[talk] Genron NPO Economists Meeting

Jesper Koll

Chief Economist of Merrill Lynch Japan Securities, Graduated Johns Hopkins University, was at JP Morgan and Tiger Management LLC before his present position; publications include "Nihon Keizai korekara Ogonkie"
Paul Sheard

Chief Economist of Lehman Brothers Securities, Asia, PhD. from Australian National University; publications include "Main Bank Shihonshugino Kiki" (The Crisis of Main Bank Capitalism)
Robert Feldman

Chief economist of Morgan Stanley Securities, Graduated Yale University, PhD from MIT(economics), Worked at NY Federal Reserve Bank and IMF before the present position; publications include "Nihon no Suijyaku"

What kind of political management is the Koizumi government forced to undertake when the Japanese economy continues its slide? This second economists' meeting highlighted future tasks for the Koizumi administration through the discussions of three economists over the problems of direction and speed of reform, the issuance of new government bonds within a 30 trillion yen framework, prevention of deflation, the Bank of Japan, disposal of non-performing loans, policy mix, and an evaluation of reform schedule.

In this second economists' meeting, heated discussions were carried out from various angles over such issues as direction and speed of reform, the issuance of new government bonds within a 30 trillion yen framework, prevention of deflation, the Bank of Japan, disposal of non-performing loans, policy mix, and an evaluation of reform schedule.

One of the typical arguments is that the framework of 30 trillion yen of new bond issuance doesn't make sense in economic terms. However, it makes political sense (Mr. Koll). In contrast, Mr. Sheard said the framework of 30 trillion yen of new bond issuance fails to put first things first and asserted that the top priority should be given to the disposal of bad loans. He further pointed out the risk inherent in the decreased importance attached to a policy of disposing of non-performing loans in relation to the fact that the start of pay-off (only 16 months of probation).

Regarding deflation, Mr. Feldman pointed out that it is too naive to assume that deflation can be stemmed based on the relationship between the money supply and the demand curve. He said that the issue of supply side which contributes to deflation should not be ignored.

Concerning the argument whether the disposal of bad loans would not be effective, the three economists agreed that only by promoting the disposal of the non-performing loans will deflation be prevented.

With respect to the reform itself, Mr. Feldman supported it, whereas Mr. Sheard focused his attention on the incoherence in a policy of disposal of bad loans and was rather hard in his assessment.

Mr. Kudo representative of Genron NPO, referring to the government's failure to give a proper priority to policies, pointed out the Koizumi government's "twisted part" and the possibility of a general election. Mr. Feldman also argued the necessity of a general election.

Finally, a question on what the Koizumi government needs to break through the current doldrums was raised. Mr. Koll presented his ideas on the activation of Kasumigaseki, Mr. Sheard on desirable policy mix and Mr. Feldman on the demonstration of Koizumi's leadership. The persuasive discussions by these three economists exhibited elements that should be taken into consideration when we think of Japan's reform.

KUDO: (Genron NPO Facilitator) Last time we presented questions to State Minister of Economic and Fiscal Policy Takenaka, who gave us his response (which was carried out in October issue of this site). First of all, I would like to ask your impression to Mr. TakenakaÅfs responses. Then, we would like you to sum up Koizumi's reforms after six months of his administration. What do you think, Mr.Feldman?

The speed of Koizumi's reforms is not slow.

FELDMAN: The difference between the current government and the former governments is that the current government has attempted to thwart the power of insiders' vested interests by using the power of outsiders. Adopting the attitude that things should be decided democratically by taking various opinions into consideration, is a big step forward for Japanese politics.

Regarding structural reform, some say it is too slow. I don't think so. In the financial world the passage of time is different from that of mass media and the political world. It is true that we want reform to be done more quickly but we have to evaluate it by using the proper timeframe.

As to the economy, according to current economic theory price is determined by the intersection of the supply and demand curves. It is naive to assume that deflation will be stemmed on the basis of the relationship between the money supply and the total demand curve. Such an argument ignores a more complex issue, the extent to which the supply side contributes to this deflation.

(With respect to the independence of the Bank of Japan) As concerns the setting of policy targets, it is too simplistic to assume that it should be left to the government as a matter of course. In other countries although the right of the final decision rests with the government, the government makes policy in collaboration with its central bank.

The current problem of the supply side lies in the fact that due to the fiscal and monetary policy a large number of inefficient corporations were preserved. Without discussing these points we cannot discuss what the Bank of Japan should or should not do.

KUDO: How about Mr. Koll?Åú The reform seems to be heading in the right direction and I have an impression that the speed of reform seems relatively fast.

KOLL: I told Mr. Takenaka to carry out deregulation and to create positive deflation. The government should take further measures to increase purchasing power. For example, the government still holds power in regulation and setting prices in the areas of telecommunications and beverages.

What measures has the Financial Supervisory Agency taken for the disposal of non-performing loans? Judging by the market, the speed of reform is slow and there seems to be no progress in this regard. However, as the Asahi Bank and a foreign security company are trying to undertake the disposal and repayment of non-performing loans by themselves, market mechanisms or the efforts of the private sector seem a likely method to solve the problem of non-performing loans.

Thirdly, some argue that there is the possibility of a deflation crisis or deflationary spiral. The current situation definitely shows that the Japanese economy is still going downhill. However, it is not the case that negative growth is equal to a deflation crisis or a deflationary spiral because real disposable income of households is increasing. Therefore, in this respect, I do not believe that Japan is in a critical situation, yet.

KUDO: How about Mr. Sheard?Åú The government should not stick to the 30 trillion yen framework of new bond issuance

SHEARD:

There are impressive remarks in the answers of State Minister of Economic and Fiscal Policy Takenaka. First is his acknowledgement of negative growth. Don't you think this remark illustrates his policy change?

The second is sticking to the 30 trillion yen limits on new bond issuance solely for political reasons. Economically this is very risky. If the government continues its stance to cap new bond issues to 30 trillion yen, it may be obliged to change its policy later. This pledge should be removed and reexamined.

The third is the relationship between the Bank of Japan and the government. There are arguments such as independence of means or independence of purpose.

These arguments should be divided into two parts. First, what can the government and the Bank of Japan do within the current legal framework? Second, is the answer to the first question correct and how will the framework be tampered with in the future? The previous remarks by Mr. Takenaka are closer to the latter issue. When we discuss this issue now we are not sure how long it will take, but this is not such an urgent task to address right now. What is more important is what we can do now within the present framework.

The fourth is the pace of reform. What Mr. Feldman said is, I think, right. There is political time framework. When we evaluate political issues, we need to pay attention to the content of the issue and then examine whether this it is carried out quickly enough.

What I focus on above all else is the problem of non-performing loans. Perhaps, we are going to analyze this issue in more detail later. To me this task is the most urgent problem. Nevertheless, in my judgment, the efforts to address this issue seem to be the slowest.Åú How do we assess the framework of 30 trillion yen of new bond issuance and prevention of deflation?

KUDO: There are largely two different opinions toward the remarks of Mr. Takenaka. One is the issue of the framework of 30 trillion yen of new bond issuance. The other is the issue of deflation. I want you to focus on these two points and then move to the next one.

FELDMAN: The framework of 30 trillion yen of new bond issuance is after all merely a target. The purpose is fiscal discipline. In order to achieve fiscal discipline we have to think in terms of the framework of 30 trillion yen of new bond issuance. I agree with this idea. I think that the target of 30 trillion yen frameworks was useful to achieve the purpose.

On deflation, certainly we have to stem deflation but first we need to consider the mechanism by which the price of a commodity is determined. The point here is price is determined by a financial variable, money supply or supply side. We should not ask why the Bank of Japan is not in cooperation with the government, rather we should ask why the government does not cooperate with the Bank of Japan.

On the cooperation between the government and the Bank of Japan, in my opinion, the Financial Supervisory Agency bears the heaviest responsibility. Certainly, it is not the only issue that weighs heavily on the agency. Nonetheless, why doesn't the prime minister issue an order to the agency that says,ÅgDon't let the bank divide debtors. If you think Company A doesn't belong to the second category, then put that company in the third category.Åh The prime minister has the right to say this.

It is not the Bank of Japan that does not cooperate with the government, the government does not cooperate with the Bank of Japan, and that should be changed. We should commend what the State Minister of Economic and Fiscal Policy said--"Let the Council of Economic and Fiscal Policy checks whether the Financial Supervisory Agency does its work properly."

KOLL: Due to the relationship between the Financial Supervisory Agency and the Council of Economic and Fiscal Policy and the market mechanism, an efficiency of checks and balances has begun.

Briefly speaking on two questions, the 30 trillion yen framework of new bond issuance does not make sense from the point of view of an economist. However, this framework is politically very effective.

Concerningdeflation, the price level of Japan was very high at its starting point. There are various figures one could use, but compared with the global standard prices in Japanese are about 25-30 percent higher. As globalization occurs it is natural that the prices will come down.

On the other hand, deflation produces a bad effect on debts and liabilities. The following has been argued for long time: Unfortunately, those companies which have not yet adjusted their balance sheet should go bankrupt, but what safety net is prepared for them? A structure of injecting public funds has been already prepared and it should be used.Åú Only 16 months of moratorium

SHEARD: If we see the current economic situation objectively, it is very bad. In addition, the balance of the non-performing loans is higher than ever before.

Under these circumstances, the first stage of payoff is due to come into effect at the end of March 2002. The real crunch point is the end of March 2003, 16 months ahead. When the complete payoff (the central government's 10 million yen limits on deposit insurance) comes into effect, about a half of deposits will be turned into risk assets overnight. Under such circumstances, if the balance of non-performing loans reaches historical levels, probably it will cause a tumult of collection of deposits. This is a foregone conclusion, which may occur some time ahead.

The government declared the final disposal of non-performing loans within two or three years or normalization of the issue of the non-performing loans within three years. More precisely, this is to reduce the rate of non-performing loans to 2-3 % over seven years, far from its scenario. Japan can not afford to settle the bad loans in three years, let alone seven years. If Japan does not address and find a mean to settle this issue within less than a year and create a situation under which the Japanese financial system is healthy again, the Japanese economy will encounter a very serious situation.

The framework of 30 trillion yen of new bond issuance may be O.K. as a long-term target or purpose but it is not an urgent task. That aside, I want Mr. Koizumi to address the issue of non-performing loans squarely and give us an answer.

There has been a heated debate among economists concerning deflation. If the Japanese economy and financial system are firm, a minor deflation may not matter. However, Japan has huge problems such excessive national debts, non-performing loans, excessive bank deposits?this is an excessive liability, and excessive liabilities of corporations. Given this situation if deflation is allowed, the issue of non-performing loans will not be settled. Price deflation and asset deflation both affect each other and will add to the concern.

Then, what will happen unless the bad loans are disposed? The general purpose of the reforms will not be achieved. As Mr. Koll said before, the Japanese economy wants to rely on market mechanisms as much as possible, which is the aim of the Koizumi government as well as the financial big bang.

KUDO: How about the summing-up of the Koizumi reform in midterm?Åú It is necessary to debate with a broader point of view.

KOLL: What is most important is to take responsibility by oneself. Those who become ministers have to do what they have to do whatever the time framework is.

Mr. Takenaka is a minister in charge of economic and fiscal policy. Eventually, Japan has been moving forward to change the compilation of budget, without an austerity policy and without a large-scale supplementary budget.

Next, in the beginning a top priority was given to the disposal of non-performing loans. Nevertheless, there is no progress. In this regard, the issue of responsibility will be definitely on the rise. That aside, how does the government solve this issue? Five or six years ago, the frame for the solution was already made. Actually, the government began to solve the problem. It was made clear that the bankruptcy due to the excessive liabilities of more than 1 trillion yen could be supported by the Japanese system. In the future, I think the government should take responsibility, set a realistic time line and move toward the solution of bad loans.

When we listen to the arguments on Japan's structural reform, they seem to discuss only domestic matters. The reform should be considered more broadly as cross-national strategy.Åú The prime minister should back State Minister of Economic and Fiscal Policy Takenaka.

SHEARD: When we focus on the leadership of the prime minister and a policy mix, matters rest on the prime minister. At first, I expected a lot the Council of Economic and Fiscal Policy. This council as something like a command module and dealt with issues which were not addressed before such a council was organized. A new system started working this year. Therefore, I expect great things from the role of this council.

In order for this system to work well, the prime minister has to display his leadership. The most important point in this regard is probably to give overwhelming political support to State Minister of Economic and Fiscal Policy Takenaka. Mr. Takenaka is attempting to set forth sound policy, a policy mix that can resuscitate the Japanese economy. The problem is to implement it in the right order and the biggest point is whether the government can implement it.

In summing up, the biggest issue for Japan is that Japanese economic policy is passive and there is no concerted system to implement its economic policy. What is necessary is to unfold economic policy actively. It is important that each economic policy, for example, monetary policy, monetary system policy and fiscal policy, should be coordinated and implemented under the concerted system.

Looking at the reform schedule set in September, I was discouraged. In my judgment, it was not the answer to the issue. I think the government is moving in the wrong direction.

KUDO: Could you elaborate that point?ÅúDo you think a general election is needed?

FELDMAN: I think so. The last time Prime Minister Koizumi said there would be no possibility of a general if reform could progress quickly. In part that might be meant to spur reform, but it could also be a threat. He must mean that he would call a general election if there is no progress on reform. I'm not sure whether that what he really meant, but I think it's easy to see that's what's in his mind.

KUDO: In some way taking the reforms gradually is the proper way to go, on the other hand, as Mr. Shard says, reforms over a 16 month term won't deliver results. Let me begin the interview by asking you to talk about what the real problems will be and how they can be overcome. Mr. Coal, would you go first, please.Åú Actual problem is the Kasumigaseki-reform.

KOLL: Japanese structure has already been accomplished completely. Contrary to this, it's easy to suggest they arrange a new plan with a clean slate, and economists might be bent on discussing that. However this is not practical. I think the Kasumigaseki is actual problem. That structure is changing now, but on the other hand that organization still remains as it was in some phase. For change of that, people within Ministers should exercise leadership.ÅúWhat kind of policy mix is necessary?

SHEARD: he main point is the development of Japanese politics next year, and I'm slightly skeptical. Historically an LPD government has been in power, with the exception of one year, since 1955. That's why I regard the LDP as a political franchise and their primary purpose are to keep their own value as a franchise. That means they would stay in power on any account. It's a very flexible regime that sometimes opposes reformist prime ministers that get support from the people and could temporize the party. When that doesn't succeed, as in the case of Mr. Hashimoto (Ryutaro Hashimoto, former Prime Minister) resigned, they reverse policies.

The people have diverse expectations. For instance, if Koizumi can't succeed in reform because of resistance in the party, he should split from the LDP and form a new political party "Nihon-saisei-to." But I don't think that will happen.

Koizumi has policies to attack problems such as reform of the Japan Highway Public Corporation, abolition of the housing loan corporation, making changes in how tax revenues are used, and post-office savings. The conundrum is that Japan has to tackle all these problems but focusing on each one at a time may not be successful.

Then what he should do? Looking in particular at financial reconstruction, he should divide that into halves, macro level and micro level. By micro level I mean that he should carry out fiscal restructuring reform as soon as possible. The more serious problem is the macro level of financial policy. I suggest he controls it flexibly in response to the economic situation. That is the best way to carry out actual structural reform on the micro level? Financial system problem, deregulation, public sector reform, everything. He cannot postpone the payoff. By doing that he can relax reform at the macro level while maintaining a consistent system. Without this policy-mix, Koizumi administration may be finished and everything doomed to failure. I'm concerned about it.Åú Koizumi is a leader in step with the times.

FELDMAN: Mr. Sheard said all depended on the prime minister. Of course I'm sure that some part of reform depends on the [prime minister's leadership. However I think there are two types of leader, a natural-born leader, leader who is in step with times, and reluctant leaders. Koizumi is the leader who is in step with times, I think. A leader of that type does not exercise one-man rule but takes into account people's views.

KUDO: How about the policy-mix between financial reform and structural reform, as Mr. Sheard said, making financial macro management flexible?

FELDMAN: Of course financial, financial architecture, all are involved in the pricing model. I agree that the theoretical structure Mr. Shard mentioned is right. However I think the method that divides the two would result in failure. He should carry out all simultaneously. That's the point. That's why trying to resolve the problem by accusing the BOJ (Bank Of Japan) of failure never succeeds. I think he should use a more modern economic structure model for reform.

KOLL: Mr. Feldman said people are responsible for problem solving but, simultaneously, the market is as well. It's important. How should the bad loan problem be resolved? The market would be useful. Unfortunately, there is never a boost for the market. Mr. Yanagisawa and Mr. Mori managed to protect their conservative traditional structure. On the contrary, the government, ministers, and other leaders are responsible for accelerating market boost. The market mechanism is moving now. If either BOJ or finance intervenes, the financial socialism typical of the past would continue.

Why don't you abolish this?