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CWEF Forum: Richard C. Koo

More Spending, Less Austerity


More Spending, Less Austerity


Austerity has been the rage in Western economies, but Richard Koo argued at the CommonWealth Economic Forum that deficit reduction is exactly the wrong prescription for their economic woes.



More Spending, Less Austerity

By Shu-ren Koo
From CommonWealth Magazine (vol. 515 )

In the second half of 2012, three out of the world's four biggest economic entities – the United States, Europe and Japan – launched a new round of monetary easing measures to spur economic growth.

But at the opening session of the CommonWealth Economic Forum, Richard C. Koo, the chief economist of the Nomura Research Institute, analyzed the state of the global economy and questioned the effectiveness of the monetary easing approach.

Arguing that Europe and the United States find themselves in the same "balance-sheet recession" that plagued Japan during its lost decade in the 1990s, Koo said the only way for Western economies to stimulate growth and ease high unemployment was through expanded fiscal spending – having the government buy more goods and services – instead of simply injecting more cash into the banking system.

Koo is anything but a typical economist. He does not have an impeccable educational pedigree and refuses to hide in an ivory tower. Instead, he pursues economic news as diligently as any business beat reporter, personally observing economic trends and developments in many countries from the front lines.

Though he only has a master's degree from Johns Hopkins University, his experience at the Nomura Research Institute and as a longtime adviser to the United States Federal Reserve Bank of New York has afforded him a unique perspective on global economic issues.

Europe, the U.S. Facing Lost Decades?

Koo developed his balance-sheet recession theory after studying Japan's battle with deleveraging and stagnant growth in a zero interest-rate environment during the 1990s, and he said at the forum that Europe and the United States face a similar crisis today.

Since the 2008-2009 global financial crisis, most countries have maintained interest rates at or approaching zero and pursued loose monetary policies to provide financial markets with massive capital injections.

At the same time, however, most households and companies in Europe and the United States, saddled with debt from the bursting of real estate bubbles that sparked the crisis, have been actively trying to "deleverage" themselves by reducing their debt burdens. That means they have been less willing to borrow, invest or consume, even with the cost of borrowing near zero, resulting in economic stagnation.

In other words, the massive injection of liquidity into financial markets has not found its way into the real economy, which is why it has failed to ignite growth or create employment, Koo argued.

Koo said that with the private sector not investing or consuming, the fiscal austerity policies being pursued in Europe and to a lesser degree in the United States are, in fact, dangerous. If Western governments do not increase spending to fill the gap in demand left by deleveraging businesses and households to spark growth, their economies could very well descend into a vicious circle of more austerity and higher unemployment, and even be vulnerable to collapse, he said.

Japan experienced a similar problem 15 years ago. Housing prices in the country plummeted by as much as 90 percent, but the Japanese economy still maintained marginal positive growth because of increased fiscal spending by the government.

Koo's use of his balance-sheet recession theory to explain the current economic doldrums in the United States and Europe made an impression on those attending the CommonWealth Economic Forum.

"It's a pretty good theory," said China Steel Corp. Chairman J.C. Tsou, who led a group of his colleagues in attending the conference for the third consecutive year.

In a later session at the forum, Acer Inc. founder Stan Shih repeatedly cited Koo's analysis.

But when Koo first presented his concept in 2003, it was fiercely challenged by mainstream Western economists. And even after the 2008 financial crisis ravaged global economies, most governments showed contempt for Koo's prescription for recovery.

Writing the Correct Prescription

Koo has engaged in spirited debates about his theory with Nobel Prize economist Paul Krugman (though their key difference has been more over the effectiveness of monetary easing than the need for fiscal stimulus) and has also tenaciously defended it in the media against naysayers.

It is only now, more than four years after the crisis erupted, that mainstream economists and Western governments are starting to realize that traditional economic theories were unable to accurately diagnose the problems facing Europe and the United States or offer effective remedies.

They have turned to studying the Japanese experience of the past 20 years more closely and paid more attention to what Koo has to say, making him a suddenly popular invite among policy-making circles in advanced Western economies.

In a working paper published on Jan. 3, 2013, just four days before the opening of the CommonWealth Economic Forum, the International Monetary Fund admitted that its previous advocacy of fiscal austerity for Europe, especially in countries such as Spain and Greece, had been based on an erroneous calculation and created far more economic damage than expected.

"While economists expected that cutting a euro from the budget would cost around 50 cents in lost growth, the actual impact was more like 1.50 per euro," the paper said.

"I have been arguing for more than ten years that fiscal multiplier is greater during balance sheet recessions, and I am glad to note that the IMF finally understood it," Koo said at the forum.

In forecasting global growth for 2013, Koo stressed that Western countries will have trouble recovering until policy-makers truly understand the nature of their economies' sluggishness and replace austerity measures with fiscal stimulus to promote growth. But he warned that the deleveraging process and the use of government spending to revive economies would take time, especially in Europe.

Translated from the Chinese by Luke Sabatier