Japanned

In early 2008, as global stock markets hit their lows and many of the world's banks seemed on the brink of outright collapse, Macro maestro was reading a lot of comparisons between the US/UK economies and Japan. He was told the Anglo-Saxon economies now faced a similar 'lost decade' of growth. At the time, this analysis didn't seem right. Sure there were similarities - huge private-sector debts, rapidly falling asset prices, zombie banks - but there were also important differences.

Above all, the Federal Reserve and Bank of England seemed to have learned the lessons of the Japanese experience. Rather than wait for their economies to enter recession, they cut interest rates rapidly in anticipation of that weakness. Then, when there was no more space to cut interest rates, they moved to quantitative easing (QE) - adding further monetary stimulus by effectively printing money. It took the Bank of Japan almost a decade to try quantitative easing, the Bank of England tried it within 18 months of the crisis hitting their economy.

By the end of 2009, it seemed QE was having the desired effects. While the money supply and bank lending remained weak, asset prices were growing strongly. Stock markets had surged, credit conditions had improved and in the UK, even house prices had confounded expectations and started to rise again. The world's central banks seemed to have convinced markets that 1) they would do whatever it took to restore growth and 2) there were new monetary policy options available even at the zero bound (zero nominal interest rates).

But once again things are starting to look decidedly shaky. Growth has returned, but it is uneven and fragile. Bank lending and money supply remains weak. The US housing market is yet to see any genuine improvement and the UK market seems to be turning down. To some extent, this loss of momentum was inevitable. The effects of past monetary stimulus must eventually start to fade. For example, cutting interest rates boosts disposable income growth for a while but then as rates stabilize the effects on additional growth diminishes. Still, the problems seems to go deeper than that.

In response, the Fed and the BoE seem to be hinting at another round of QE. But will this be effective? The main benefit of QE last time was that is stabilized desperate private-sector sentiment and reassured financial markets. But if the first wave of QE failed to encourage a genuine self-sustaining economic recovery, it seems likely the private sector will be more skeptical this time. Indeed, additional QE might actually undermine confidence rather than restore it. ("Are policymakers really that desperate? Damn, things must be worse than I thought!") And that, of course, leaves us in a genuine nasty position. Bond markets seem to have imposed a limit on fiscal consolidation, at least in Europe. While monetary policy seems to have run out of effective options. Suddenly, those comparisons with Japan don't seem so misguided...