Response to Craig Freedman's Comments

Takahiro MIYAO (Professor, GLOCOM)

This comment originally appeared in the "Japan-U.S. Discussion Fourm" ("http://lists.nbr.org/japanforum) on May 24, 2003: posted here with the author's permission.

This is my response to Craig Freedman's comments (http://www.glocom.org/debates/20030526_freedman_issue/). First, I would like to thank him for clearly identifying an important issue of the causation between flow variables (income, consumption, etc.) and stock variables (stocks, real estate, etc.). Freedman says "in every instance I can think of, the causation flows from increased aggregate demand [flow variables] leading to increased asset prices [stock variables] which feeds back to a further boost to aggregate demand" and "I can't think of an example where an economy saw asset led growth."

Let me point out two examples. (1) The Japanese economy experienced its asset-led growth in the 1980s, when the Bank of Japan lowered interest rates sharply in response to the 1979-80 recession due to the second oil crisis and also the brief slump due to 1985-86 yen-daka, leading to a tremendous boom in stocks and real estate, which significantly increased consumption, investment and imports (as a result, Japan's trade surplus went down to a desirable level for the first time in many years). Of course, the boom needed some correction, but a little more modest boom could have continued until now, if Japanese policymakers had avoided their mistakes in handling the overshooting and the subsequent adjustment of the asset markets towards what I call the "higher equilibrium with the virtuous circle of asset appreciation and income growth." Japan's unfortunate experience in the 1990s is also an example of asset variables affecting flow variables, although in the negative direction.

(2) The U.S. economy enjoyed its asset-led growth in the 1990s, when the Federal Reserve Board cut the discount rate to the level of inflation so that the real interest became zero, which led to a boom in the stock market first, and then a housing boom in the late 1990s, contributing to the decade-long economic recovery and growth in income, consumption and investment. I believe there is clear evidence that the U.S. economy, especially the household sector, has been supported mainly by housing price appreciation (due to declining mortgage rates), when the stock market has been correcting itself (so called "IT bubble bursting) from its overshooting position to a more reasonable level ("higher equilibrium") for the last couple of years. Fortunately, U.S. policymakers, most notably, Alan Greenspan, seem to understand the crucial importance of asset markets and have been lowering interest rates in trying to prevent the stock market from sliding down to the "lower equilibrium" with the vicious circle of capital losses and declining income.

Finally, my comment on Freedman's sympathy for "the younger generation being priced out of the housing market" in a housing boom. They are not necessarily getting worse off because mortgage rates are declining and incomes are increasing while housing is appreciating, so that there should be little change in the so-called affordability index for them. If I may say so, you should show more sympathy for about 60% of the Japanese people owning their homes, whose asset values have been declining for more than 10 years with virtually no buyers in the existing home market, while no policy measures have been taken to lighten their burden of mortgage payments, as some tax credit is given only to new home buyers and not to those who already own their homes -- yet another policy mistake on the part of the Japanese government.