Richard Koo: Fiscal Stimulus Required To Keep U.S. From Following Japan (Deflation) Until Private Sector Recovers

Richard Koo (BloombergTV)
Richard Koo, chief economist at the Nomura Research Institute in Tokyo, was interviewed on Bloomberg TV yesterday (4/26/2011). He thinks Federal Reserve policies (0% rates; QE2) are not doing much for the U.S. economy, but says the economy needs government stimulus to keep GDP from collapsing. If fiscal stimulus is pulled before the private sector recovers due to political pressure, Mr. Koo believes there is a risk that the U.S. could follow the same path as Japan (deflation). Watch the Bloomberg video after the jump. The text below is not from an official transcript.

"When the private sector is deleveraging and government deleverages too, the whole thing collapses. That's what happened during the great depression. We made the same mistake in Japan in 1997 and 2001, and I see Europeans making the same mistake right now. And if the U.S. congress makes a move towards fiscal consolidation, the U.S. will be making the same mistake next year; and I don't want to see that happen."

"I think that what the market is telling us is that this is no ordinary recession. This is a very special type of recession that happens only after the bursting of a nationwide asset price bubble. We went through that in Japan 15 years earlier; now the U.S. and Europe are going through this recession, which I call a balance sheet recession, because there's no other name for it. And in this recession the key point is that the private sector is actually minimizing debt, not maximizing profits, because asset prices collapsed, liabilities remain and the balance sheets of these private sector ...  are under water. In this type of situation, even if the Federal Reserve lowers interest rates, very little happens because people with balance sheets under water are not going to borrow money at any interest rates, and the bankers won't be lending them that much money either; especially if bankers themselves have balance sheet problems. So in this type of recession I'm afraid monetary policy is largely irrelevant."

"Well the Fed had to do something. Quantitative easing was the only thing they could do. But, if you look at what happened to money supply in the United States for example, it did not grow as much as suggested by the liquidity in the system. Credit available to the private sector actually fell during this period. So I'm afraid quantitative easing didn't do all that much. It didn't do much harm, perhaps except through the commodity prices. But other than that, I don't think it did very much. We have had 0% interest rates for the past 2 years, house prices are still falling; we have unemployment at 8.8%. This is no usual economy."