by Neil Irwin
In the years that followed, the BOJ became a more conventional central bank. In the late 1980s, as the speculative bubble was inflating, all that money the banks were pumping out was going to bid up the prices of assets like office buildings and shares of stock—not driving up the prices of rice or gasoline. With inflation well under control, the BOJ saw no need to tighten the money supply, and the boom continued unabated. By 1989, when things were getting truly out of control, the bank finally hiked interest rates, trying to prick the bubble. In hindsight, the action succeeded all too well.
The end of the Japanese bubble wasn’t so much a pop as a fizzle. Soon, the very cycle that had led to ever-rising asset prices and bank lending was working in reverse: Prices for real estate and other assets fell, banks faced losses so they cut back on new lending, and economic growth ground to a halt. In the early 1990s, the Bank of Japan did what a central bank is supposed to do when the economy weakens: It cut interest rates, giving businesses more incentive to invest for the future and consumers more incentive to spend their money instead of save it. But it did so slowly, failing to understand the degree to which the national economy was in peril. It lowered its rate from 6 percent in 1991 to 0.5 percent in 1995. The Japanese economy seemed to improve a bit in 1996 before resuming its fall in 1997.
In a milder version of the deflation that paralyzed the world economy in the early 1930s, prices were stagnant to falling. That made the overhang of debt incurred in the boom years even more onerous, as the yen being used to repay loans were more valuable than those that had been originally lent out. Steady deflation even made the BOJ’s low-interest-rate policies less effective at boosting growth, because it meant that “real,” or inflation-adjusted, interest rates were higher than they would have been during a time of inflation.
On March 20, 1998, Masaru Hayami, a longtime corporate executive who had worked at the BOJ many years earlier, became the central bank’s twenty-eighth governor. It was four days before his seventy-third birthday. He inherited a once booming economy that was mired in nearly a decade of economic stagnation and falling prices. The usual tool a central bank uses to guide the economy was already proving ineffective. What could Hayami-san do to try to fix the Japanese economy? And, more importantly, what would he do?
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Economists call it ZIRP: zero-interest-rate policy. The challenge that Hayami inherited—and which seemed at the time to be a uniquely Japanese phenomenon—was that the Bank of Japan had already cut rates to zero and the economy was still lousy. Cutting interest rates further isn’t very plausible. A negative rate would mean, in effect, charging bank customers to keep their money in savings accounts, and would lead to people taking their money out of banks to avoid that charge.
As Japan started grappling with this problem in the late 1990s, some of the biggest minds in academic economics, both Eastern and Western, started coming up with possible solutions, arguing that the BOJ still had plenty of ability to boost economic activity—if it was courageous enough to act. They pointed out that because the institution had the unique and unlimited ability to create Japanese currency, there was no reason it had to allow the yen to become too dear. The BOJ, for example, could pledge to keep its low interest rates in place for many years to come, or until inflation finally returned to normal levels. If people viewed the promise as credible, the economy would pick up as businesses started charging higher prices in anticipation of higher inflation.
But talk is cheap, and the BOJ could, these economists argued, move more directly to increase the supply of money in the economy. The bank could create yen from thin air and use them to buy things—government bonds, shares of stock, office buildings. The existence of all those extra yen in the economy would create enough inflation to break the cycle of falling prices. In one story that made its way around the Bank of Japan and was repeated by economist Richard Koo, but which may be apocryphal, Bernanke visited Tokyo in the early 2000s as a Fed governor and argued that the BOJ could pump yen into the economy by buying anything—even tomato ketchup. (Bernanke doesn’t remember saying it and doubts he would have been so flippant. Former BOJ officials interviewed in 2012 had heard about his comment, but none could attest to hearing it themselves.)
Even if Bernanke never used it, the ketchup line gets at one of the basic problems facing a central bank in a zero-interest-rate world: Although the bank has the unlimited ability to create money, getting that money circulating around in the economy isn’t necessarily easy. When a bank raises or lowers interest rates, it changes the price of money in the economy, but it doesn’t determine who gets money and who doesn’t. It doesn’t, in other words, favor the makers of ketchup over those who make mustard—or, for that matter, houses or clothing or automobiles. In theory, choosing winners and losers in the economy is a job for democratically elected officials—for fiscal policy, not monetary policy. Modern societies have generally accepted that it’s a good idea to have unelected economists turning the dials of the money supply. If they start deciding not just the amount of money created but also what it’s used to buy, however, they’ve gone an undemocratic step too far.
In a time of ZIRP, a central bank needs some help from fiscal authorities to spread its newly created money through the economy. Getting it can mean violating the independence from politics that modern central banks hold dear. Bernanke acknowledged this reality in a 2002 speech about Japan’s troubles: A central bank, he said, could buy government bonds, and fiscal authorities could then use that money to temporarily cut taxes. It would be a “helicopter drop” of money on an ailing economy.
Later, when critics nicknamed him “Helicopter Ben,” Bernanke surely regretted invoking that particular metaphor.
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Masaru Hayami spent his adult life witnessing a Japan ascendant. Born in 1925, he spent the middle decades of the twentieth century rising through the ranks of the Bank of Japan. Although he held only an undergraduate degree, he worked on the international staff, representing the bank in Basel and in other overseas forums. He was a devout Christian, unusual in a predominantly Shinto and Buddhist nation, and peppered his public comments with references to Bible verses. He also had, people who knew him said, a deeply felt sense that a strong currency was equivalent to a strong nation. “In the first half of the postwar period, he attended many negotiations with Western countries when the yen was very weak,” said Kazuo Ueda, a BOJ policymaker from 1998 to 2005 and now a University of Tokyo professor. “Probably he thought the weakness of currencies is painful. . . . Over time the economy developed, the yen became stronger, and maybe he saw some causal relationship between the two.” That made him reluctant, as governor of the Bank of Japan, to do anything that would push the value of the yen down sharply—even if that’s exactly what economic theory suggests the nation needed to get its economy back on track.
Besides, he saw many other problems that needed repair before the country could return to long-term prosperity: a banking system that was slow to write down bad loans and recapitalize, networks of industrial companies that protected each other from the brutality of global competition, a political system that wasn’t capable of making hard decisions. He seemed skeptical of the theories that academics, both inside the BOJ and from the West, offered as answers to the nation’s problems. According to some who were in policy meetings with him, he didn’t always understand other economists’ technical arguments.
In late 1998, the interest rate that investors demanded to lend the government money rose sharply, from 0.7 percent to 2 percent for ten-year Japanese government bonds. Politicians pressured the BOJ to intervene in the bond market by buying securities in order to push rates downward. But Hayami viewed such an action as a grave threat to independence, comparing it to when the bank printed money to fund the government’s military buildup in the 1930s and ’40s, resulting in a period of high inflation. “Purchasing Japanese government bonds can’t be an option,” Hayami told th
e parliament. “It would be detrimental to fiscal discipline and generate vicious inflation.”
Hayami, however, was willing to make more conventional interest rate cuts and use the power of communication. In February 1999, the Bank of Japan went all in on ZIRP, cutting its target short-term interest rate from 0.25 percent to 0.15 percent. (It had been 0.5 percent when Hayami took office the previous year.) The governor pledged that ultralow rates would stay in place “until there are prospects for an end to deflationary fears,” which would seem to imply a fairly long time. Yet the cut held for little over a year.
“To this outsider,” Bernanke said in January 2000, “Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.”
Indeed, Hayami was eager for any excuse to get away from a low-interest-rate policy—and began backing away from the policy in the early months of 2000, when the Japanese economy did seem to be gaining some ground. “We are getting closer to the stage where we can say deflationary concerns have been wiped away,” Hayami said in a May 2000 news conference that essentially reneged the earlier promise of a long period of low rates. The policy was formally abandoned in August as the bank hiked rates back up to 0.25 percent and then to 0.5 percent.
When the Japanese economy slumped again, Hayami’s BOJ took a different step: quantitative easing. “The BOJ had to do something to ease, but the governor did not want to do exactly the same thing, because it would be clear that he had made a mistake,” said Ueda. So in addition to cutting rates back to zero, the bank began buying bonds to increase the amount of money in the economy, aiming for the Japanese banking system to increase the number of yen on its books from four to five trillion, a rise then equivalent to about $8 billion.
“The decision to end the zero-interest-rate policy was not wrong,” Hayami said in a press conference announcing the change in March 2001. Driven by the governor’s desire to save face, the action was something that no modern independent central bank had undertaken before. Almost against his will, Masaru Hayami had pioneered a very unusual type of monetary policy—one that Helicopter Ben and the Federal Reserve would adopt a decade later to fight the megacrisis.
“It was a very difficult decision to make,” Hayami told reporters in 2003. “It was the first time that this had been done. I was very unsure and even felt fear. At times like those, I would remember . . . that God is always with me, that Jesus loves me and that He sees and knows all.”
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Central bankers are a conservative bunch. The awesome responsibility that society grants them comes with a demand for certain traits: seriousness, sobriety, caution. No head of state would entrust control over an entire economy to someone inclined toward frivolity and risk-taking. Most of the time, that’s just fine. We want central banks to be led by people who are boring. The idea of “first, do no harm” is a powerful one, and a central banker who was too quick to experiment could do a great deal of harm to his economy.
But it is precisely when an economy needs the most help from a central bank that the job demands what seem like radical departures from orthodoxy. The very qualities that lead to a person’s being selected to help lead a central bank make him reluctant to engage in the bold experimentation that might help get an economy out of a deep rut.
For all its excessive caution, the Bank of Japan did eventually cut rates to zero, pledge to keep them there, and purchase a variety of assets with newly created yen—and even those efforts weren’t enough to “fix” the economy. A generation of Japanese has seen diminished prospects; if economic output per person had risen at the same pace from 1991 to 2011 in Japan as it did in the United States, the average Japanese person would have an extra $9,500 a year in income.
Monetary policy is indeed powerful—but it’s not all-powerful. As Princeton economist Alan Blinder put it in the closing session on that fall day in 1999 at the Woodstock Inn, “Does an economy with a zero nominal interest rate follow more or less the same economic laws as it does in normal times—except that one variable is stuck at zero? Or is the situation more akin to physics at zero gravity, or near absolute zero temperature, where behavior is fundamentally different, even strange? I think the conclusion we seem to be reaching here at Woodstock is that it may indeed be a new world.”
Ueda, representing the Bank of Japan, closed the event with a pledge—and a warning that would prove all too prescient once the Federal Reserve, the Bank of England, and the European Central Bank had joined their Asian counterpart in the strange new world of ZIRP.
“I promise,” he said, “to bring all the interesting ideas I have heard in this conference to the attention of my colleagues in Tokyo. Meanwhile, I must say that one of the most important messages of the conference has been: Do not put yourself into the position of zero rates. I tell you it will be a lot more painful than you can possibly imagine.”
EIGHT
The Jackson Hole Consensus and the Great Moderation
For the world’s central bankers, the gathering at Wyoming’s Jackson Lake Lodge in August 2005 was a moment of triumph. After centuries in which their predecessors had frequently failed to guide the nations of the world through boom and bust, inflation and deflation, they had finally, it seemed, learned all the important lessons of how to manage an economy. The 110 central bankers and other economists convened in the Explorers Room seemed to have all the answers, and they had created a more stable and prosperous world than any known before.
One scholar after another took to the lectern in that Friday morning, standing beneath elk-antler chandeliers to pay tribute to the great man. Alan Greenspan, slightly hunched and with big glasses, a hangdog face, and a smile as enigmatic as that of the Mona Lisa, was soon to step down as the chairman of the Federal Reserve, the central bank that decided the fate of the then $12.6 trillion U.S. economy, the largest in the world. Colleagues from nations large and small in every corner of the globe had come together to see Greenspan off into retirement properly and consider his legacy. The official name of the event was the Federal Reserve Bank of Kansas City Economic Policy Symposium. But it’s known across the world of finance simply as Jackson Hole, for the ancient glacial basin where the gathering takes place each summer. If Basel is where central bankers come together to discuss the latest economic developments among themselves, Jackson Hole is where they address bigger, longer-range issues, surrounded by both the broader community of economic thinkers and spectacular scenery.
Taking the stage, Allan Meltzer, the leading historian of the Federal Reserve, asserted without reservation that Greenspan held “the top rank” among the many men who’d run the central bank in its ninety-two-year history. Bank of England governor Mervyn King said that Greenspan’s “departure from the central-banking scene will deprive us of a source of wisdom, inspiration, and leadership.” Two other colleagues, while acknowledging “some negatives” in Greenspan’s record, wrote that “when the score is toted up, we think he has a legitimate claim to being the greatest central banker who ever lived”—praise that seems all the more generous when one considers that the lead author of that paper was Princeton’s Alan Blinder, who had resigned as Greenspan’s vice chairman after a brief and unhappy experience a decade earlier.
If anything, people outside that room had been even more effusive in their praise. Bob Woodward titled his 2000 book about Greenspan Maestro. The year before, Time magazine had put Greenspan on its cover as a member, with Bob Rubin and Larry Summers of Bill Clinton’s Treasury Department, of “the Committee to Save the World.” He was named a commander of the French Legion of Honor and granted an honorary British knighthood. (“It’s a very unusual day for an economist,” Greenspan said after Queen Elizabeth II knighted him at her Balmoral estate in Scotland.)
It was the high point of what had already been dubbed the Great M
oderation—a moderation, that is, of the various forces that had whipsawed national economies in centuries past: boom and bust, inflation and deflation, financial panic and its attendant destruction of wealth. The U.S. economy had been expanding for a quarter century, interrupted by only two brief and shallow recessions. The unemployment rate averaged 5.5 percent during Greenspan’s nineteen years in office, compared with 6.4 percent in the preceding two decades, and inflation was held in check. The great powers of continental Europe, after a century in which they regularly met each other on the battlefield, had become so intertwined economically that they were sharing a currency. The British economy was in a veritable boom, with London prospering as a global banking hub and threatening to reclaim from New York the title of world financial capital. China and other developing nations were growing rapidly, pulling hundreds of millions of people out of dire poverty into the global middle class, in no small part by absorbing the lessons of free markets and their sound management taught by the West’s leading economic thinkers.
The men and women in the Explorers Room had a sense of common purpose, believing that they were guiding the entire world toward an ever more prosperous future—and doing quite a good job of it, thank you very much. They had learned from the mistakes of their predecessors and had the knowledge, the tools, and the will to keep even the nastiest of economic events from leading to widespread human misery. During Greenspan’s time as Fed chair, there had been two recessions, and the Great Moderation also included two stock market crashes in the United States, a long economic stagnation in Japan, and financial crises in Mexico, Russia, and Argentina. But none of these became a global calamity.