At the end of June, Richard Koo, Chief Economist at the Nomura Research Institute delivered a speech, reviewing the root causes of Japan's recession on its balance sheet and providing analysis and recommendations on China's current economic situation.

This speech sparked heated discussions in the economic research community. According to incomplete statistics from National Business Daily (NBD), as of July 12, more than 10 articles have been written by China's top domestic economists, financial scholars, financial journalists, and columnists, engaging in debates with Richard Koo from various perspectives.

Recently, NBD conducted an exclusive interview with Richard Koo. In the hour-long interview, he provided a detailed analysis of the explanation for the balance sheet recession and shared his views on the current booming Japanese stock market. He also responded to the doubts and theories put forward by other economists.

Richard Koo Photo/provided to NBD

About balance sheet recession: fiscal stimulus is needed, but it must be implemented in the long term

NBD: I would like to start with a simple question that you may have been asked a thousand times: what is balance sheet recession?

Richard Koo: balance sheet recessions usually occur after the collapse of a national asset price bubble. When the bubble, which was blown up by debt, bursts, asset prices collapse, but all debts remain at their original value. As a result, debts are far greater than assets. This situation is called "technical insolvency".

If the borrower has no cash flow, everything is over and he will go bankrupt. But if he still has cash flow, he will use the cash flow to repay the debt. When he continues to repay the debt, the asset-liability balance will be restored, meaning that the debt is no longer greater than the asset.

Then he can go back to his original profit maximization mode. But when he uses cash flow to repay debt and repair the asset-liability balance, he is actually minimizing debt, not maximizing profit. This is the right thing to do on an individual level. I would do the same in that situation, and you would do the same in that situation. But the question is, what will happen to the national economy when everyone does this at the same time? In a country's economy, there should be people who save money or repay debt, as well as people who borrow money or spend money. But if everyone saves money and no one borrows money, the economy will shrink.

In general, if there are more borrowers than savers, interest rates will rise; if there are fewer borrowers, interest rates will fall, to ensure that all funds are borrowed and spent. But in an asset-liability recession, even if the central bank lowers interest rates to zero, borrowers are still busy repaying debt. The lack of borrowers means that the private sector's additional savings cannot return to the income stream of the economy, and the economy begins to shrink. This is asset-liability recession.

NBD: Can balance sheet recession be understood as a psychological explanation, that is, the psychological shadow of debt repayment is too great, so people choose not to borrow again, and thus monetary policy fails?

Richard Koo: If you are technically insolvent, it is not a psychological problem, but a real big problem.

Suppose you are company A and you want to supply goods to company B. However, company B has already technically gone bankrupt. In that case, you will definitely require company B to pay cash before shipping the goods, and you do not want company B to go bankrupt after shipping the goods.

In this case, company B cannot do business, because in a normal business environment, there is usually a 60- or 90-day payment cycle. Once the other company finds out that your company is technically insolvent, you have no choice but to repair your asset-liability balance as soon as possible.

Psychological problems only occur after the asset-liability balance is repaired. Because the repair process is really terrible, you may never want to borrow money again.

NBD: So, can only time heal the trauma caused by such experiences?

Richard Koo: Absolutely correct. Only time can heal, and it takes a long time.

NBD: You have always advocated that in a balance sheet recession, government fiscal spending is needed to help the economy recover. What is the principle behind this?

Richard Koo: Let me give you an example with numbers. Let's say I have an income of $1000, and I spend $900, which becomes someone else's income. I deposit the remaining $100 in the bank, and the bank lends this $100 to someone else. When that person borrows and spends it, the economy continues in this way.

But in a balance sheet recession, even if I have an income of $1000, spend $900, and deposit $100, no one comes to borrow money, even at zero interest rates. Everyone is busy repaying debts, and this $100 gets stuck in the bank. The economy contracts from $1000 to $900.


About Japan's monetary policy: excess reserves too large, and Ueda is still thinking

NBD: We have noticed that Japan's stock market has performed better than major global markets this year, and that Japan's GDP grew 2.7% year-on-year in the first quarter, and inflation and wage data are also on the rise. How do you understand these positive signs?".

Richard Koo:Japan has no domestic inflation at all. The inflation is imported. I think only the United States and some European countries have domestic inflation. Most countries have encountered higher import prices, which is not good for families because their real income is declining.

However, because of the Bank of Japan, interest rates are low, and the yen is depreciating. Suddenly, Japanese assets become very cheap, so foreigners realize that since Japanese assets are so cheap, we should allocate some of them, so they push up the Japanese stock price.".

In general, most Japanese people are under pressure from high prices, and income growth cannot keep up. This is not good news for ordinary people, and only some stock traders will be happy.

NBD: So overseas investors are just seeing an investment opportunity, not betting on the fundamentals of the Japanese economy?

Richard Koo: Japan's fundamentals have never been particularly bad, it's just that Americans and Europeans are unwilling to look closely. We who are in Japan will say that we have always been doing the right things, but Europeans and Americans are unwilling to admit it, until recently they found out that they should buy some Japanese assets.

NBD: You have always believed that the Bank of Japan's monetary policy is useless, but low interest rates can reduce the interest burden, support asset prices, and accelerate the repair of balance sheets, right? How do you evaluate the role of the Bank of Japan?

Richard Koo: When borrowers disappear because of balance sheet problems, interest rates will fall to zero, which has nothing to do with monetary policy, because no one borrows money, and interest rates will eventually fall to zero on their own. But if the Bank of Japan says that we have this policy or that policy, which can make the recession end faster, it is lying to the people. As long as no one borrows money, whatever the Bank of Japan does will not have a positive effect.

I believe that the previous Governor of the Bank of Japan, Haruhiko Kuroda, has proven 100% that monetary policy is completely useless in raising inflation. He increased the monetary base so much, but until he ended his term, Japan's inflation rate was still below 2%. I think Kuroda has made a great contribution to the economics community: he proved that when people don't borrow money, monetary policy is completely useless.

NBD: This year, the Bank of Japan welcomed a new governor, Ueda Kazuo, and everyone is expecting him to change the policies of his predecessor. What do you think?

Richard Koo: Like many people, I am actually a little disappointed that Ueda Kazuo has not started monetary policy normalization, I thought he would start taking action as soon as he took office. I believe he will eventually do so, but the scale of the excess reserves of the Japanese banking system is too large, probably about 520 trillion yen, almost the same as Japan's GDP.

My guess is that he has to sit down and think carefully before taking action. I guess Ueda Kazuo must have been shocked when he just took office: he didn't expect the problem to be so big. I'm sure he's thinking about this issue every day now, how to normalize monetary policy without letting the market crash.

Editor: Billy