Societe Generale analyst Dylan Grice has attacked the idea of the balance sheet recession, pioneered by Richard Koo, suggesting that it’s a sham.Grice notes that the balance sheet recession episode that Japan has encountered is only one blip in history, and may not represent the “base rate” for what is likely after the collapse of a credit bubble. The “base rate,” for Grice, is the underlying likelihood of something based upon statistical analysis. It ignores specific additional details, if they are deemed irrelevant.
As such, the “base rate” of a prolonged deflationary crisis is actually quite low.
From Dylan Grice:
But what’s the ‘base rate’ for prolonged (let’s say more than five years) deflationary crises? I can think of three off the top of my head – Japan in the 1990s, the US in the 1930s and the US the 1870s – and I’m being generous because I believe the categorizations of each are questionable. But let’s leave aside the specifics for another day and count that as three. Now let’s look at the number of economies that had burst credit bubbles which didn’t cause prolonged debt-deflation crises: Spain in 1977, Norway 1987, the UK in 1989, Sweden in 1990, Finland in 1991, Philippines in 1997, Indonesia in 1997, Thailand in 1997, Malaysia in 1997, Hong Kong in 1997, Korea in 1997, Argentina in 1998. Let’s again leave the specifics of each for another day and count that as 12. (The jury is still out on Ireland, Greece, Spain and Portugal which may yet find themselves stuck in prolonged debt deflations but where it is too early to say. But then, it’s too early to reach verdicts on Latvia, Hungary and Iceland, which all had savage crashes and deep recessions, yet which all now seem to be recovering.) I make the ‘base rate’ 4 to 1 against the odds of a prolonged debt deflation.
Grice also notes that, in previous episodes of high public debt levels, there has been a high “base rate” of inflationary events. As such, focus on theories like Richard Koo’s “Balance Sheet Recession” may be misleading, as they pay too much attention to specifics.
From Dylan Grice:
Indeed, maybe this experiment even sheds light on the uses and abuses of history, where all too often elaborately eloquent narratives of single specific episodes form the basis of compelling narratives and then detailed theories, which are extrapolated into general ‘laws’ before finally being masqueraded as knowledge, under the banner of “lessons from history.” I won’t win any friends among my ‘fellow contrarians’ for saying so, but I believe currently popular theories of balance sheet recessions, liquidity traps and debt deflations are exactly such shams, based on the specific and applied to the general when it should be the other way around.
Such a critique is a direct assault on Richard Koo’s theory, which is based on the two events: the U.S. Great Depression and Japan’s lost decade. Whether or not the specifics of this economic environment outweigh the underlying trends and make the balance sheet recession view true remains unknown.
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