Rejoinder to Prof. Freedman's Response

Takahiro MIYAO (Professor, GLOCOM)

This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on May 5, 2003: posted here with the author's permission.

In his comment on my piece regarding asset deflation (http://www.glocom.org/debates/20030506_freedman_response/), Craig Freedman wrote:

"At the same time the value of those assets, especially the change in their value, has an impact on aggregate demand. Mr. Miyao is correct I think in pointing out that this impact is often under rated. The policy question is which side of the equation is more important to attack first....the focus should be on aggregate demand. For Japan, the key here is the long standing problem of non-performing loans.......Japan stands out as the one country that failed to deal with the issue."

I appreciated Prof. Craig Freedman's understanding of the main point of my argument that asset values tend to affect aggregate demand, a point that is completely missed by many outside observers.

However, I do not agree with Prof. Freedman regarding the relative importance of asset values and aggregate demand. I tend to think that asset prices are more important determinants than aggregate demand in advanced economies, where the total value of accumulated assets is far greater than (almost 20 times as large as) the value of aggregate demand. That is, asset prices are the cause and aggregate demand is the effect must point out that Japan's banking problem is unique in that the financial crisis has been created not only by asset market fluctuations, but also by serious policy mistakes which have made the balance-sheet much worse than any other countries in recent history. This is why it is so difficult to deal with the issue in a conventional way in Japan. We need to deal with the problem from the asset side rather than the debt side.

One more point: As I recall, Alan Greenspan cut the discount rate to 3.5%, almost as low as the inflation rate of 3.0% by 1991, still under the Bush administration. Later he cut it again to 3.0% (possibly under the Clinton administration) in order to make the "real" interest rate virtually zero, which sent the stock prices to an even higher level. All these have proved the crucial importance of asset price policies for an economic recovery.