All students who specialize in economics t theories of micro and macro-economics, will usually complete their studies with a sound understanding of each theoretical instrument or policy. A Keynesian policy, for example, involves the public sector or government increasing the aggregate demand, by either lowering or increasing the interest rate in the economy. The government could also resort to taxation, again lowering or heightening it across the board and in different categories of labor and services to control the general levels of economic activities. When these policy levers are pulled, the economic machine will go forward like a car, either braking gently or accelerating.
Indeed, under a monetary policy, the central bank could increase or decrease the circulation of money supply in the whole economy. Again using the car analogy, the economy would either have more fuel orless of it, to go forward. The whole idea is to exert some degree of control over the speed of the economy.
The quest for control and speed manifests in the attempts to increase employment concurrent with the goal to keep inflation in check. In other words, while a car can reverse itself, swerve sideways or go forward, there must not be excessive exhaust fume. Anything less than the above ideal would suggest the economy is not working well..
Welcome to the world of developed economies. None of the leading economies in the West or Japan, are functioning as the theories say they would. The only salvation lately are numerous phases of Quantitative Easing (QE), which are attempts made to keep the economy afloat, though, barely.
Richard Koo argues that the reason none of the economic instruments are working in concert is due to the lack of awareness over the “essence” of money and ultimately profits. Both are important.
In conventional economics, all theories affirm the importance of profit maximization. In other words, when there is money to be made,or borrowed, everyone will plunge into action.
They will take up the loans offered at the cheapest interest rates and resort to various streams of economic activities according to their own interests and specializations. The general equilibrium of economic activities, as predicted by John Maynard Keynes or Milton Friedman would then obtain.
But money is both for making profit and potentially a debt (if money is borrowed and not first made) which everyone wants to pare down. The latter is now the general trend across developed economies.
Thus, what is meant by Richard Koo as a “balance sheet recession,” is precisely that case where the majority of individuals and corporations are racing against time to bring down the level of their debts. The economists in the West have missed this key element altogether. Their theories cannot explain the fear of holding debt; and the intention to eliminate them from their balance sheet(s) immediately. Invariably, when the economic theories cannot account for this key motivation, any amount of money injected into the systemwill distort general economic dynamics.
Companies may borrow the cheap money available to buy into various classes of assets, in order to keep their revenue streams flowing. But these purchases are done by the billions in liquid financial markets. They don’t necessarily trickle down to any economic demands that can exert a locomotive effect to drive the entire economic machine forward.
This is the reason why Japan has not had any strong economic rebound since 1989. Due to the oversupply of money and overly aggressive corporate acquisitions in the booming 1960s and 1970s, the appetite for more economic profits have dwindled. Instead, the desire to reduce debt at the quickest possible rate has taken over. This is why Richard Koo believes that every QE in the West right now poses a serious systemic risk to the entire global economy.
Companies adept at using cheap money, offered at nominal interest rate, will capitalize on such easy credit. But they will use them to buy various baskets of currencies to defray the risk of more debt. With huge amounts of such transactions, the economy will not gain necessary traction in the future, thus, prolonging the recessionand affecting the general strength of the recovery. Japan, according to Richard Koo, is a perfect prototype of what the West is facing, since the central banks in the West have literally lowered the interest rate to near zero, without any economic effects.