Stephen Roach
May 4, 2015
The world economy is in the grips of
a dangerous delusion. As the great boom that began in the 1990s gave way to an even greater bust, policymakers resorted to the timeworn
tricks of financial engineering in an effort to recapture the magic. In doing so, they turned an unbalanced global economy into the Petri dish of the greatest experiment in the modern history of economic policy. They were convinced that it was a controlled experiment. Nothing could be further from the truth.
The rise and fall of post-World War II Japan heralded what was to come.
The growth miracle of an ascendant Japanese economy was premised on an unsustainable suppression of the yen. When Europe and the United States challenged this mercantilist approach with the 1985 Plaza Accord, the Bank of Japan countered with aggressive monetary easing that fuelled massive asset and credit bubbles. The rest is history. The bubbles burst, quickly bringing down Japan’s unbalanced economy. With
productivity having deteriorated considerably — a symptom that had been obscured by the bubbles — Japan was unable to engineer a meaningful recovery. In fact, it still struggles with imbalances today, owing to its inability or unwillingness to embrace
badly needed structural reforms — the so-called third arrow of Prime Minister Shinzo Abe’s economic recovery strategy, known as Abenomics.
Despite the abject failure of Japan’s approach,
the rest of the world remains committed to using monetary policy to cure structural ailments. The die was cast in the form of a seminal 2002 paper by US Federal Reserve staff economists, which became the blueprint for America’s macroeconomic stabilisation policy under Fed chairs Alan Greenspan and Ben Bernanke.