Over the weekend The Baseline Scenario posted an excellent overview of the Japan Scenario. I’ve discussed the similarities between the current U.S. situation and that of Japan starting in the late 1980s elsewhere. These are discussed in more detail at The Baseline Scenario. They also list reasons why we might avoid the Japan Scenario:
First, the U.S. government has moved much more quickly to attempt to fix problems in the banking sector.
Second, the Fed has in just a few months acknowledged that its main monetary instrument – the Fed funds rate – is no longer useful, and has instead hinted at a broader program of quantitative easing, through some combination of printing money and buying all sorts of assets to prop up prices and push down yields.
That said, we still can’t be sure that we won’t see a replay of 1990s Japan. First of all, while we have the political will to spend large amounts of money, it’s not clear that we have the political will to shut down insolvent banks; the bailout packages so far have been notable for their attention to the interests of existing shareholders. Second, simply because Bernanke is willing to use a broader arsenal of tools, earlier in the crisis, than was the Bank of Japan doesn’t mean those tools will work; we are essentially in uncharted territory for any central bank. Third, Japan managed to create its boom and bust largely on its own, and when it did begin to come out of its lost decade it was largely thanks to exports to a booming world. This time, with more or less the entire world slowing down in unison, there is no external growth engine to bail us out.
The longer this crisis drags on without upticks in personal consumption and inflation, the more comparisons to Japan you are going to see. Let’s hope it doesn’t come to that.