Monetary-policy delusions

Nor does the ECB have reason to be gratified with its strain of quantitative easing. Despite a doubling of its balance sheet, to a little more than 3 trillion euros ($4 trillion), Europe has slipped back into recession for the second time in four years.

Not only is QE's ability to jumpstart crisis-torn, balance-sheet-constrained economies limited; it also runs the important risk of blurring the distinction between monetary and fiscal policy. Central banks that buy sovereign debt issued by fiscal authorities offset market-imposed discipline on borrowing costs, effectively subsidizing public sector profligacy.

Unfortunately, it appears that Japan has forgotten many of its own lessons, especially the BOJ's disappointing experience with zero interest rates and QE in the early 2000s. But it has also lost sight of the 1990s, the first of its so-called lost decades, when the authorities did all they could to prolong the life of insolvent banks and many nonfinancial corporations. Zombie-like companies were kept on artificial life-support in the false hope that time alone would revive them. It was not until late in the decade, when the banking sector was reorganized and corporate restructuring was encouraged, that Japan made progress on the long, arduous road of balance-sheet repair and structural transformation.

US authorities have succumbed to the same Japanese-like temptations. From quantitative easing to record-high federal budget deficits to unprecedented bailouts, they have done everything in their power to mask the pain of balance-sheet repair and structural adjustment. As a result, America has created its own generation of zombies, in this case, zombie consumers. Like Japan, America's post-bubble healing has been limited, even in the face of the Fed's outsize liquidity injections. Household debt stood at 112 percent of income in the third quarter of 2012, down from record highs in 2006, but still nearly 40 percentage points above the 75 percent norm of the last three decades of the 20th century. Similarly, the personal-saving rate, at just 3.5 percent in the four months ending in November 2012, was less than half the 7.9 percent average of 1970-99.

The same is true of Europe. The ECB's uber-aggressive actions have achieved little in the way of bringing about long-awaited structural transformation in the region. Crisis-torn peripheral European economies still suffer from unsustainable debt loads and serious productivity and competitiveness problems. And a fragmented European banking system remains one of the weakest links in the regional daisy chain.

Is this the "cure" that Abe really wants for Japan? The last thing that the Japanese economy needs at this point is backsliding on structural reforms. Yet, by forcing the BOJ to follow in the misdirected footsteps of the Fed and the ECB, that is precisely the risk that Abe and Japan are facing.

Massive liquidity injections carried out by the world's major central banks, the Fed, the ECB, and the BOJ, are neither achieving traction in their respective real economies, nor facilitating balance-sheet repair and structural change. That leaves a huge sum of excess liquidity sloshing around in global asset markets. Where it goes, the next crisis is inevitably doomed to follow.

The author is a faculty member at Yale University and former chairman of Morgan Stanley Asia, and the author of The Next Asia.

Project Syndicate

(China Daily 01/22/2013 page9)

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