Friday, October 2, 2015

Japanese Monetary Policy in the United States

An Old Forecast Appears to be Coming True, Unfortunately

In December of 2001 I wrote and published (on an older website) a monograph that I titled "A Strong Form of Monetary Theory based upon Excess Reserves and Bank Demand Deposits."  (The pdf is still stored on the original site which is actually a reasonably popular site that I created to explain a phonics method that I devised.)

My intent at the time was to explain a theory of fractional banking that I believe actually worked, but one that had eluded the Federal Reserve even as they enjoyed its benefits. However, as I've re-explained in six recent posts here, starting with the post titled Monetary Policy Theory: Part 1 - Fractional Reserves, the Fed has drifted a long ways from the system it operated in the 50's, 60's, and 70's, and it will now be difficult to return to the environment in which the theory I espouse can be operational.

The Forecast, or at Least, The Foreshadowing

In the monograph cited above, on page 8, I wrote in December of 2001 the following regarding Japan's decade-long stagnation with near-zero interest rates at that time:

Where next? Japan and America 
Japan should stand as fair warning to America that the economics of banking is an imperfect science. Thus far, no one has adequately explained to the powers-that-be either a reason why they are in a sustained period of recession, or a reasonable way off that path. Yes, theories abound, but either they are so imperfect that they are not taken seriously, or they have been implemented and found wanting.
There is no reason that we must follow Japan’s path. However, there is also no good reason why we will not. Under current economic theory, we are doing what we must to avoid it, but we are also doing the same thing that Japan did (in monetary terms) and simply expecting different results. If Japan’s economic recessions are being caused by monetary events, as I believe is likely, we might think twice before conducting an imitation of their recent policy, as we now appear to be doing.

Today, as 2015 draws to a close, with the Fed now growing increasingly concerned that the economy, or at least the global economy, could be slowing, and with the fed funds rate still at only 25 basis points, we are now in Japan's situation, unfortunately.


The Strong Form of Monetary Theory that I present in the monograph enabled me to write the above two paragraphs back in 2001 with some degree of confidence because under that theory the central bank loses control both of the money supply and, therefore, of the economy, at zero interest rates.

But it's also important to realize that this isn't the typical "zero-lower-bound" problem popular with so many, a theory that declares that if the market economy drives short term interest rates to zero, the central bank might lose its ability to conduct effective policy. No, instead, under the strong form, this was simply a mistake made by the central bank, a correctible mistake.

All the Fed has to do is raise the fed funds rate to a modest positive level, say 1.5% to 2% and they will again regain control, and the Fed is perfectly capable of doing so; it just doesn't understand the reasons why it should be done. The answers are in both the monograph and the six recent posts here on monetary policy.

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