This week the Federal Reserve announced another round of quantitative easing, called QE2, in a desperate attempt to buoy the U.S. economy. Perhaps we should take a look at Japan’s recent experience with its own quantitative easing for clues to see if it is likely to work for us.
The problem is that America is faced with what is called a “balance sheet recession.” This is where consumers are aren’t going to be spending money because they are in the process of deleveraging. There is simply too much debt, both in business and individually, and the lack of confidence will cause them to pay down debt instead of spend.
Just like Japan suffered.
Take a look at the chart of Japan’s deleveraging while interest rates were zero, for ten years. It does not instill hope for the U.S. economy.
Features of a Balance Sheet Recession
Richard Koo, Chief Economist at Nomura Institute in Tokyo, recently issued a warning about balance sheet recessions. He defines them as having these characteristics:
- Emerges after the bursting of a debt-financed asset price bubble that leaves many private-sector balance sheets with more liabilities than assets.
- To repair their balance sheets, the private sector moves away from profit maximization to debt minimization.
- Private sector deleveraging, even with zero interest rates, means there will be no borrowers of newly generated savings and debt payments. With no borrowers, the economy will continue to loose aggregate demand equivalent to the sum of unborrowed savings and debt repayment.
- The economy will not enter self-sustaining growth until private sector balance sheets are repaired.
- Fiscal consolidation should begin only after it is ascertained that funds not borrowed by the government will be borrowed and spent by the private sector.
Here is Richard Koo speaking on the subject at the Opening Session of the Inaugural Conference of the Institute for New Economic Thinking:
