The Katz-Miyao Debate #9: Miyao on Katz

Takahiro MIYAO (Professor, GLOCOM)

This comment is adopted from Prof. Miyao's original piece which appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on May 23, 2003: posted here with the author's permission.

I would like to respond to Mr. Richard Katz' question (http://www.glocom.org/debates/20030526_katz8/).

It is important to distinguish between two separate issues involved here: (1) How we should view the current situation in the Japanese economy, and (2) how we should view the boom (bubble) years in the 1980s. There are various views on each of these two issues and, therefore, we should treat these two issues as separately as possible, although they must be related somehow.

Needless to say, the issue (1) is more important for the sake of our correct diagnosis and prescriptions for Japan's economic illness. And in this sense, Mr. Peter Tasker is right in saying that "balance sheet problems have played a major part in Japan's troubles," regardless of whether the late 1980s were equally abnormal bubble years or a little bit of overshooting from what I call a "higher" equilibrium with the virtuous circle, as in the U.S. economy in the late 1990s (please note that the U.S. economy seems to be still on its higher equilibrium after some correction of overshooting for the last couple of years).

Those who focus too much on Japan's "abnormal bubble phenomena" in the late 1980s tend to misunderstand the current situation and even regard the current depressed state of asset markets as "desirable," as Mr. Tasker points out. In fact, such mentality has prevailed among Japan's policy makers, especially the MOF and the BOJ people, as well as the general public so that policy mistakes have not fully been corrected even now.

Furthermore, the "bubble" view is not particularly helpful in analyzing the current state of the Japanese economy for the following reason. Even though one can admit that the current situation is serious and a kind of "negative bubble" phenomenon, one might conclude from what Mr. Katz says about the bubble ("While most economists think the bubble would have collapsed eventually--because that's what all bubbles do") that this negative bubble is unsustainable and will return to normal eventually because that's what all bubbles do. This view also would lead to non-action on the part of policy makers facing asset deflation. One might remember that Koizumi and Takenaka had repeatedly said that "now is the best time to buy stocks because their prices are just too low." before they became more serious about declining stock values for the last few weeks.

I believe my view on the issue (1) is most reasonable and useful in analyzing the current situation and coming up with correct prescriptions for Japan's economic problem for the short- and medium-term. That is that currently the Japanese economy is on or a little below a "lower" equilibrium with the vicious circle of asset deflation, where the balance sheet problem is getting worse if nothing is done. This is a kind of "trap," where lower values of assets are making the balance-sheet problem worse, leading to shrinking returns and yields and justifying even lower values of assets over time.

Now we turn to the issue (2). I happen to believe that the Japanese economy in the late 1980s was more or less like the U.S. economy in the late 1990s, that is the state of a little bit of overshooting from the "higher" equilibrium with increasing asset prices and growing returns on investments. The Japanese economy could have gradually slowed down to its higher equilibrium after a little bit of correction in 1990-1991, as the U.S. economy did in 2000-2001, and might have enjoyed steady economic growth of 4-5 percent a year in the rest of the 1990s with a series of structural reforms taking place without much resistance as the total pie in the market would be growing rather than shrinking. This is in fact the scenario that I clearly described in my book "The Age of Stock Economy" (in Japanese) published by Nikkei Shinbun-sha in 1990, and later translated and published in Korea.

I still believe that my scenario would have prevailed if Japanese policy makers did not make fatal mistakes in the early 1990s. When the markets were correcting their overshooting themselves in 1990 and 1991, the BOJ and the MOF (of course, officially adopted by the Kaifu administration) tried to kill the markets by raising the interest rate sharply, imposing tight credit control over real estate and increased taxes on stocks and real estate at once. These mistaken policies brought the economy down not only from the previously overshooting position but also from the "higher" equilibrium position to the "lower" equilibrium, or the asset deflation trap, as I pointed out above. Later, those policy makers apparently realized their error but did not admit it, and adjust their policy a little by little by lowing interest rates, lifting credit control, and lowing taxes only in a "too little too late" way. But those incremental policies have been ineffective to push up the trapped economy away from the lower equilibrium with the vicious circle back to the higher equilibrium.

Having said about my view on the "past" issue (2) in relation to the "current" issue (1), let me repeat that these two issues can be treated separately. That is that those who (probably including Mr. Katz) do not agree with my view on the past issue (2) can still agree with my view on the current issue (1), which is more important than the past issue (2) in the case of Japan (although the issue (2) may be more relevant to today's U.S. economy).

Finally, I would like to repeat my original proposal to Mr. Katz in order to clear up a possible misunderstanding that I might be advocating something radical or something completely new in terms of policy measures. My proposed measures, or their variations, have been proposed by some economists in Japan and the U.S., or already partially adopted. I only put them in the right order and from the right perspective with a clear target for asset reflation. They are: (1) setting an asset inflation target for stocks and real estate, (2) the BOJ to purchase ETF and REIT, (3) suspension of all capital gains taxes on stocks and real estate, and (4) setting aside public funds to purchase stocks and real estate, if necessary. These measures should be announced at once, and adopted in this order successively until the target is achieved.