In the 1990s, Japan suffered a lost economic decade of disappointing economic growth and price deflation. It did so in the aftermath of its massive stock and real estate market bubble burst. It is questionable whether the United States is not now poised for a decade of poor economic performance by allowing unusually large bubbles to form again in its asset and credit markets and by ignoring caution in the management of their public finances.
Even before the start of the COVID-19 pandemic, the US economy was showing disturbing signs of Japanification. After the 2008 housing bubble and credit market burst, the United States experienced its slowest economic recovery on record, while inflation remained consistently below the 2% inflation target from the Federal Reserve.
Meanwhile, its heavily indebted companies borrowed heavily at very low interest rate spreads, and the country seemed to have lost its constituency for fiscal discipline on both sides of the political aisle. Republican administrations were very keen to cut taxes but were loath to cut government spending. Meanwhile, Democratic administrations have shown interest in increasing government spending but hesitant to raise taxes. The net result has been that the country is now grappling with a record budget deficit and on an unsustainable public debt trajectory.
The excessively expansive response of US monetary and fiscal policy to last year’s single health crisis makes it all too likely that in the years to come the Japaneseification of the US economy will accelerate.
By increasing the size of its balance sheet in less than a year by more than $ 4 trillion through its aggressive bond buying program and keeping interest rates ultra-low, the Federal Reserve has created an unsettling “everything” bubble in the United States. equity, housing and debt markets. U.S. equity valuations are now more than double their long-term averages and at high levels they’ve seen only once in the past 100 years.
Meanwhile, house prices are now well above their 2006 all-time high and continue to rise by around 15%, while interest rate spreads on high-yield debt are now close to their all-time lows. .
By providing a fiscal stimulus of up to 12% of GDP in 2021 at a time when the Fed has pushed monetary policy hard and the Congressional Budget Office estimates the country’s output gap to be only around 3% , the Biden administration has increased the risk of economic overheating and still high inflation by the end of the year. At the same time, far from thinking of long-term fiscal consolidation to restore public debt sustainability, Biden hastily passes Congress a poorly funded and $ 1,000 billion infrastructure spending bill. a $ 3.5 trillion plan to fight poverty and climate control. This should increase the risk of high budget deficits and an endless unsustainable debt trajectory.
With inflation already reaching a level not seen in the past 30 years and a level that is more than double the Fed’s inflation target, it will only be a matter of time before the Fed is forced to curb its monetary policy. to achieve its inflation target. The Fed will do this first by decreasing its bond buying program and then raising interest rates. This in turn is more than likely to burst the “everything” bubble in the asset and credit market, which was based on the assumption that ultra-low interest rates will last forever. It is also likely to worsen the country’s public finances as tax revenues will inevitably be affected by a further downturn in the economy resulting from the bursting of current asset and credit market bubbles.
In the same way that the bursting of its real estate and stock market bubble in the early 1990s cost Japan a lost economic decade, the bursting of the American “all” bubble must be expected to usher in an extended period. disappointing economic growth, low inflation rate. , unusually large budget deficits, the proliferation of zombie companies and a new wave of quantitative easing from the Fed. This can only strengthen the Japaneseification of the American economy, which already seems to be well under way.
Desmond Lachman is a senior researcher at the American Enterprise Institute. He was previously Deputy Director of the Policy Development and Review Department of the International Monetary Fund and Chief Emerging Market Economics Strategist at Salomon Smith Barney.