29 November 2021
Central Banking in an Era of Crisis
2021, Yale University Press, 536 pages,
Reviewer: Melissa Davies, Chief Economist, Redburn
‘Tumultuous Times’ is a fascinating canter through Japanese economic, political and social history from the 1980s onwards through the eyes of Masaaki Shirakawa, who rose from the International Department at the Bank of Japan in 1972 to the highest echelons of the Bank of Japan as Governor from 2008 to 2013. This memoir knits together recollections of significant events in recent Japanese political history – the late 1980s bubble economy, the navigation of the so-called ‘lost decade’, the Global Financial Crisis, the 2011 earthquake and nuclear disaster, and the advent of Abenomics. It is filled with personal recollections of career highlights, perspectives on economic theory, and insights into the inner workings of central bank operations. The book successfully and deftly impresses on the reader the difficulties of making monetary policy decisions in real time when faced with unexpected crises, financial emergencies, natural disasters, and competing clamouring voices from the political sphere and society at large.
Shirakawa attempts in many ways to set the record straight on Japan’s experiences with financial crisis and deflation, highlighting the highly innovative and bold policy measures the bank took in dealing with the bursting of its debt bubble, from which other central banks have drawn lessons ever since. His direct experiences and reflections bring home a conclusion that is, in some ways, surprising coming from an economist who has dedicated his life to central banking – that the powers of monetary policy are, although essential, somewhat limited relative to the political and societal burdens placed on it, and that a period of reflection and introspection is needed to reassess the role and nature of independent central banking.
Where this introspection should lead is left open, but it is clear from Shirakawa’s writings that unfettered and unlimited monetary policy stimulus, or closer cooperation between the monetary and fiscal policy authorities, does not provide an answer to today’s economic challenges. In fact, it may make them worse by threatening the fundamental function of the central bank – to preserve the stability of money and the financial system – in pursuit of objectives that cannot be delivered. Tumultuous Times is an important antidote to the current fashion in favour of MMT-style macro policy support from the eyes of someone who has directly experimented with unconventional monetary policy and been able to observe its costs and benefits over several decades.
Tumultuous Times is a wide-ranging work but a clear theme which emerges is the limits of monetary policy – specifically, the limited impact lowering interest rates and raising the quantity of money can have on the overall trajectory of inflation and GDP growth. Shirakawa’s frustration with the prevailing ‘deflation’ discourse narrative in Japan is clear, whereby ‘ending deflation’ became a political objective and radical monetary policy intervention the only solution. As Shirakawa discuses, the sources of deflation were far more complex and difficult to tackle, including the fallout from the boom years of the 1980s, the working-out of debt and labour overhangs, globalisation, technology and the shifting Japanese terms of trade, and the social and political constraints to dealing with crises in real time. He also tackles popular obsession with the strength of the yen – much more a function in his view of shifting global capital allocation and risk appetite than specifically driven by the quantity of Japanese current account balances.
In Chapter 20, Shirakawa lays out four questions we should ask about the effectiveness of monetary policy decisions. Firstly, is it able to preserve financial stability? Secondly, does it move financial asset prices in the right direction? Thirdly, does it have the expected impact on real economic activity and inflation? And fourthly, do the benefits of action outweigh the costs? While Shirakawa is comfortable that Unconventional Monetary Policy satisfies the first two, he is much more sceptical about the third and fourth.
The central bank can – and must – play a powerful role in ensuring financial stability by acting as lender of last resort in a crisis. But there are no guarantees when it comes to generating inflation or stimulating growth if secular forces are weighing on both. And the costs of large-scale liquidity provision may be greater than the benefits. This could be said of US monetary policy in the 2003-2007 period, which was perhaps overly stimulative and laid the groundwork for the financial instability of 2008. It also begs the question, perhaps, as to whether today’s extraordinarily stimulative monetary policy interventions are laying the foundations of something unpleasant, prioritising short-term growth and employment over long-term stability. Only time will tell.
Shirakawa’s recollections of the 2013 shift towards QQE are striking, when the Bank of Japan succumbed to political pressures to adopt an explicit inflation target: ‘Most members of the Policy Board, however, continued to believe that the problems faced by the Japanese economy would not be solved without wide-ranging economic and fiscal reforms. Perversely, a possible benefit of significantly increasing the aggregate current account balances at the bank was that perhaps both politicians and economists would eventually come to understand the meaninglessness of such massive increases in quantity.’
Indeed, the author’s frustrations with the increasingly strident view that deflation could simply be defeated by aggressive monetary policy are clear, as is the muddiness of the public discourse around ‘deflation’, which became a catch-all word for all of Japan’s economic malaises. As Shirakawa quips, Friedman did not say ‘deflation is always and everywhere a monetary phenomenon’. As current experiences show, economists continue today to grapple with the mysteries of both inflation and deflation, and the answers, ironically, may lie outside the remit of inflation-targeting central banks.