Richard Koo on the state of the world

Koo sees the world staring into the abyss of a deflationary spiral due to a policies imposing fiscal austerity in a "balance sheet recession."

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The world in balance sheet recession:  causes, cure, and politics
by Richard C. Koo  (Nomura Research Institute, Tokyo)

Koo concludes:

It is laudable for policy makers to shun fiscal profligacy and aim for self-reliance on  the part of the private sector. But every several decades, the private sector loses its self-control in a bubble and sustains heavy financial injuries when the bubble bursts. That forces  the private sector to pay down debt in spite of zero interest rates, triggering a deflationary  spiral. At such times and at such times only, the government must borrow and spend the  private sector’s excess savings, not only because monetary policy is impotent at such times  but also because the government cannot tell the private sector not to repair its balance sheet.

Although anyone can push for fiscal consolidation in the form of higher taxes and  lower spending, whether such efforts actually succeed in reducing the budget deficit is  another matter entirely. When the private sector is both willing and able to borrow money, fiscal consolidation efforts by the government will lead to a smaller deficit and higher growth  as resources are released to the more efficient private sector. But when the financial health  of the private sector is so impaired that it is forced to deleverage even with interest rates at  zero, a premature withdrawal of fiscal stimulus will both increase the deficit and weaken the  economy. Key differences between the textbook world and the world of balance sheet  recessions are summarized in Exhibit 17.  

With massive private sector deleveraging continuing in the U. S. and in many other  countries in spite of historically low interest rates, this is no time to embark on fiscal  consolidation. Such measures must wait until it is certain the private sector has finished  deleveraging and is ready to borrow and spend the savings that would be left un-borrowed by  the government under an austerity program.

There will be plenty of time to pay down the accumulated public debt because the  next balance sheet recession of this magnitude is likely to be generations away, given that  those who learned a bitter lesson in the present episode will not make the same mistake  again. The next bubble and balance sheet recession of this magnitude will happen only after  we are no longer here to remember them.

While Koo and MMT are in agreement on many points in the analysis, Koo seems to cling to the loanable funds doctrine and the intertemporal government budget constraint in thinking that the government's deficit ("public borrowing") needs to be reduced pro-cyclically to make space for private sector borrowing. According to MMT loanable funds and the IGBC are inapplicable under the existing monetary system for currency sovereigns, although currency users like the countries of the EZ are in a different situation. Lumping them together is incorrect.

Moreover, the government's fiscal deficit is automatically counter-cyclical in that tax revenue falls in recessions and the automatic stabilizers force government payments up. The opposite occurs upon recovery, bringing the deficit down as tax revenue rises and stabilization falls.

So while Koo is close to MMT, he is not there yet.