This Classic Richard Koo Presentation Will Help You Understand The Real Reason The Fiscal Cliff Is Such A Huge Deal

richard koo

The buzz in the media is non-stop: Fiscal Cliff, fiscal cliff, fiscal cliff.

Unfortunately, a lot of people have no idea what it means, or why it’s significant. A lot of people think it has something to do with our huge deficit or national debt. In fact it’s just the opposite: The goal right now is avoiding deficit reduction, by preventing spending cuts and tax hikes that could be economically crippling.

To understand the significance of this event, a Richard Koo presentation from this spring given at the Institute For New Economic Thinking in Berlin is a great jumping off point to get a framework for thinking about this economy.

Koo, an economist at Nomura, is an expert on the great lost decades of Japan, and he’s broken new ground in understanding the unique nature of balance sheet recessions. A balance sheet recession is one that’s characterised by the private sector aggressively paying down debt. Monetary policy has very little effect in this type of a recession, and instead what’s required is aggressive fiscal stimulus, so that government debt counteracts the private sector debt reduction. In Japan’s downturn, it’s been the periods of premature fiscal tightening that have resulted in the most lost ground.

This presentation took a look at the state of the global economy, what’s been tried to jump start things, what’s worked, and what hasn’t. A few of the economic datapoints are a tad old now, but the themes are very relevant.

Let's get started ...

US housing has mostly looked Japanese (although lately it's looked better)

Commercial real estate tells a similar story.

Drastic rate cutting has only had modest effect on employment and house prices.

The US economy is still well below the previous peak

Europe is much worse

The one country doing well: Germany, of course

In a balance sheet recession, Fed pumping doesn't work. Just look at Japan.

Even more proof that liquidity measures don't increase the money supply

Same in the UK. Pumping didn't help.

Again, no benefit to liquidity pumping in Japan.

The deleveraging cycle can take a LONG time ...

In Japan, GDP grew despite deleveraging because the government borrowed so much

Government spending keeps GDP afloat

This is the most important chart: When Japan tried fiscal austerity, the economy deteriorated and the deficit got WORSE!

The same story is happening in the US. There's been a big increase in private sector savings.

Same in the UK. MASSIVE private sector deleveraging.

Meanwhile, the bond market says the whole word is going Japanified.

The Eurozone, on the other hand, is seeing yields explode higher

Again though in the Eurozone, there's been tons of private sector deleveraging

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