Krugman wrote that we don’t have to worry about rising prices by all the inflation we’re creating to stimulate our economy because of the ‘liquidity trap.’ Krugman posits that this is the reason that Japan didn’t see increased prices even though they grew their money supply by a huge percentage.
Does anyone have a better explanation why Japan didn’t get hit with higher prices (I want to say inflation but I’m sure someone will scold me that inflation is the creation of money and credit and rising prices are an effect) during their ‘lost decade.’
My best guess is that Japanese consumer subverted this because they did not trust banks and kept much of their cash in their house instead of depositing in banks. I’m also curious if the Yen carry trade had an effect, perhaps of exporting inflation to other countries, at least temporarily. Just a guess, though. Seems like it would end up causing domestic inflation, though.
Anyone have an idea why Japan didn’t see rising prices during that period even though they created a huge amount of inflation?
Liquidity trap does exist…it happens when the central bank overloads the system with debt and there is nothing else that can be done from the central bank or government to revert the painful adjustment.
As of inflation please note Krugman might confuse inflation with the CPI. If there was asset inflation of any kind he might have overlooked this.
dont forget that what happened in Japan was a special case…the whole economy was a bubble.
Chinese inflation. The Chinese keep the relationship between their currency and the US Dollar steady, in other words they keep reducing the value of their currency, that has the effect of keeping Chinese people poorer than they would be otherwise but gives their exporters an advantage. This devaluing of the US currency then Chinese is really a hidden transfer of wealth from Chinese workers to Japanese consumers.
Banks are keeping reserves. The nation of Japan is in a liquidity trap. That is that the banks refuse to lend money as they still have to cover loan losses. And there is still the remnants of commercial and home real estate bubbles. If the Japanese central bank would raise rates sharply or better yet close up shop and stop intervening in the economy then the bad banks would go bust. The good ones would be able to charge rates that will allow them to cover previous losses as they would not have the competition from failing banks.
The Japanese are retarding the growth in their economy by intervening in the entrepreneurial process of development outlined by Mises. Entrepreneurs are being regulated and taxed to death and find it better to not work 90 hours per week and instead of get free stuff from the government. If the Japanese government would let entrepreneurs work more freely then they would start to plan for the future and query banks for loans. This would spark real growth and raise prices.
The Japanese government continues to subsidize wide ranges of products and services. These products appear to consumers to be cheaper when purchased partially through taxes. A major area is real estate lending that has been taken over almost completely by government. These too big to fail organizations can loan as much as they want and tax payers foot the bills. Of course the real reason for subsidization is to limit competition. This is especially prevalent in medicine and education.
Note that 1 directly involves the USA and in 2, 3 and 4, you could simply switch the word Japan with USA and the results would be the same.
I don’t really follow. Why didn’t Japan see an increase in consumer prices during the ‘lost decade’ even though they were inflating their currency throughout this period to finance spending? We can see the inflation being created but we didn’t see a rise in consumer prices. Typically you see the rise in prices after creating the inflation (in money and credit), but the lack of this happening in Japan is what Krugman and Keynesian’s point to when they advocate bigger and bigger stimulus spending over here as a solution to our recession/depression. They argue that we won’t have inflation (in the sense of rising prices) just like Japan didn’t. That’s why I’d like to analyze Japan’s situation more thoroughly so I can refute that point of view. But I am not sure why Japan didn’t see rising prices after all that inflation they created.
I don’t follow. Japan didn’t decrease it’s money supply during this period. They should have seen the effects through higher prices.
Is it possible that the Japanese citizens’ distrust of banks (many kept their money out of their banks and stuffed their savings in safes or mattresses or wherever) help keep prices in check by reducing Velocity of money supply (banks are the main culprit when it comes to 'velocity?) And perhaps the Yen carry trade that then went on during this period exported much of this money abroad, which kept it from seeping into the Japanese economy and thus triggering higher consumer prices?
Or if a liquidity trap is valid, how does a Keynesian deal with this excess money? By withdrawing it before it can show up in consumer prices? In the 70’s, according to a stat I saw from Friedman, prices increased for 5 years AFTER the Fed began decreasing the money supply. The genie was very difficult to get back in the bottle once it was let out. Does the Keynesian model take into account that this excess liquidity might find its way into other asset classes, such as equities or commodities, causing inflation/bubbles there instead of consumer prices? Or maybe it will be exported abroad entirely, causing inflation but for the country the money flowed to and not Japan?
I’m still confused. I do accept the simple economic principle that when a government prints more money, it causes the purchasing power of each dollar/yen/whatever to decrease. And a symptom of this inflation will be higher prices. Krugman argues differently. He says that the U.S. needs a much bigger stimulus and that guys like me are dead wrong. He says we can keep printing dollars into the trillions and we won’t see the effects of inflation because of the liquidity trap. He points to Japan’s period during the ‘lost decade’ where they increased money supply and spending to record levels but didn’t see a rise in consumer prices (effect of inflation). Isn’t there a rational economic argument that can explain this other than buying into Keyne’s liquidity trap hypothesis?
Regarding the hazy interpretation of these historical events, it’s a case of we don’t know why Krugman is wrong, we just know that he is. There is no need to explain what happened. Krugman will fish out the details that suit his conclusion and ignore anything else.
That’s not good enough of for me. Do we have any professors on here that can help me out? I’m challenging a man’s knowledge and expertise of the field where he’s not only a professor but a Nobel Laureate as well. I’d like to have a better understanding of the factors at work in the scenario I mentioned. Perhaps Krugman is correct, but everything I believe I understand about economics screams that’s he’s dead wrong and I want to counter that type of thinking whenever I can because so much is at stake.
I’ll have to start doing some self study to see if I can figure it out.
If in google you search site:mises.org japan there is a lot of good stuff. What I got was that banks are not lending the newly printed money, because they prefer to keep it for themselves. They are terrified that the loans they already gave will not be repaid. Also mentioned is what you said, that people there don’t trust banks now and keep their money under the mattress. And they save like 25% of their income. Finally that prices are supposed to drop always as technology improves.
Why does the liquidity trap need a counter argument? It’s perfectly consistent with Austrian monetary and capital theory. An increase in the supply of money is only inflationary when all other things are constant. Banks don’t lend when there’s extreme risk and when the entire economy is plagued by malinvestments (all symptoms of a malformed capital structure). It’s possible that we will enter into a prolonged period of stagnation because of government policies, but it’s more likely that we’ll see intense inflation. But no one knows for sure.
The problem for me is that Krugman sees the problem of prices increases in some fairy sense rather than as a problem of redistribution, which happens regardless of where prices go.
So let me get this straight. There is a liquidity trap if banks can’t lend out this new money, which is really what gets the inflation cycle going in the first place. However, there is inflation, only it will show up in asset bubbles in things like equities or commodities or overseas instead of trickling down to consumer prices?
And if this is correct (it sure seems to jive), then Krugman is guessing the banks in this country won’t be able to lend to consumers, hence the inflation not showing up in consumer prices. But does he discount the idea that this money will find other places to go and does he worry about the bubbles that this money is causing?
Thanks for the insight. I’m going to do some reading about Keyne’s liquidity and see if there’s anything interesting to learn there.
Explains what a liquidity trap is [refusal of people to invest, because the interest rate is too high to make profit],shows how THERE WAS NO SUCH THING IN JAPAN, how Krugman jumped through hoops to make one up [that part is a bit over my head].
Thanks. I’m trying to get some good reading in this weekend. See if I can’t polish off some of Mises works I’ve been meaning to get to for months but haven’t had the time/energy.
Did you see the swipe Krugman took at Austrians on his blog? Fortunately there’s enough Austrians around to put up an articulate defense against his smear and the attacks of the simpletons that follow his every word like he’s their Messiah.