The Holy Grail of Macroeconomics:
Lessons from Japan’s Great Recession
By Richard C. Koo
It has been my feeling, for some time now, that our economy might be on the path of replicating with certain select differences the Japanese post-bubble scenario.
Dr. Koo’s book is an insightful look at precisely that economic period in Japan. What makes his work particularly valuable is his extension of his analysis of the Japanese anomaly to a macro-economic theory to help us deploy monetary and fiscal policy correctly at times of similar critical turbulence.
The two most interesting concepts the author proposes are: his analytical work on balance-sheet recessions and his identification of whether an economy is in yin or yang mode. Koo argues that monetary policy is largely ineffective during balance-sheet recessions, which usually occur when an economy is in yin mode. Yin modes are the result of post-bubble dynamics, when the private sector dedicates all of its efforts to debt and leverage reduction. According to the theory, large fiscal deficits are the only workable solution and because of the counterbalancing effect of the private sector’s action, such deficits will not result in significant inflationary pressures.
Koo argues that Keynesian policies failed in the 1970s and resulted in strong inflation because those policies were applied during yang economic times, that is, when monetary policy is the only appropriate response to slowdowns in the business cycle.
The macro-economic concepts presented in this work are very timely and useful in helping us craft the proper policy response to these extraordinary economic times. While I find myself in agreement with Koo’s findings, I can not help but think that yin mode is affecting the entire global economy, which consists of largely global and mobile financial flows but relatively static and nationalistic fiscal and labor dynamics. My fear is that protectionism and overwhelming deficits could still ultimately derail any yin-mode policy initiatives.