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.