August 5, 2010

It's a little (pardon the pun) depressing to read that our economic policy in the face of this "balance sheet recession" is exactly the wrong one. Japanese economist Richard Koo has been sounding the alarm for a while, citing Japan's economic collapse after following the International Monetary Fund's advice to cut their deficit:

Hearing comparisons between the US and Japan? Confused about deleveraging, private saving, and government spending? Look no further – Richard C. Koo explains it all in his testimony before the Committee on Financial Services U.S. House of Representatives.

The first point Koo makes is that ordinary recessions – which tend to come up every so often – and full-fledged depressions are “two different diseases requiring totally different treatments.”

What’s the difference? In a depression, the private sector is focused solely on getting rid of debt. Who cares? Just take an example: a family makes $1000 and saves $100. Normally that $100 is lent by the family’s bank to a borrower who can invest and use that money. But in today’s world, where everyone is trying to get rid of debt, no one wants to borrow that $100.

This is just what happened during the Great Depression, and also what happened to Japan in the 1990s. But Japan was smart: the government borrowed and spent $100 instead, keeping the money flowing. Even though it increased the government’s debt by 460 trillion yen, it sustained over 2,000 trillion yen – “making it a huge bargain,” the understated Koo points out. On the other hand, cutting spending and government deficits will have the opposite, devastating effect.

His testimony is here and it's the clearest argument yet for the administration to stop pushing this deficit nonsense.

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