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The Forgotten Lessons of Japan in the ’90s

Deficit obsession has been immensely destructive as an economic matter.

An admission: Sometimes it seems to me as though economists and policy makers have spent much of the past six years slowly stumbling to figure out stuff that they would already have known if they had read my Brookings paper from 1998 about Japan’s liquidity trap.

For example, there’s been huge confusion about whether Ricardian equivalence makes fiscal policy ineffective and vast amazement that increases in the monetary base haven’t led to either inflation or big increases in the broader money supply. Yet that was all clear 16 years ago, once you thought hard about the Japanese trap.

And, now, here we go with another example: the role of troubled banks. Europe has done its stress tests, which haven’t turned out too bad, but now we’re seeing worried commentary about how maybe, just maybe, a clean bill of banking health won’t stop a slide into deflation.

Folks, we’ve been here before. In the 1990s it was conventional wisdom that Japan’s zombie banks were the problem, and that once they were fixed all would be well. But I took a hard look at the logic and evidence for that proposition in my paper (pages 174-177), and it just didn’t hold up.

I know, I know – blowing my own horn and all that. But if I’m not for myself, who will be for me? In any case, it has been really frustrating to watch so many people reinvent fallacies that were thoroughly refuted long ago.

And if people had read my old work they might have managed to avoid embarrassing themselves so much in open letters to former Federal Reserve Chairman Ben Bernanke and such.

The US Deficit Is Down, and Nobody Knows – or Cares

Earlier this month, the Congressional Budget Office told us that the federal deficit in the United States was way down – under 3 percent of gross domestic product. In The Washington Post, the economist Jared Bernstein noted that President Obama seemed to get no credit for this reduction.

You may ask: What did you expect? But the truth is that a few years ago many pundits claimed that Mr. Obama would reap big political rewards by being the grown-up, the responsible guy who Did What Had to Be Done. Worse, some reports said that the White House political staff believed this.

It was, of course, nonsense on multiple levels. While pundits may like to script out elaborate psychodramas about voter perceptions, real perceptions bear no relationship to their scripts: A majority of voters think that the deficit has gone up on Mr. Obama’s watch, while only a small minority know that it has gone down.

And the deficit scolds themselves are unappeasable – nothing that doesn’t involve severely damaging Social Security or Medicare, or both, will satisfy them. Why, it’s almost as if shredding the social safety net, not reducing the deficit, was their real goal.

Deficit obsession has been immensely destructive as an economic matter. But it has also involved major political malpractice.

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