The Holy Grail of Macroeconomics  (Revised Edition) - Lessons From Japan's Great Recession, Paperback Book

The Holy Grail of Macroeconomics (Revised Edition) - Lessons From Japan's Great Recession Paperback

4 out of 5 (2 ratings)


The revised edition of this highly acclaimed work presents crucial lessons from Japan's recession that could aid the US and other economies as they struggle to recover from the current financial crisis.

This book is about Japan's 15-year long recession and how it affected current theoretical thinking about its causes and cures.

It has a detailed explanation on what happened to Japan, but the discoveries made are so far-reaching that a large portion of economics literature will have to be modified to accommodate another half to the macroeconomic spectrum of possibilities that conventional theorists have overlooked.

The author developed the idea of yin and yang business cycles where the conventional world of profit maximization is the yang and the world of balance sheet recession, where companies are minimizing debt, is the yin.

Once so divided, many varied theories developed in macro economics since the 1930s can be nicely categorized into a single comprehensive theory- The Holy Grail of Macro Economics


  • Format: Paperback
  • Pages: 356 pages
  • Publisher: John Wiley and Sons Ltd
  • Publication Date:
  • Category: Economics
  • ISBN: 9780470824948



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Will the U.S. be like Japan? Many fear the U.S. GDP will plateau, as Japan's has for over a decade. Interested in learning more about the Japanese episode, I picked up "The Holy Grail of Macro-Economics", by Richard Koo.The book had much that I was looking for on Japan: about the conditions of their corporations, the levels of indebtedness, and the ways in which their government tried to deal with it.In addition, it turned out to be a more ambitious book than I expected. Koo talks about the slow down of growth in Germany, and about the Great Depression of the 1930's, and he tries to tie these together to address some fundamental questions in economics.Koo's thesis is that:Some recessions are special (they're "balance sheet recessions") and are marked by some fundamental behavioral changes because people go into "balance sheet repair mode" for a while.These changes in motivation and behavior, can make it seem as though certain laws of economics are temporarily suspended. For instance, monetary policy does not have its normal effect (e.g. even with rates at zero people could be unwilling to borrow)Fiscal policy can have an impact by spending wealth based on promises of repayment by future generations. He contends this it worked in Japan, and the stagnation that resulted was a good thing; otherwise the country would have seen some years of falling GDP and painful readjustmentsKoo terms a balance-sheet recession as the "Yin" phase of an economy, and says it is marked by a drive to strengthen one's balance sheet even allowing possible profit opportunities to slip by (with "Yang" being the typical profit-maximization phase of an economy). He says: "in this phase, monetary policy is ineffective, because firms are all rushing to pay down debt, and private sector demand for funds is essentially non existent."The notion of a business cycle characterized by over-indebtedness, ending in a crash, followed by deflation is not new. Monetarist Irving Fisher presented it in the 1930's. Among conventional economists, the monetarists advocate "printing" more money as a solution. However, Koo (primarily Keynesian) stresses the futility of monetary policy in the context of a credit-based economy. In such an economy, the central bank can inflate "narrow/core/high-powered money", but the broader credit money-alternatives can continue to deflate while borrowers remain in "balance-sheet repair" mode.Monetarist economists stress the supply-side of money and credit, giving very little importance to the demand side. The simplified versions of the quantity theory of money assume that demand for money is stable. This works most of the time; however, when people are uncertain about the economic future, the demand for money and credit changes. Creating more money has little effect, because most of it is deployed into the safest asset and and does not "multiply" into business credit expansion. In this narrow area, Koo, the Keynesian would actually find agreement from von Mises who criticized the Quantity Theory of money for excessive focus on the supply of money, and for paying too little attention to demand, addressing it only indirectly via the "velocity of circulation".Keynes propounded a situation called a "liquidity trap", where monetary policy is ineffective. While the phenomena that Koo describes is very similar, there are crucial differences. Koo says: "Keynes, ... had to argue that it was a decline in the marginal efficiency of capital that induced corporations to stop investing. But he never convincingly explained why the marginal efficiency of capital should suddenly fall."I interpret this in the following way: Keynes suggested that an economy might face a shortage of investment, but did not explain how this could happen. The mistake Keynes was making is that he was proposing this as a general theory. The type of situation Keynes described can occur, but only in the special and rare case of a balance-sheet recession. In other words Keynes was wrong to think that what he saw was an intermittent "natural" occurrence in a free-economy; rather, it was caused by a large number of people shifting into "balance-sheet repair" mode in the aftermath of a bust in a credit-driven boom.Be warned that Koo's solution is Keynesian. He wants governments to borrow to the hilt and is comfortable leaving twice or thrice our current debt to the next generation. If you're not willing to read through those types of recommendations don't pick up the book. I will say that Koo is a clear writer, so at least he does not hide his recommendations in obfuscation and throw an epistemological load on the reader. Though many Keynesians see their recommendations as part of a general theory, and would like to see an economic "fine tuning" czar, Koo's book gives it a different spin. If one thinks a mixed economy is legitimate, and if one thinks the government ought to redistribute wealth, then -- in that special case -- there are times when fiscal spending can accomplish the redistribution and can "work" in the sense this its advocates think it ought.Koo tries to relegate Keynesian prescriptions to a special case, arguing that monetary means at better for regular "fine tuning" by our economic Gods! Of course, as some skeptic note: for Keynesians temporary means forever!The free-market solution to balance sheet crises is intelligent private-sector driven liquidation and readjustment. If one does not believe in government redistribution, this is also the fair way. In the longer scheme of things, it is also the more efficient way, because the sharper readjustment morphs into a faster turn-around and because it does not build long-term "moral hazard' into the system.Despite his faulty recommendations, I found Koo's book to be useful. I learnt about recent Japanese economic history. In addition, Koo is an articulate champion for his variant of Keynesianism and it is useful to understand his point of view if one is going to argue against it.

Review by

A well-written quick read that solves the puzzle why the Japanese economy took so long to recover from its burst real estate bubble in the early 1990s. Koo offers a good explanation about why liquidity traps occur and firms pay-down their debts in a low-interest environment. Balance sheet recession is his name for the Kabuki dance firms perform when their assets are worth less than their liabilities. If the situation would be handled according to the laws in place, these underwater but not insolvent firms would be placed in receivership and reorganized. This is, however, not what happens in the real world of oligarchy power.Politics and regulators pretend not to notice the underwater situation of these firms led by their buddies, prop them up by fake "stress tests" and capital assistance. This unwillingness to cure the patient by surgery (removing incompetent managers, wiping out the old shareholders) condemns an economy to an exceedingly slow recovery as these firms pretend to do business as usual, while they effectively can't. This is my problem with Koo's book. He is one of the insiders, a Davos man, a protector of the status quo with a believe in the system that I barely understandable. He writes - in 2008 (p. 179): "Large asset-price bubbles have occurred elsewhere - witness the U.S. housing and Chinese stock market/real estate bubbles. When these bubbles eventually burst, it is comforting to know that Japan's recent experience has clearly demonstrated what sort of policy is required to deal with their aftermath." Granted that Koo could not expect the level of incompetence of both the Bush and Obama administrations. He fails to look for the root of these problems: Most of these bubbles (from Tulipomania, the South Sea craze to the dotcom bubble) are driven by oligarchies that have more money than sense, investing in foolish adventures. When the bubble bursts, the oligarchy's political power prevents a clean resolution. Koo clearly sides with the oligarchy. Thus, he is shocked about Paul Krugman's quip of disappropriating it via inflation.His Japanese "hammer" might not work well in a US situation where, the financial industry apart, the debt problem is not one of enterprises but consumers, as Elisabeth Warren has so clearly shown. Overall, he offers a good account and explanation of the Japanese case which, with modifications, is useful in looking at other countries. Koo also shows that local expertise is the key to understanding. US economists with limited knowledge about Japan are perhaps not the best consultants to listen to. Likewise, Koo is not the best person to offer macroeconomic advice on Germany and Europe, as the bolt-on chapters on the US, China and Germany demonstrates.