of the Great Contraction in the United States’ of the 1930s.
His observation was prescient. In late 1997, Japan was still dealing with the consequences of the asset price bust of the early 1990s and the Asian financial crisis was still unfolding. But Japan was otherwise still seen as an economy experiencing something like a normal business cycle.
Friedman argued that Japanese monetary policy was too tight. His evidence was low inflation, low nominal GDP growth, and low interest rates. The Bank of Japan’s (BoJ) overnight call rate had not yet hit zero per cent, but the zero bound loomed large. Friedman argued that ‘the answer was straightforward: The Bank of Japan could buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan’; in other words, engage in quantitative easing (QE).
The BoJ did resort to QE from 2001 to 2006, but with little conviction, serving only to accommodate an increase in the demand for additional reserves on the part of Japan’s troubled financial institutions. With the onset of the global financial crisis in 2008, the BoJ pursued QE again, but with insufficient commitment. Today, the level of nominal GDP in Japan is almost unchanged from its level in 1992.
Last week, the BoJ embarked on a much more aggressive approach to QE with a view to raising the inflation rate to 2% in two years. In principle, this goal is achievable, but will be much harder to reach in practice because the BoJ lacks credibility after so many false starts.
Japan’s problems are much deeper than just monetary policy, and only thorough-going structural reform can raise long-run growth in real GDP per capita. But Japan’s problems have been made much worse by the BoJ’s failure to follow Friedman’s advice 15 years ago. Structural reform is harder to achieve in an economy devoid of a long-run nominal anchor.
Dr Stephen Kirchner is a Research Fellow at the Centre for Independent Studies.
