This blog is really a two-part blog which is a follow up on previous blogs I have written about Overt Monetary Financing (OMF). The former head of the British Financial Services Authority, Adair Turner has just released a new paper – The Case for Monetary Finance – An Essentially Political Issue – which he presented at the 16th Jacques Polak Annual Research Conference, hosted by the IMF in Washington on November 5-6, 2015. The paper advocated OMF but in a form that I find unacceptable. I will write about that tomorrow (which will be Part 2, although the two parts are not necessarily linked). I note that the American journalist John Cassidy writes about Turner in his latest New Yorker article (November 23, 2015 issue) – Printing Money. Just the title tells you he doesn’t appreciate the nuances of central bank operations. He also invokes the Zimbabwe-Weimar Republic hoax, which tells you that he isn’t just ignorant of the details but also part of the neo-liberal scare squad that haven’t learnt that all spending carries an inflation risk – public or private – no matter what monetary operations migh be associated with it. I will talk about that tomorrow. Today, though, as background, I will report some research I have been doing on Japanese economic policy in the period before the Second World War. It is quite instructive and bears on how we think about OMF. That is the topic for today.
Takahashi Korekiyo – was the 20th Prime Minister of Japan and held office twice the last time in an acting capacity in 1932. He had previously worked in the Bank of Japan. For the most part though, he was Finance Minister under various administrations from the late 1920s until his death in 1936.
I have been researching documents in the Bank of Japan archives for some time now as part of a book project I am working on. I am up to the period that Takahashi Korekiyo was a major player in Japanese economic policy making and it just happens to fit in with the comments I wish to make about Adair Turner and John Cassidy.
But I thought this background would help us for tomorrow.
Takahashi Korekiyo is famous for abandoning the Gold Standard on December 13, 1931 and introducing a major fiscal stimulus with central bank credit which rescued Japan from the Great Depression in the 1930s. That is quite a reputation. His actions and the subsquent results provide a solid evidence base for assessing whether OMF is desirable.
I note that OMF is core Modern Monetary Theory (MMT) policy, a point that Cassidy seems to be worried about. More about that tomorrow.
As to Takahashi Korekiyo, I don’t think his monetary acumen had anything to do with his assassination (in his sleep by gunshot and sword) by rebel army officers in 1936 during the so-called – February 26 Incident – which was a failed coup d’état.
He had in fact reduced military funding because he was a moderate and wished to reduce Japan’s martial tendencies. Enemies were thus made and they were the type of enemies that carried weapons and knew how to use them!
As background, Japan had experienced a major private banking collapse in 1927 (the Showa Financial Crisis) as a result of what has been referred to as “cumulative mismanagement of cover-ups and halfway measures against earlier flaws dating back to the post-war collapse” (quote from Takahashi, Kamekichi [1955a], Taisho Showa Zaikai Hendou Shi (A History of Economic Fluctuations during Taisho and Showa Eras), vol.2, Toyo Keizai Shinposha, Tokyo, p.739).
In other words, the banksters were out in force in Japan during the 1920s. It is argued by Takahashi Kamekichi that the stimulus measures introduced by Takahashi Korekiyo were assisted by the reforms that were made in the late 1920s to deal with the Showa Financial Crisis.
There were three notable sources of stimulus introduced by Takahashi Korekiyo:
1. The exchange rate was devalued by 60 per cent against the US dollar and 44 per cent against the British pound after Japan came off the Gold Standard in December 1931. The devaluation occurred between December 1931 and November 1932. The Bank of Japan then stabilised the parity after April 1933.
2. He introduced an enlarged fiscal stimulus. In March 1932, Takahashi suggested a policy where the Bank of Japan would underwrite the government bonds (that is, credit relevant bank accounts to facilitate government spending).
This proposal was passed by the Diet on June 18, 1932. The Diet passed the government’s fiscal policy strategy for the next 12 months with a rising fiscal deficit 100 per cent funded by credit from the Bank of Japan.
Bank of Japan historian Masato Shizume wrote in his Bank of Japan Review article (May 2009) – The Japanese Economy during the Interwar Period: Instability in the Financial System and the Ipact of the World Depression – that:
Japan recorded much larger fiscal deficits than the other countries throughout Takahashi’s term as Finance Minister in the 1930s.
On November 25, 1932, the Bank of Japan started ‘underwriting’ the government’s spending.
3. The Bank of Japan eased interest rates several times in 1932 (March, June and August) and again in early 1933. This easing followed the cuts by the Bank of England and the Federal Reserve Bank in the US. Monetary policy cuts were thus common to each but the size of the fiscal policy stimulus was unique to Japan.
Masato Shizume wrote that:
[The full reference is: Shizume, Masato (2009) “The Japanese Economy during the Interwar Period: Instability in the Financial System and the Impact of the World Depression”, Bank of Japan Review, 2009-E-2]
A number of observers who focus on the macroeconomic aspects of the Takahashi economic policy praise Takahashi’s achievements as a successful pioneer of Keynesian economics. Kindleberger points out that Takahashi conducted quintessential Keynesian policies, stating, “his writing of the period showed that he already understood the mechanism of the Keynesian multiplier, without any indication of contact with the R. F. Kahn 1931 Economic Journal article.”
The next graph is a reproduction of Chart 7 Macroeconomic Policies of Japan and Other Countries from Masato Shizume’s paper. It is self-explanatory.
The big variation between the different currency blocs and Japan is in fiscal policy.
There is substantial discussion in the literature about the relative impacts of these three different stimulus measures. But what followed is clear:
1. Real GDP growth returned quickly and stood out by comparison with the rest of the world which was mired in recession. Between 1932 and 1936, real industrial production grew by a staggering 62 per cent.
2. Employment, which had also plummeted in the early days of the Great Depression, grew robustly after the Takahashi intervention.
3. Inflation spiked as a result of the exchange rate depreciation in 1933 but quickly fell to low and relatively stable levels in 1934 as the economy’s growth rate picked up under the support of the fiscal and monetary stimulus.
It was clear that abandoning the Gold Standard was a crucial first step because it gave the government space to introduce major domestic stimulus policies. These policies were not possible under the Gold Standard because they would have pushed out the external deficit and the nation would have lost its gold stocks.
I note a number of the current Republican presidential potentials in the US are once again calling for a return to the Gold Standard. They clearly haven’t a clue what they are talking about given the appalling record of nations when they were on such exchange rate mechanisms.
It was the Gold Standard that ensured the Great Depression ensued. As the US started to run trade surpluses in 1929 (after the recession choked off imports), other nations started to deplete their gold stocks which meant they had to raise interest rates to attract capital inflow. The US recession spread and many investors in Europe considered that the central banks would have to devalue. Anticipating that, they withdrew gold and the contractionary effects on the money supply worsened the downturn. Then banks collapsed and so on.
There is an interesting article (November 12, 2015) by Greg Ip – What Republicans Get Wrong About the Gold Standard – that bears on this issue. It is targetted at those stupid Republican candidates.
Clearly, Takahashi Korekiyo understood the constraints that the Gold Standard and the need to maintain the money supply in proportion with the nation’s stock of gold imposed on domestic policy. Once he removed that constraint he could then use the fiscal and monetary tools available to him (and through the Bank of Japan) to target domestic demand.
Some researchers have suggested that the combination of the exchange rate depreciation and the fiscal stimulus “had significant impacts upon the level of activity” (see Nanto, D.K. and Takagi, S. (1985) ‘Korekiyo Takahashi and Japanese Recovery from the Great Depression’, American Economic Review, 75, 369-74).
Most of the studies suggest that the monetary policy easing (cutting interest rates) was not as significant as the other two stimulus measures.
Another strand of argument is that in the transition from democracy to fascism in the early 1930s, the trade unions were suppressed and industrial disputation fell. Real wages fell as a result, which some claim caused employment and output to rise.
An interesting paper was published on September 30, 2000 by the Korean scholar Myung Soo Cha – Did Korekiyo Takahashi Rescue Japan from the Great Depression?.
It sought to decompose these stimulus factors and wage reductions to see order their impact on the exceptional recovery during the Great Depression. He also includes world output impacts (on Japanese exports) to see whether the recovery was driven by events outside of Japan.
He uses statistical techniques (Vector Autoregression) and historical data released by the Bank of Japan to show that it was the fiscal initiative that “was critical in reversing the downswing” in Japan in the early years of the Great Depression.
As an aside, the Bank of Japan runs an excellent Historical Statistics page. There are other sources of data that is of use in studying this period – for example the League of Nations, International Statistical Yearbook – which is available on-line through Northwestern University in the US.
The next graph is a reproduction of Myung Soo Cha’s Figure 1 and show the evolution of Industrial Production from the mid-1920s to 1937.
It is clear that Japan’s experience was quite different to the other major economies of the day, especially after the major stimulus package introduced by Takahashi Korekiyo.
It is also interesting that the turning points in the graph for the respective countries “matches the sequence of going off gold in the wake of the Depression: Britain, Germany and Japan in 1931, the U.S. in 1933, and finally France in 1936”. That is not coincidental.
I won’t go into his methodology (it is standard) and you can read the paper yourself if you are interested in this sort of econometric analysis.
The results of his study are fairly clear:
1. He writes “one cannot but be impressed by the prominent role of Takahashi’s fiscal expansion in ending the Great Depression in Japan”.
2. “In particular, his deficit spending was found to have been crucial in ending the depression quickly”.
3. “Devaluation did help during 1932, but its contribution to output growth was modest.”
4. “The depreciating yen provided some stimuli as well, but they were not sufficiently strong to outweigh the contractionary influences from the rest of the world.”
Another finding from Shizume Mazato’s work is that while inflationary expectations rose somewhat during the shift from liberal democracy to fascism, “the shift in expectation from deflation to inflation was chiefly the result of the currency depreciation, not the BOJ underwriting of government bonds”.
Some might argue that it was the increased military spending that provided the fiscal stimulus, which would be undesirable in today’s world.
But research suggests that the military part of the fiscal shift to stimulus was fairly insignificant (see for example, Metzler, M. (2006) Lever of Empire: The International Gold Standard and the Crisis of Liberalism in Prewar Japan, Berkeley, University of California Press).
There is little doubt that Takahashi Korekiyo’s economic policy stance – which was very MMT in operation – saved Japan from the Great Depression.
The large fiscal stimulus that was mostly underwritten with central bank credit did not cause interest rates to sky-rocket nor inflation to accelerate.
Inflation rose for a time then fell again but this was mainly the result of the massive exchange rate depreciation. That is a result that would always occur in a small open-economy such as Japan (at the time – small that is).
While there were aspects that were unnecessary – for example, the military spending – it is clear that Takahashi Korekiyo’s ‘experiment’ has relevance for us today in discussions concerning Overt Monetary Financing.
I have argued in my current book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015) – that OMF could save the Eurozone (from itself).
But try to get the policy makers in Brussels and Frankfurt to display as much policy acumen and foresight as Takahashi Korekiyo did in 1931.
Politics in the Pub – Hamilton – November 17, 2015
Tonight, I will be the speaker at the Politics in the Pub, which is held at the Hamilton Station Hotel, Beaumont Street, Hamilton (a suburb of Newcastle, NSW).
The title of my talk will be ‘Why budget deficits are good for Australia’ and I will motivate the talk with the quote from US philospher Daniel Dennett who told the New York Times on April 29, 2013 that:
There’s simply no polite way to tell people they’ve dedicated their lives to an illusion …
We will have some fun with that!
The event starts at 18:30.
I hope to see local readers there.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.