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To: waldo who wrote (20859)	10/6/1998 3:20:00 PM
From: Alex	Respond to of 116825

The problem is still Japan By David Warsh, Globe Staff, 10/06/98 'Ibelieve that we are in the most serious financial crisis since World War II,'' the chief of the Federal Reserve Bank of New York, William McDonough, told the Institute of International Bankers yesterday. He's probably right. And if it isn't altogether agreed upon what to do about it, we should at least be clear about why it happened. The slump now threatening to spread from Asia to the rest of the world was made in Japan. It stems from the economy's superheated boom in the late 1980s, and the subsequent bust that started in 1992. It has been exacerbated by the austerity demanded by the International Monetary Fund as the crisis spread from place to place - Thailand, Indonesia, South Korea, Russia, Brazil. But the problem's root cause remains the stagnation of the world's second-biggest economy. How serious is it? Japanese employment has held up well enough, though today's 4 percent jobless rate is awfully high by its historic standards. Otherwise, the economy has lost all its its oomph, at home and throughout the rest of Asia. Having grown at an average rate of 3.7 percent a year from 1981 through 1992, Japan has barely grown at all since - and this year its economy will significantly shrink. How bad is it? The Nikkei 225 stock index peaked on Dec. 29, 1989, at 38,916. Yesterday it fell 2.1 percent to 12,948 - a third of its top value. It was the first dip below the psychologically important 13,000 since early 1986. Nobody has been more vigorous in diagnosing Japan's problem than Paul Krugman, a policy whiz at the Massachusetts Institute of Technology. The affliction is a classic ''liquidity trap,'' he says, little different from the condition of oversaving that gripped the global economy in the 1930s. The idea was cooked up by John Maynard Keynes and refined by John Hicks at the depth of the Depression. A liquidity trap occurs because of excess savings - consumers stop spending and save even as the interest rate drops toward zero. (Japanese money market rates have been below 1 percent since 1995.) At a certain point money itself and bonds become perfect substitutesfor one another; monetary policy ceases to have any effect. Now, in an article prepared for the latest Brookings Papers on Economic Activity, Krugman has spelled out the clearest version yet of his analysis - including some surprising reflections on the banks. (A version of the paper can be found on his Web page at mit.edu krugman/www.) Little has been heard in recent years about liquidity traps, writes Krugman; the abstracts of just 21 papers in all of technical economics since 1975 contain the term. Two factors contributed heavily to the idea's eclipse. The first was the long postwar boom, during which nominal interest rates stayed comfortably high. The second was the reinterpretation of the Depression by Milton Friedman and Anna Schwartz, who argued that it had been caused by bad monetary policy and could easily have been avoided. These combined to convince economists that the liquidity trap ''can't happen, didn't happen, and won't happen again.'' ''But it has,'' Krugman writes, ''and to the world's second-largest economy.'' It will not do to pull the old analyses of the Great Depression out and apply them to Japan, says the economist. That has led the US Treasury to prescribe tax cuts and public works spending to the Japanese. It hasn't worked. Instead, economists must take account of what has been learned in the years since Keynes and Hicks - much of it having to do with the centrality to policy of expectations, the mobility of capital in the global economy, and the ever-more-complex financial industry. That's where the Japanese banks come in. The conventional wisdom is that the economy can't get going again until thebanks cleanse their balance sheets of the staggering inventory of bad loans made during the pell-mell expansion throughout Asia. The Japanese situation today makes America's savings and loan workout mild by comparison. A financial cleanup is necessary, says Krugman, but it is unlikely to bootstrap Japan out of its liquidity trap by itself. That perhaps only a policy of ''managed inflation'' will do - about 4 percent a year for 15 years would serve, causing the yen to depreciate by something like 20 percent or 25 percent. Heresy? Yes, in this era of price stability. But it is also the most interesting idea around to get Japan growing again. This story ran on page D01 of the Boston Globe on 10/06/98. © Copyright 1998 Globe Newspaper Company. - - - - - - - - - - - - - - - - - - - - - - boston.com