Posted on Thursday, October 21, 2010
By JON HILSENRATH
As a Princeton professor in the 1990s, Ben Bernanke lectured Japanese officials for mishandling their economy.
Jon Hilsenrath discusses Bernanke's criticism of Japan's central bank a decade ago, saying it offers hints of what the Fed's next steps might be.
Today, Tokyo's economic problems are more than academic for the Federal Reserve chairman. They are a window into his own situation as he stares at what could be a long period of slow growth, high unemployment and declining inflation in the U.S.
Mr. Bernanke is preparing for a potentially important policy speech Friday, when he could detail his thinking on the Fed's next steps at a conference sponsored by the Federal Reserve Bank of Boston on monetary policy in a low-inflation environment. The conference is a reprise of a 1999 conference at which Mr. Bernanke and other academics took Japanese officials to task for failing to get their economy moving.
Buried in Mr. Bernanke's earlier writings on Japan are hints of how he is shaping the Fed's responses to today's slow recovery.
Ben Bernanke once criticized Japan's central bank, now heads America's.
Just a few months ago, Fed officials were focused on how they would exit from their easy-money policies. Now, they are positioning themselves to do more to support growth.
High on the list of options: restarting a program of buying U.S. Treasury bonds to drive down long-term interest rates and boost growth, despite strong reservations among some colleagues. Fed officials also are debating how to make clear their commitment to preventing deflation, a state of falling prices that economists say can be even more debilitating than inflation. This is a task that puts them in the uncomfortable position of calling for more inflation.
Compare the U.S. and Japanese economies by inflation, interest rate, labor force growth and more.
Many Fed officials agreed at a policy meeting in September that if growth doesn't pick up and inflation remains low, "it would be appropriate to provide additional monetary policy accommodation," according to minutes of the meeting released by the Fed Tuesday.
Mr. Bernanke's mission, in part, is to make sure the U.S. stays off the path trod by Japan. Yet it's proving harder than he thought when he was offering advice to officials overseas.
Japan's stock market peaked in 1989 and its property bubble popped two years later. Since then, it has averaged annual growth of just 0.7%. Its national government debt has soared to more than 200% of its national output. And in seven of the past 10 years its consumer prices have fallen.
All this happened even though the Bank of Japan has held short-term interest rates at or near zero since 1999 and has taken other stimulative steps such as buying government bonds and short-term corporate debt.
"I remember once making a comment in a Federal Open Market Committee meeting that this seemed easier when I was advising other people how to do it than when I was involved in doing it myself," says Donald Kohn, who retired from his post as Fed vice chairman last month. The comment, he recalls, was met with nervous laughter by other officials.
Mr. Kohn says he took two lessons from Japan: Be aggressive about providing stimulus to the economy in the early stages of a downturn and avoid canceling it too soon.
Before becoming Fed chairman, Mr. Bernanke led a band of U.S. academics who argued that Japanese officials weren't doing enough to jolt their economy out of its torpor. In a 1999 paper, Mr. Bernanke lashed out at Japanese officials, saying their country's woes were the result of their own "self-induced" paralysis. Japan's responses to deflation, he charged in atypically blunt terms, were confused, inconsistent and too cautious.
Mr. Bernanke has since told others privately he regrets the tone of those attacks. But the lessons he drew have played a role in shaping the Fed's responses to the economy and could shape decisions in the weeks ahead.
Further Reading From Bernanke on Japan and Fighting Deflation
• "Perhaps it's time for some Rooseveltian resolve in Japan."
• "The BOJ should consider a policy of reflation before re-stabilizing at a low inflation rate primarily because of the economic benefits of such a policy. One benefit of reflation would be to ease some of the intense pressure on debtors and on the financial system more generally."
• "The FOMC will strongly resist deviations from price stability in the downward direction. Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation."
Mr. Bernanke urged Japan to commit to keeping interest rates low until it got more inflation, and he defended novel ideas like buying government bonds with the understanding that fiscal policy makers would use the money thus raised to finance tax cuts to boost consumer demand.
The analogy between the U.S. economy and Japan's isn't perfect. Japan has an older population, less-profitable banks that didn't get quick capital or attention from regulators after the property bust, low job-market turnover and many industries shielded from international competition.
Other differences: Japan is a big exporter, while the U.S. is a big net importer; Japan wasn't a big debtor to the rest of the world, as is the U.S.; and Japan has a high savings rate, so its deficits have been funded internally. While Japan has experienced many years of deflation, the U.S. hasn't had any in the modern era.
But the similarities between the two economies are striking. Both countries went through stock and real-estate busts that severely damaged financial systems, Japan in the early 1990s and the U.S. in 2007 and 2008. Both saw unemployment rise and developed much slack in their economies.
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Both ran up large budget deficits and pushed interest rates to zero. Both have important globally traded currencies that didn't dramatically weaken after their bubbles burst. That meant their exports didn't soar, as happened in some smaller economies after financial crises.
Mr. Bernanke's first significant brush with Japanese officials was in 1999. Consumer prices had started falling, and the Bank of Japan had already pushed short-term interest rates to near-zero.
Falling prices meant that real interest rates—nominal rates minus inflation—were rising. Household and business debts, in other words, were growing harder to pay off. Officials were stumped over what else the central bank should do, if anything.
It could purchase Japanese government bonds, the academics said—a money-pumping approach now called quantitative easing. But having just gained independence from the Ministry of Finance, Bank of Japan officials were reluctant to start funding the government. And buying bonds exposed the central bank to big losses if private investors starting shedding the investments.
At a conference at sponsored by the Boston Fed in Woodstock, Vt., that October, Kazuo Ueda, then a BOJ policy member, issued a warning to the largely American audience: "Do not put yourself into the position of zero rates," he said. "I tell you it will be a lot more painful than you can possibly imagine."
Mr. Bernanke shot back that Japanese policy makers might be making the same "extreme policy mistakes" Americans made in the 1930s—being too timid about reversing deflation. A few weeks later, in a blistering research paper, he said even though conventional tools were expended, there was plenty the Japanese could do to boost consumer demand, business spending and prices.
Among his suggestions: Cheapen the yen by selling it in the currency markets; or buy long-term debt from the Ministry of Finance to finance tax cuts, something he said was akin to just dropping money from a helicopter.
One objection at the time was that Japan's economic problems weren't the result of too little stimulus by the central bank but of structural problems in Japan's banking system and in protected industries.
Mr. Bernanke said structural problems didn't negate the need to find ways to push up consumer demand and business spending.
"Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced," he concluded. "Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn't absolutely guaranteed to work."
Mr. Bernanke was particularly troubled by Japan's emerging deflation. He argued that Bank of Japan officials had to aggressively manage the public's expectations, because convincing households and businesses that deflation wouldn't persist would help to spur economic activity.
Mr. Bernanke felt that Japan's central bank needed to make a commitment to get inflation higher and keep policy accommodative until it increased. Among his proposals was a suggestion that the bank publicly adopt an inflation target of 3% to 4%.
Kunio Okina, a former Bank of Japan official whose research was attacked by the academics, says they didn't pay much attention to the risks associated with such measures. Their stance was that the BOJ "should jump with its eyes closed," Mr. Okina says. "There is a big difference between when they were having a carefree discussion about the BOJ's monetary policy and when it becomes a real problem to themselves."
While a Fed governor in the early 2000s, amid rising U.S. unemployment and worries about an unwelcome decline in inflation, Mr. Bernanke backed the Fed's push to keep rates low. The "painful experience of Japan" led the Fed to decide to act pre-emptively to head off deflation, Mr. Bernanke said earlier this year.
The Japanese, Mr. Bernanke and other academics felt, had been too quick to raise interest rates in 2000 when it looked as if their economy was recovering. Mr. Bernanke had a new idea. Japan, he suggested in a May 2003 speech, should adopt something called a "price-level target."
With an inflation target, the central bank would aim for, say, 1% inflation every year, no matter what happened the year before. With a price-level target, it would react to what happened before. If the price index undershot 1% growth one year, the central bank would play catch-up, targeting higher inflation the next. In Japan, he called for a "reflationary phase" of policy.
This approach, he said, would relieve the pressure Japanese debtors felt from high real interest rates, and also help break deflationary expectations. There was a risk of overshooting and getting too much inflation, but it was worth taking the chance, he said.
The U.S. central bank should consider a similar price-level target approach today, two presidents of regional Fed banks, William Dudley of New York and Charles Evans of Chicago, have said in the past few weeks. The idea came up at the Fed's last meeting, according to minutes released Tuesday.
Japan's experience remains a puzzle. Japanese policy makers over time tried many ideas the U.S. academics promoted. They pushed interest rates to zero and committed to keeping them there until deflation reversed. Ultimately the Bank of Japan tried quantitative easing, increasing its holdings of loans, securities and other assets by 42% between 2001 and 2006.
For a time, the policies seemed to get traction. Japan averaged annual growth of 2.4% from 2004 to 2007. A long spell of falling consumer prices showed signs of abating. But then came the global recession of 2008. Japan's economy contracted 5.2% in 2009, and deflation was back.
"I don't think any model would have predicted the degree of persistence of Japan's problems," says Mark Gertler, a New York University professor and former coauthor with Mr. Bernanke. "It is pretty hard to account for."
Japan's deflation has turned out to be the deepest mystery of all. Economists expected that a little deflation would turn into an ever-more-dangerous spiral: As consumer prices fell, the burdens of rising real interest rates could worsen, damaging the finances of banks, households and businesses and sinking the economy even deeper, as happened during the Great Depression.
They worried about a deflationary mentality, with one year's deflation cementing expectations of even more the next year. But it hasn't worked out that way. Rather than spiral, deflation in Japan has stuck at around 1% a year. It hasn't gotten severe but it has lasted much longer than expected. Surveys of economists show that expectations of future deflation have never really set in.
Toshihiko Fukui, who was governor of the Bank of Japan from 2003 to 2008 and adopted some of the easy-money policies Mr. Bernanke advocated, said the Fed chairman was "critical but honest" with Japan in his days as an academic. Mr. Fukui said his advice for Mr. Bernanke today is the same that Mr. Bernanke once gave him. "Have a decisive mind."
—Megumi Fujikawa contributed to this article.
Write to Jon Hilsenrath at firstname.lastname@example.org