Rejoinder: Empirical Studies on Household Wealth Effects

Takahiro MIYAO (Professor, GLOCOM)

This comment originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on May 29, 2003: posted here with the author's permission.

This is my response to Craig Freedman's comments (http://www.glocom.org/debates/20030602_freedman_com/).

I would like to thank those who have sent me comments, including Prof. Freedman, about real estate and consumption. Many of their points are well taken. I just wish to add a few words to get our discussion back to the original purpose of the current debate on asset deflation.

1) I believe that focusing our discussion on the effect of real estate values on consumption may well cloud our view on the entire picture of asset deflation in Japan. As I have pointed out a couple of times, there are other asset effects (which are often overlooked in typical flow-oriented empirical studies) working on consumption, as elderly people have been steadily increasing their consumption since 1990 due to the accumulation of cash and deposits in spite of declining housing values, while people in their 40s and 50s have cut back on their consumption, as indicated by the 2001 White Paper on Economic and Fiscal Policy. Therefore, we need a disaggregated asset-oriented study (that is hard to come by), rather than a typical aggregate study, in which the household sector as a whole might not appear to suffer much from asset deflation in general and decreases in housing values in particular.

2) Then the question is why and how asset deflation has so negatively affected the Japanese economy. The answer is through its devastating effects on balance-sheets in the corporate sector and, of course, in the financial sector as a result. Here all we need is casual observations and stylized facts (needless to say, there are a number of serious empirical studies such as Yutaka Harada at www.glocom.org): the corporate sector used be the largest borrower of funds in the economy, but now it is repaying its debt in a massive amount, as repeatedly pointed out by such economists as Richard Koo. Not many corporations are borrowing money to invest, and positive corporate profits are no longer a sign of economic recovery or prosperity, because those funds are used to pay back their debts in many cases. We need to focus on these issues rather than on household consumption in the case of Japan.

3) Finally, I agree that empirical studies are important, but sometimes reconsideration of the existing theoretical or conceptual framework is even more important in getting insight into a difficult issue such as the rise and fall of the Japanese economy in the last few decades. If you stick to the conventional economic model of a single stable equilibrium and try to test an ordinary hypothesis on the economy which has experienced extraordinary fluctuations, you might as well suffer from specification errors and other fatal errors, resulting only in seeming (apparent) correlation among the variables that you happen to choose.

Having this in mind, I have tried to present my view on asset deflation in Japan, namely, an asset-oriented dynamic approach with multiple equilibria to explain the current state of the Japanese economy as trapped in the vicious circle of asset deflation, and proposed a set of policy measures which would constitute a "big push" to get the economy out of this trap. Needless to say, this kind of approach (although not necessarily asset-oriented) is well established in the field of economic development of the Nurkuse-Myrdal type.

I hope these comments will help us get our discussion back to a broader issue of how to grasp and deal with asset deflation in Japan as a whole instead of narrowing it down to a specific question such as the empirical effect of housing value on consumption.