This week we had the chance to talk (via phone) with star economist Richard Koo of Nomura Securities.
Koo is famous for popularizing the idea of the “balance sheet recession,” which is an unusual state where the primary motive of private sector actors (households, businesses, etc.) is not to maximise profit, but to minimize debt. In such instances, the proper policy response is fiscal stimulus, replenishing the private sector, allowing it to accomplish this goal. Monetary policy, in his view, doesn’t work.
Here are some key highlights from our conversation.
Koo on why all the talk about Nominal GDP targeting by the Fed could do more harm than good…
Well, just like quantitative easing, they tried it, the GDP is still growing slowly weakly prices still not doing well. So it’s not a huge harm at least in the first instance, but in two ways I think it’s damaging.
The first instance, is that it distracts the people from talking about the needed policy, which is the fiscal stimulus. And if federal reserve continues to say “well, there’s still some more that we can do,” then people kind of put their hopes on these policies. But even at the best of circumstances, those so-called non-traditional policies achieve very little. I mean, probably better than nothing, but just a little of positive, whereas having the correct fiscal policy can have a huge impact on economy in the current circumstances. Because so many people are pinning their hope on the federal reserve, there’s little discussion on what is the right fiscal policy and that I think is very unfortunate.
And the second part of the problem is that if central banks are viewed in such a way that these guys are going to pump money into the system so that something happens to the nominal GDP, that can cause people to worry that if they’re gonna pump that much money into the system, the dollar may collapse. And that can cause another set of problems like foreign investors dumping U.S. treasuries or something because if they know that central bank has limited capacity but are forced to do something to get the nominal GDP going, people might assume that “Well then, the central banks might really do something crazy,” and that’s not good for the credibility of the dollar or the central bank.
Koo on why even long-term fiscal consolidation plans may be a bad idea…
Now, long-term entitlements, I think they can discuss that. And if they find a good formula to reduce problems with this long-term entitlement, they should be encouraged to do so. But even on that point, you have this term called “policy duration effect.” People see that, “Yeah, fiscal stimulus is coming, but it’s only for two years and after that they’re gonna cut budget deficit,” then even those two years with fiscal stimulus might not have the maximum impact when people think that after two years everything will be back to this mess. And if you don’t think your balance sheet is repaired within two years, then you start preparing for the worst today.
Koo on whether the ECB should cut rates immediately…
Given that the entire Eurozone is in a balance sheet recession, and some of the most affected countries like Spain, Ireland, and even Portugal are having these balance sheet problems. Cutting interest rates one way or the other I think is largely irrelevant. And, some people are making a big fuss out of it. I consider that a waste of time because if you brought rates down to those low levels and these guys still refuse to borrow money.
Koo on the real reason Trichet hiked interest rates earlier in the year…
I think that was done by Mr. Trichet just to keep Germans quiet. It’s entirely political. I don’t think that Mr. Trichet really believed that inflation is becoming a big threat or that it’s just around the corner. He just had to do that to show to the Germans that yes, the ECB really cares about inflation, we’re going to preempt all of this, in spite of all the government bond purchases that ECB has to do to keep some of these bond markets going.
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