DJ Fed Study:US Can Learn From Japan's Deflation Experience --
(This article was originally published Monday)
By Joseph Rebello
Of DOW JONES NEWSWIRES
WASHINGTON (Dow Jones)--Japan's persistent economic decline over the last 12
years offers a key lesson for U.S. policymakers, a new Federal Reserve study
says: An economy that remains sickly even after a historic barrage of
interest-rate cuts deserves special care.
The study, published last week, asserts that Japan's experience shows that
economic policymakers should go extra lengths to revive a slumping economy well
before inflation dwindles to zero. That's because deflation is more debilitating
to economies - and harder to control - than inflation.
"The failure of economists and financial markets to forecast Japan's
deflationary slump in the early 1990s poses a cautionary note for other
policymakers in similar circumstances: deflation can be very difficult to
predict in advance," the study says.
Accordingly, as interest and inflation rates sink closer to zero, policymakers
should "take out sufficient insurance" against the prospect of deflation, the
study says. It recommends the use of both interest-rate cuts and tax cuts or
spending increases to give the economy an extra boost.
US Econ Situation Reminds Economists Of Japan In 1990s
As the U.S. economy slipped into recession for the first time in a decade last
year, the Fed cut its key interest rate to a 47-year low. But the recovery has
been fitful: The economy is thought to have grown less than 3% in the second
quarter of 2002, down from 5.6% in the first quarter. Stock prices continue to
tumble, and inflation has receded: The price index for personal consumption
expenditures, a gauge favored by Fed policymakers, has hovered slightly above
zero this year.
Many economists say that reminds them of Japan's descent from giddy economic
prosperity in the 1980s into a deflationary slump in the 1990s that its
policymakers have been unable to reverse. In the last six months a growing
number of Fed policymakers also have fretted about the prospect of deflation in
the U.S., saying the U.S. central bank should act just as preemptively to fight
deflation as it has to fight inflation.
"I would be prepared going forward to focus on preempting disinflation, or
more crucially, deflation, if that became necessary," Alfred Broaddus, president
of the Federal Reserve Bank of Richmond, said in April. Fed policymakers are
scheduled to meet Tuesday and Wednesday to decide the course of interest rates.
They are widely expect to leave the key federal funds rate unchanged at 1.75%.
Japan Didn't Take `Sufficient Insurance' Vs Deflation
The Fed study - written by 13 economists - makes no assertions about the
danger of deflation in the U.S. But it argues that policymakers in the U.S. and
other countries can learn from Japan's experience. "An analysis of Japan's
experience may shed light on a host of questions that potentially could face
policymakers in the United States and other economies at some future point," the
study says.
In the late 1980s, Japan's economy grew so rapidly that its top policymakers
worried that the economy might overheat. The Japanese central bank began raising
interest rates in 1989 to fight the danger of inflation. Stock prices plummeted,
and the economy began to deteriorate. In response, Japan's central bank began a
protracted campaign of interest rate cuts - the overnight call-money rate
declined from more than 8% to zero by 1999. But the economy never recovered.
The Fed study says, in hindsight, that Japanese policymakers acted too slowly.
"Perhaps the most important concern raised by Japanese policy during this period
was not that policymakers did not predict the oncoming deflationary slump -
after all, neither did most forecasters - but that they did not take out
sufficient insurance against downside risks through a precautionary further
loosening of monetary policy," the study says.
A Fed econometric simulation of the global economy shows that had the Bank of
Japan cut short-term interest rates by "a further 200 basis points at any time
between 1991 and early 1995, deflation could have been avoided," the study says.
The window of opportunity, however, closed in the second quarter of 1995. By
then, the study says, "inflation had already fallen below zero." The Japanese
government also cut taxes and increased government spending - but not in a way
that might have ensured an economic recovery.
Japanese Mistakenly Drew Comfort From Zero Inflation
The slow reaction of Japanese authorities was "understandable," the study
says. Most economists - including forecasters at the Fed - expected Japan's
slump to last no more than a few years. Besides, "the BOJ believed that it was
delivering an unprecedented degree of monetary stimulus" that would yield
results.
Fed policymakers also have drawn a measure of comfort from the magnitude of
interest-rate cuts they implemented in response to the U.S. recession last year.
In March, for example, they argued that "the inflation-adjusted federal funds
rate was at an unusually low level," enough to "support an economic recovery,"
Fed documents show. But they also have remained alert to the dangers of zero
inflation. Price stability, for Fed Chairman Alan Greenspan, has meant inflation
at a rate low enough that it doesn't affect the decisions of businesses,
consumers and investors.
By contrast, Japan's central bankers "seemed to be comfortable with the
prospect of sustained zero inflation, notwithstanding the fact that zero
inflation on average over time will likely imply shorter periods of deflation as
well as inflation," the Fed study says. They also didn't recognize that
deflation would be harder to control than inflation. Accordingly, they may have
worried too much that "lowering interest rates might engender conditions
favorable to the emergence of a new bubble in equity and land prices," the study
says.
"What if the BOJ had loosened substantially in 1994, to guard against the risk
of deflation, and then unanticipated favorable shocks had lifted output gaps and
inflation well into positive territory?" the Fed study asks. In that scenario,
inflation probably "would have risen above desired levels for a number of years,
but a tightening of monetary policy by the BOJ in response would have caused ...
inflation to decline back to its original baseline."
-By Joseph Rebello, Dow Jones Newswires; 202-862-9279;
Joseph.Rebello@dowjones.com
(END) DOW JONES NEWS 06-25-02
08:00 AM- - 08 00 AM EDT 06-25-02
Source DJ - Dow Jones |
