Koo: Monetary Aggregates Behave Totally Different ...

I know, the out-smarts on the Wall Street will say that all bears should retire. Richard Koo, chief economist at Nomura and one of respected experts of Japanese balance sheet recession, wrote in the note yesterday:

Under normal circumstances, a given percentage increase in the monetary base by the central bank should produce an equal percentage increase in the money supply and in private-sector credit. But this relationship no longer held in Japan starting in the 1990s or in the US from 2008, as a shortage of both borrowers and lenders caused the money multiplier to fall to zero or even turn negative at the margins.

During such phases, central bank liquidity can help address certain financial problems, such as a dysfunctional interbank market. But it should not be expected to stimulate the economy. The fact that private-sector credit declined in Japan and the US despite large injections of liquidity by the Bank of Japan and the Federal Reserve suggests that these funds never reached the real economy because there were no willing borrowers or lenders.

Click on chart to enlarge, courtesy of Nomura.

Similarly, a reduction in the supply of central bank liquidity during such phases will have only a limited impact on the economy and the markets because a shortage of liquidity is not a constraining factor on the economy to begin with.

Bonus reflation in trading rooms and fear of currency debasement leads the monetary indicators and the life on the Main Street.