Contrarian Nomura urges greater deficit spending in Europe, US

Nomura chief economist Richard Koo has told the CFA annual conference in Paris that further government stimulus is needed and fiscal deficits should be widened to bring growth to Europe and the US.

Koo also suggested the Eurozone must impose new rules whereby sovereign debt can only be purchased within the state where it is issued to avoid a repeat of the Greek crisis.

Speaking to an audience of finance industry professionals gathered in Paris on day two of the Chartered Financial Analyst (CFA) Institute’s annual conference, Koo said developed Western economies are on the same deflationary trajectory as Japan was in the 1990s, while problems dating back to that period still affect Japan.

The Japanese case signposts the direction of those economies despite markets commentators describing the environment as uncertain, said Koo. “It’s uncertain if you don’t know what’s happening. It’s not uncertain if you do know what’s happening.”

“Japan is running 10km ahead of you. Look through [a pair of] binoculars and see what Japan is going through,” he said.

Where policymakers are proposing to cut deficits, Koo told the audience: “Put on your seatbelts.”

“Reducing the deficit is right if the private sector is lending,” he said. But private sector deleveraging means growth has stalled and government stimulus is needed in the absence of credit supply, he said. “The private sector is minimising debt, not maximising profit.”

“You will soon be seeing the exit problem. That’s the one Japan is facing.”

He blamed historically low interest rates, citing Bank of England governor Mervyn King’s policy of quantitative easing combined with 0.5% rates: “There is no way the UK is going to get out of this mess through these monetary measures,” said Koo.

“Mervyn King said: ‘We are going to increase the money supply very quickly.’ In Japan, we said, ‘okay, try it.'”

In spite of a “remarkably slow” economic response to fiscal stimulus already injected into Europe, the US and UK economies, Koo said more is needed to avoid the “two mistakes” made by Japan in 1997 and 2001. There, fiscal consolidation was undertaken prematurely due to pressure from international economic organisations, he said.

“Prime Minister Hashimoto was listening to the OECD, IMF, all those people who know nothing about anything, who said Japan must cut spending.

“[In Japan] fiscal stimulus worked when it was put in, it did not when it was pumped out again.”

“Japan could have lost 10% of its GDP every year, just like in the US Great Depression,” he added.

Although Japan’s asset price bubble took place in commercial real estate, whereas in the US it was the housing market, Koo said the lesson still applied.

“Commercial real estate collapsed, falling 87% nationwide. But GDP never fell below the peak of the bubble. That’s quite a remarkable achievement.”

“The unemployment rate was never higher than 5%,” he added.

The US has unemployment of 9.5%, despite three years of rates held at virtually 0%. What did Japan do differently?

Increasing government borrowing and expenditure, said Koo. “¥460trn was needed to stop the economy from falling [equivalent to] 92% of GDP.”

“It was arguably the best economic policy in human history. Try to imagine the counterfactual of what might have happened in the absence of Japanese action,” he said.

“Japanese GDP should have fallen at least 60%, if not more.”

“As long as you put in fiscal stimulus from the very beginning, you can keep living standards from collapsing, and allow the private sector to pay down debt,” he said.

Policymakers implemented the correct measures in 2009, but the shift to emphasis on fiscal deficit reduction endangers growth, said Koo.

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