Paul Krugman and Pico Iyer on Japan

A few years ago I started to push the view that most economists had misinterpreted the Japanese liquidity trap.  The BOJ had not tried valiantly to inflate, and failed.  Japan was not “stuck” in any sort of trap.  The low interest rates and bloated base did not mean easy money.  I often point out that the BOJ tightened twice (2000 and 2006) when there was no inflation, which made mild deflation almost inevitable.  At one time I got into a bit of a debate with Paul Krugman:

Hmm. I see that Scott Sumner has a post heatedly attacking the idea that Japan is stuck in a deflationary trap; he insists that Japan has deflation because that’s what the Bank of Japan prefers:

“I was under the impression that the Bank of Japan was an ultra-conservative bank, and liked mild deflation. Indeed I thought that was pretty widely understood. I guess not.”

He guesses right: that’s not at all the view of those who have been following Japanese monetary policy since the 1990s, and have even talked to BOJ people now and then. I’m sorry to say that the fact is that Japan is in a deflationary trap. You can argue that the BOJ should have done more — and I would. But persistent deflation isn’t a target, it’s what has happened because conventional monetary policy has lost traction and the BOJ isn’t willing to be more adventurous.

Here’s Paul Krugman yesterday:

What you need in this situation is a negative real interest rate — which means that you need some expected inflation, because nominal rates face the zero lower bound.

But Japanese policy has never sought to achieve this. Deficit spending has put part, but only part, of the excess desired private saving to work; this has mitigated the slump, but not produced a booming economy, except perhaps briefly circa 2007. And the Bank of Japan has always pulled back on monetary policy when the economy looks better, instead of doing what it should, which is to keep the pedal to the metal until the inflation rate is solidly into positive territory.

I don’t think his position has technically shifted, as a close look at the earlier post tells a similar story to the recent post.  But I do think there’s a sort of change in emphasis.  Earlier he was skeptical of the ability of the BOJ to get Japan out of a deflationary trap.  Now he’s (correctly) pointing out that all this talk of stimulus is boosting the expected rate of inflation in Japan.  They are not “stuck.”  So I see the “pedal to the metal until the inflation rate is solidly into positive territory” as emphasizing that effort matters, it isn’t all about managing expectations.  And that wording seems slightly closer to the monetarist perspective on Japan.  Again, these are slight differences of nuance so I don’t want to make too much of it. He might argue that “pedal to the metal” resolve was a way of managing expectations.

It’s harder than most people assume to pin down the difference between new Keynesianism and market monetarism.  Perhaps we are simply more confident that the BOJ can succeed if it tries.

Here’s one way of putting it.  Krugman and I both agree that the failure to put the pedal to the metal was a sufficient reason for deflation to persist. I also view it as a necessary condition, whereas Krugman tends to be a bit circumspect about how big the “expectations trap” hurdle would be if the BOJ became determined to inflate.

Pico Iyer?  Krugman’s post reminded me of a recent article in the NYR of Books, entitled “Masters of Doing Nothing at All.”  Here’s the opening sentence:

Japanese literature is often about nothing happening, because Japanese life is, too.

PS.  In case I have any Japanese readers, here’s what I posted on November 15, 2012:

Each day I check out the major stock markets.  This morning I saw that Hong Kong and Singapore were down over 1%.  Britain, Germany and France were also down.  But the Japanese market, which tends to move with the other Asian markets, was up by 1.90%.  That’s a surprisingly large divergence.  Is there any news?  It turns out that there is news, but only if you don’t believe in “liquidity traps.”  Travis Allison sent me the following:

“The yen slumped to the lowest in more than six months against the dollar on prospects Japanese elections next month will hand power to an opposition party that advocates more aggressive monetary easing.”

And here’s a graph of the Nikkei since that date, up 32.3% in less then 3 months:

Don’t say I didn’t tell you!  Beats the rate of return on that account at the Postal Savings Bank.   :)

PPS.  Paul Krugman jumped on board the Abe bandwagon on January 11, when they announced a fiscal stimulus proposal.  By then the stock market was already up sharply, mostly on persistent rumors of a 2% inflation target for the BOJ.  But I’ve been talking about this issue from day one of the Great Nikkei Bull Market.

PPPS.  Not much help to investors in America, as the yen has fallen sharply.  But the Japanese CPI has barely budged, so it’s a pretty big real increase in Japan.

PPPPS.  The smiley face is because as much as I’d like to take credit for a lucky call, I still believe in the EMH.

HT:  Saturos



24 Responses to “Paul Krugman and Pico Iyer on Japan”

  1. Gravatar of ant1900 ant1900
    6. February 2013 at 19:48

    The N225 rallied 3% yesterday, reportedly in part based on the news that the BOJ chairman announced he was resigning earlier, presumably making the way for Abe’s pick to start sooner. (Always take stories about the market rallying for XYZ reason with a grain of salt). But looking at the bigger market move since Abe was elected, the N225 seems to believe that inflation is coming.

    When does Carney start at the Bank of England? It seems like we could have the Fed, BOE, and BOJ all doing some form of QE at the same time in the near future.

  2. Gravatar of Benjamin Cole Benjamin Cole
    6. February 2013 at 20:55

    I am happy to see people talking about Japan.

    That is what we should be talking about, not inflation.

    It is true, Japan never got out of its ZLB, perma-gloom, slow-growth recessionitis. 20 years and counting. Monetary purgatory. The world has passed them by, especially Korea and China.

    I have to think Sumner (and Milton Friedman) are right, the BoJ just needs to digitize (print) money, then digitize more money, and keep on digitizing money until they get powerful growth and inflation.

    Note to readers: I will stop believing in Market Monetarism when I see this: You throw a $100 bill down on the sidewalk and walk away, and no one stoops to pick it up. That means that fiat money has lost its ability to motivate human behavior and increase output.

    If you think Market Monetarism will not work, you can test your theory. You can covert all your assets to cash, and dump it out on the sidewalk. If no one stoops to pick it up, and later spend the dough, then Market Monetarism will not work.

    Please inform me privately of where and when you plan to test your theory that Market Monetarism will not work.

  3. Gravatar of Asco Asco
    6. February 2013 at 21:59

    “It’s harder than most people assume to pin down the difference between new Keynesianism and market monetarism. Perhaps we are simply more confident that the BOJ can succeed if it tries.”

    I agree. Most of the apparent differences are really a matter of framing – such as focusing on NGDP instead of P and Y separately, QE vs. interest rate guidance and so on.

    The NK framework is just unecessarily confusing. The interest rate approach makes people think monetary policy is ineffective, and the inflation targeting approach makes it hard to frame a credible forward guidance.

  4. Gravatar of 123 123
    7. February 2013 at 00:04

    Scott, Thanks. Abenomics trade was just like a research grant to all the market monetarists.

  5. Gravatar of Georges Georges
    7. February 2013 at 02:08

    I actually think that in terms of monetary policy, your views are very similar to the new keynesian views. You probably differ in your fiscal policy views though.

  6. Gravatar of Integral Integral
    7. February 2013 at 02:51

    “It’s harder than most people assume to pin down the difference between new Keynesianism and market monetarism. Perhaps we are simply more confident that the BOJ can succeed if it tries.”

    I’ve tried to make this point as well – there’s little in Market Monetarism that you wouldn’t find in the New Keynesian textbooks (Gali, Woodford, Walsh), except a massive change in emphasis.

    You really do need Market Monetarism to understand that “adjusting interest rates are a means to the end of price level/NGDP targeting,” as opposed to the usual NK view that “inflation targeting is a means to the end of tying down an interest-rate rule.”

    Put slightly differently, I think a key point in MM is to think in terms of ends, not means. That’s why you can talk about the central bank pushing NGDP around directly, while NK economists are stuck trying to work through transmission mechanisms at the ZLB.

  7. Gravatar of dtoh dtoh
    7. February 2013 at 04:03


    “It’s harder than most people assume to pin down the difference between new Keynesianism and market monetarism.

    I think you can easily bridge the difference and arrive at an easily understandable “Grand Unified Monetary Theory” by carefully distinguishing between the Tools, the Mechanism, and the Target.

    The Tools – OMO and Fed Guidance.

    The Mechanism – Real price of financial assets (1/ the expected real return) and expectations of future NGDP growth.

    The Target – NGDPLT

    In the case of New Keynesianism, the problem has been primarily one of viewing interest rates as the tool and the mechanism. It has viewed the setting of interest rate targets as a tool, failed to recognize the importance of real rather than nominal interest rates (prices) as the mechanism, and focused on the wrong target…. RGDP rather than NGDP.

    MM has been instrumental in stressing the importance of the right target (NGDPLT), but has tended to view OMO as one sided issuance of money as opposed to a two-sided exchange of money for financial assets, and has mis-characterized the money supply as the mechanism.

  8. Gravatar of Bill Woolsey Bill Woolsey
    7. February 2013 at 04:41


    I think you are on to something here. Inflation tying down a rule for the policy interest rate. Or interest rates (or base money) as a means to target nominal GDP.

    I think that the difference between growth rate targets (like inflation) and level targets is important too.

  9. Gravatar of ssumner ssumner
    7. February 2013 at 05:13

    Everyone, Good points. I mostly agree with all of these comments.

  10. Gravatar of The Japan quandary | Historinhas The Japan quandary | Historinhas
    7. February 2013 at 06:19

    [...] Scott Sumner has done a post on Krugman´s latest “Japan Story”. I just tried to elaborate a bit. [...]

  11. Gravatar of Andy Harless Andy Harless
    7. February 2013 at 07:56

    ‘I was under the impression that the Bank of Japan was an ultra-conservative bank, and liked mild deflation.’

    I don’t think it’s accurate to say that the BoJ “liked mild deflation.” I would say rather that it had an irrational fear of a booming economy. I’m pretty sure that if you could have just flipped a switch and raised both the actual and expected inflation rates to +1%, the BoJ would have preferred this to the mild deflation that actually transpired. Its behavior prior to the 1990′s suggests that it wasn’t upset by a positive inflation rate, as long as the rate wasn’t too high. But it got used to taking away the punch bowl as the party was beginning to get wild, and it followed the same procedure under later circumstances, not appreciating that Japan needed a wild party to get the inflation rate back up to normal.

  12. Gravatar of Saturos Saturos
    7. February 2013 at 08:50

    So, ECB still determined to sink Europe, hey?

  13. Gravatar of JP Koning JP Koning
    7. February 2013 at 09:41

    “It’s harder than most people assume to pin down the difference between new Keynesianism and market monetarism.”

    This is always a point of constant confusion for me.

    I think Miles Kimball’s exchange with you from a few months back clarifies it all.

    He asked what you think about Wallace neutrality and you replied that it’s fine in theory but not in practice. New Keynesians tend to see it as fine in both theory and practice. New Keynesians say that the Fed must promise to do the wrong thing in the future to have the right effect now (Kimball’s wording). By promising to do the “wrong” thing when it escapes from the ZLB, the Fed can escape Wallace neutrality and get a bite now, even though we are still at the so-called ZLB. Neither you nor Kimball think future overstimulation is necessary since Wallace neutrality doesn’t hold.

    Upshot: NKs and MMs are different.

  14. Gravatar of Doug M Doug M
    7. February 2013 at 10:20

    Benjamin Cole,

    “I will stop believing in Market Monetarism when I see this: You throw a $100 bill down on the sidewalk and walk away, and no one stoops to pick it up.”

    Derren Brown did this. No one picked up the money.

  15. Gravatar of marcus nunes marcus nunes
    7. February 2013 at 10:30

    Doug M
    Maybe they thought they were on “candid camera”!
    My daughter is a great finder of things on the sidewalk. I´ve lost count of the times she found the equivalent of $5 and $10 bills. Once she even picked up (from the sidewalk) a high end Nokia phone!

  16. Gravatar of Max Max
    7. February 2013 at 11:19


    To me the issue is not whether Wallace neutrality holds, but whether there is some market dislocation that QE can remedy. If markets are calm and asset prices are not depressed, then what good can QE do? I don’t see how generating inflation via massive QE (i.e. “buy everything”) is any more responsible than an explicit promise of inflation. It’s not a way around the zero bound problem.

  17. Gravatar of Kevin Donoghue Kevin Donoghue
    7. February 2013 at 16:20

    “It’s harder than most people assume to pin down the difference between new Keynesianism and market monetarism.”

    Brian: Excuse me. Are you the Judean People’s Front?

    Reg: Fuck off! We’re the People’s Front of Judea

  18. Gravatar of catotheelder catotheelder
    7. February 2013 at 16:22

    mr sumner: i’ve read a lot of your posts. has there ever been a historical example, partial or whole, where ngdp targeting has achieved the goals you say it will? how do you know you’ve considered all the unintended consequences? how do we know any success would not be a logical falacy along the lines of post hoc ergo propter hoc?

  19. Gravatar of Britmouse Britmouse
    8. February 2013 at 00:53

    JP, even that is surely a too narrow take on the “NK view” – Svensson is basically on the same page as the MMs and disagrees with Krugman – and he specifically makes the point about the CB promising to do the “right thing” not the “wrong thing” in the future contra Krugman, in one of his papers.

  20. Gravatar of ssumner ssumner
    8. February 2013 at 06:43

    Andy, Good point. It would be more accurate to say “their behavior was identical to that of a central bank that liked mild deflation.”

    Therefore it’s no surprise Japan ended up with mild deflation.

    JP, I can’t speak for Kimball, but I don’t agree that WN holds. In other words, suppose the Fed sets a 3% CPI target. I think they could peg the price of CPI futures at 3% but cutting IOR to zero and buying up less than the entire outstanding stock of Treasury debt. I presume NKs disagree. And if that didn’t work they could set the IOR at negative 3% and peg the CPI futures w/o buying up all Treasury debt. If we had a small stock of government debt, like Australia, I could envision cases where they had to buy foreign debt as well. Some Keynesians call that fiscal stimulus, although I’ve never been too clear why.

    Catotheelder, I know of no such case. But we can say that during periods where NGDP is more stable, RGDP also tends to be more stable. A good example is 1985-2007.

  21. Gravatar of JP Koning JP Koning
    8. February 2013 at 07:37

    Britmouse, yes, Svensson does seem to be on the MM page. Kevin certainly has a point.

    Perhaps it is just a question of degree between Sumner, Svensson, Woodford, Krugman, Eggertson etc. as opposed to discrete categories of thought. The more one believes in Wallace neutrality, the less “direct” power open market ops have at the zero-lower bound… if OPMs are to have any power at all, it is only “indirectly” through promising the “wrong thing”.

    Funny enough, you get to the same resting point whether you’re Sumner/Svensson or Krugman/Woodford/Eggertson… open market operations have an effect. And no matter where they fall in the Wallace neutrality spectrum, they can point to the rise in Japanese equity markets as proof of their underlying views.

  22. Gravatar of Essayisu-Lawyer Essayisu-Lawyer
    8. February 2013 at 14:35

    Is how I would summarize your debate woth Krugman:

    Sumner: The BOJ is objectively pro-deflation.

    Krugman: Im sure that is not their subjective intent.

    Sumner: Who cares about subjective intent. It is the resylts that matter.

  23. Gravatar of Essayisu-Lawyer Essayisu-Lawyer
    8. February 2013 at 14:51

    The difference between a New Keynesian and a Market Monetarist is a tiny crack. The difference between a Market Monetarist and a member of, say, Team Supply, Team Price Stability or Team Liquidationism is a gaping chasm. So why do you regard the right-left divde as whixh side of the crack you are on, instead of which side of the chasm?

  24. Gravatar of ssumner ssumner
    8. February 2013 at 19:29

    Lawyer, The differences are bigger than you think:

    1. Confidence in monetary stimulus effectiveness at the zero bound.

    2. Views on monetary offset and fiscal stimulus.

    3. Views on supply-side factors like extended UI.

    4. Views of how to measure stance of monetary policy.

    5. Views on whether monetary stimulus raises or lowers nominal rates.

    6. If Krugman is still considered NK, then I’d add paradox of toil, protectionism/CA deficits, and lots of other issues.

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