The Katz-Miyao Debate #7: Miyao on Katz and Freedman

Takahiro MIYAO (Professor, GLOCOM)

This comment originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on May 18, 2003: posted here with the author's permission.

I would like to respond to the critical comments of Richard Katz (http://www.glocom.org/debates/20030519_katz6/) and Craig Freedman (http://www.glocom.org/debates/20030519_freedman_com/) on my statements regarding asset deflation and the effects of tax cuts. Let me point out, as I have emphasized so many times before, that the main difference between the Katz-Freedman approach (pointing to the importance of aggregate demand and income) and my asset market approach comes down to the following two crucial points:

1) I have presented a "global" model of multiple equilibria in asset markets (like the Tobin model, where the "normal" equilibrium is likely to be unstable), where I have argued that elimination of taxes on key assets, along with other asset market policies, are needed to shift from a low level (bear market) equilibrium to a higher level of (bull market) equilibrium. In contrast, Richard Katz and Craig Freedman seem to be thinking within the traditional "local" model of a single stable equilibrium, where the effect of tax cuts is analyzed in a traditional way. It is my argument that in the case of the Japanese economy that underwent a catastrophic decline in asset markets and the resultant deflationary economy in the 1990s, we really need the multiple equilibrium analysis to prescribe an effective medicine so as to give a big push to the economy as a whole. Otherwise any incremental government spending or tax cuts of the traditional kind would fail to reverse the course of the declining and deflationary economy, which we have witnessed for the last decade or so. The traditional equilibrium approach, adopted by Richard Katz and others, could not give any insight into the existence of an entirely different equilibrium and dynamic (catastrophic) paths to move from one equilibrium to another.

2) In connection with the above approach, I have proposed an "asset or stock" model, where "income or flow" variables should be considered dependent variables, not independent variables, as Richard Katz seems to have assumed in his analysis, and in the asset model such flow variables as income and consumption could move in the same direction with a high corellation as Richard Katz claims, but that does not prove that income is an independent variable affecting consumption. Asset variables (including cash, deposits, bonds, stocks, real estate, etc.) are more likely to be independent variables than flow variables in an advanced economy, where the former is almost twenty (!) times as large as the latter in total value. Unfortunately, there is not much data available on assets, at least not as much as flow variables--this fact itself tends to produce some bias in favor of the flow variable approach. As I have pointed out, however, according to the 2001 White Paper on Economic and Fiscal policy, assets values along with debts seem to have a significant impact on household consumption, if disaggregated by age bracket. For the past decade (the 90s) consumption increased significantly only for the elderly people (65 or above) because they had already paid off their debts by the time asset markets were hit, and also their cash and deposits increased in value due to deflation, whereas most middle-aged households were severely hit by asset deflation with high mortgage payments remaining and their consumption declined most significantly.

Finally, I would like to take up Craig Freedman's statement that "focusing on deflation (like focusing on inflation) is simply wrong headed [because] they are symptoms of problems with the basic economy" by simply referring to our "Deflation Debate" (http://www.glocom.org/debates/200203_miyao_sum/), which took place among us (Katz, Freeman, Mera, Watanabe and Miyao) and was posted in the Japan Forum more than a year ago. I hope everyone remembers the very meaningful debate so that we don't have to waste our time repeating it.