To a man with only a hammer in his toolkit every problem seems like a nail

MPC member Adam Posen said in a speech in Hull that we must loosen monetary policy or we are in danger of having a very long period of slow growth as has been experienced in Japan. He also suggested that not loosening monetary policy at key points in Japan has been the reason for two decades of slow growth in that country.

Posen’s speech was, in fact, extremely thoughtful and was not easily summed up by the soundbites from the press. However, to take his prescription and ignore other – perhaps more important – issues would be to make the mistake of seeing this problem through the prism of somebody who only has one policy instrument in his toolkit (the loosening of monetary policy). Adam Posen’s job is to contribute a vote towards determining monetary policy; on the other hand, the government - indeed economists - should be looking at wider issues.

Monetary policy mistakes have certainly been made in Japan, but the country has seen twenty years of slow growth. Whether you have an Austrian, neo-classical, neo-Keynesian or monetarist model, twenty years of slow growth takes a lot of explaining if the cause is monetary policy alone. Adam Posen believes that monetary policy can do most of that explaining, I am not so sure.

Whatever the cause of the initial recession in Japan and whatever may be the cause of the periodic severe slowdown in economic activity that has happened from time to time, we need to look further for the long-term malaise in the Japanese economy. Japan has severe structural supply-side problems that make economic adjustment difficult; it has a debt to GDP ratio rising rapidly to 250% of GDP (as a result of failed attempts to use fiscal policy to keep the economy moving – please note, Ed Miliband); it has a rapidly ageing population (at current birth rates, there will only be about 16 Japanese people left in the year 2500). Of course, any economy that has an artificially-stoked boom also has a misallocation of capital.

The fact that supply-side mistakes have been made is no excuse for making monetary policy mistakes as well. However, we should not be so obsessed with monetary policy hammers in the UK that we neglect our deep-seated economic supply-side problems. We need lower government spending and borrowing, lower taxes, a more coherent tax system, huge improvements to the education system at all levels (best facilitated by a reduction in state interference), deregulation of the labour market (today the Equality Bill was enacted, the minimum wage increased and the scope of the minimum wage extended – not exactly a great idea when a double-dip is feared), a dysfunctional welfare system and a bureaucratic planning system. Reforms in these areas should be thought of within government as important for their own sake but also as essential anti-recession policies – action is needed now.

We had deflation and economic growth in the late nineteenth century. The two are not incompatible – I am not sure how Adam Posen does explain the coincidence of deflation and economic growth in earlier periods. However, long-term economic growth is certainly incompatible with a constipated supply side of the economy. Japan illustrates this just as much as it indicates monetary policy mistakes. 

Like Sir Alan Herbert in his election manifesto knowing ‘nothing about agriculture’, I know nothing about Japan.But having witnessed the pound sterling losing 97 per cent of its purchasing power since 1947, and having seen £200 billion of quantitative easing in the last couple of years, I think it might be a bit of an exaggeration to suggest that the UK’s monetary policy hasn’t been loose enough.

Mr Posen presumes that the solution to our problem is to get our economy pumped up in exactly the same way it was before the crunch; that once it gains sufficient momentum, the stimulus can be removed and -lo- we are back up among the big boys again. What this does not recognise is that economics, like nature, abhors a vacuum, and just pumping money in merely serves to support outdated (or even inefficient) businesses at the expense of innovative businesses. Japan experienced a “hollowing-out” of its industry as its multinationals exported the wherewithal to manufacture (capital goods) to China at the expense of domestic industry. A new policy is needed, not more of the same.

The problem with Japan is that they tried doing a Keynesian stimulus without first taking interest rates right down. Now, as for Sterling losing 97 per cent of its value since 1948,that metric is quite meaningless. The right question to ask is, what has happened to purchasing power per hour worked.If you expand the money supply by printing, a number of things can happen, but you can’t tell in what mix exceptempirically: (a) prices tend to increase across the board; (c) output tends to increase across sectors; and (c) debts get paid down.

You list a variety of ‘problems’ in your penultimate paragraph, let’s call these ‘nails’.The biggest ‘hammer’ in my toolkit is a Georgist tax/government system, where all existing taxes are abolished and the state is restricted to collecting as much as it can in Land Value Tax and dishing it out as a Citizen’s Income (or health vouchers, schools vouchers if you so wish).This would sort out most of these problems, and of course by keeping land prices and house prices low and stable, so it would prevent credit bubbles from arising in the first place (which I think was the main theme of the article).

As you know, Mark, I am sceptical of the idea of a land value tax – though I understand its merits. If it is to work at all, however, then it surely can only do so when tax is about 10% of national income. So I would disagree with the suggestion that the state should collect “as much as it can” in a land value tax – that might be the 54% of national income per year it currently spends, but I take your point if the proposal were combined with a proposal to reduce overall taxation to (say) 10% of national income.

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