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In this video, we're going to be looking now at Japan and
see how central banks may have problems when it focuses on
the inflation which is in the consumer goods and services,
and it does not take account of acid price inflation.
Just look at this chart.
It shows the illusion of the Nikkei between 1985 and 1989,
and you see this staggering rise here.
Until December 89 at the peak it reached close to 40,000.
The blue line here shows the evolution of the land price in Tokyo.
And there was a boom there.
Indeed we heard a story at the time that there was the Imperial Palace and
the land surrounding the Imperial Palace in Tokyo was worth
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You see here that between 85 and
89 the land price tripled in Tokyo, and this has a reason.
There is a reason for this.
Basically, people were seeing the staggering rise on the stock market.
And what they were doing is that they were going to their bank and
put their house in guarantee and get some money for that.
So basically they were asking for some credit, some loans.
With these loans that were provided by the banks, people would buy warrants,
they would buy option on the stock market to make money.
So the Bank of Japan was not looking at this asset price inflation,
it was looking at consumer prices, and were seeing nothing really worrying,
as consumer prices were not rising.
So, the asset price bubble kept inflating, and eventually, it burst.
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So, you see here that the peak here in the Nikkei coincides more or
less with the peak in the land price.
And basically what the central bank did nothing and let the bubble burst, and
actually even worse it was behind the curve as we have seen,
you know the central bank reacted too little too late.
It kept rising interest rates until August
90, so nine month after the stock market peaked,
the central banks were still raising interest rates.
Basically, it did the same mistake that the Federal Reserve did back in 1929,
which led to the Great Depression.
And so,
here we see that right after this one, it realized that there was really a problem.
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Central bank brought these interest rates to zero, but still it did not help.
And here we see the fundamental asymmetry, you remember the story of the donkey.
You bring the donkey to the fountain, but you cannot force it to drink.
Here, it's exactly this illustration.
The central bank should have raised interest rates when
asset prices were going through the roof.
It did not, and then when the bubble burst, it brought interest rates to zero,
but then the necessary condition for these zero interest rate policies to
be effective and lead to more growth is that banks provide more credit.
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And banks did not provide more credit, because they already had some
loans up to the roof, the so-called none performing loans.
All these people which had borrowed money to invest on the stock market by securing
that with their house
which was worth nothing you know because it was at inflated prices.
Then they could not pay back the loans so
banks did not provide more credit when interest rates were at zero.
So here you see the fundamental asymmetry of a central bank policy.
It's way much more effective, it's far easier.
When you don't want the horse to drink water, you just close the tap.
You raise interest rates and that's the end of the credit boom.
But when you want to stimulate [LAUGH] growth and
credit, you open the tap, the liquidity flows,
but banks may not necessarily be thirsty and drink the water.
So, here with the example,
we see that the back of Japan should have looked elsewhere.
It was focusing on the consumer basket of goods and
services to detect any inflation pressures and
it did not find any because inflation was elsewhere.
It was in the asset market and, in particular, in the real estate market.
So here clearly we have an example, it's a debate, but
many economists say you point to the example of the Bank of Japan.
They should have looked, they should have taken two account of this asset price
bubble and raised interest rates way before they did in 89, 90.
Now to illustrate the fundamental,
at this fundamental asymmetry that there is a central bank, far easier to
restrain credit than to stimulate credit and growth.
Just look at this chart, still referring to Japan.
You see the evolution in red, this is the money supply.
And you see the evolution in blue, that's the GDP.
And you see that it starts at 100 in 1980, and now you
see that money supply has gone through the roof, and you see that GDP is flat.
It is not responding as it did up until 1994.
It was responding to the stimulus of the central bank, but since then it was not.
So you see here the problem we have when a central bank conducts expansionary
policy and boosts money supply and brings interest rates to zero or
even negative rates.
In, with the idea that banks will take this free money and
provide more credit to the economy,
it may not actually work if banks are not willing to provide more credit.
Unless they get nationalized, they will not do so.
And so you have this disconnect as we see here between the evolution of money supply
and GDP.
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So the key question,
which we will address now in the debate with Jean-Pierre Danthine,
is should central banks include asset price in their inflation objective?
We see here clearly that the example is that Japan should have paid attention to
asset prices because that's where the true inflation was and
not in the consumer basket.
And here we see here the evolution back in the US just before the subprime crisis.
Clearly the subprime crisis of 2007 to 2009 was due to
a bubble in the real estate market.
So year two we can say that the Fed should have paid attention in some way to what
was happening there, and see here in blue the evolution of the Case-Shiller index,
which is referring to housing prices.
And you see that they peaked in 2005, 2006.
It was rising at double digit numbers, at 15% year on year, and it was really high.
So clearly, there was a bubble, and the Central Bank should have
at least looked at this bubble there to know that something wrong was going on.
But still, as you will see with Jean-Pierre Danthine,
he is not in favor of the central bank,
including formally asset prices in there objective, and so
it's a debatable, there are pros, and there are cons.
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University of Geneva- Tony BerradaSFI Associate Professor of Finance
University of Geneva- Jonas DemaurexTeaching Assistant
University of Geneva- Rajna Gibson BrandonSFI Senior Chaired Professor of Finance and Managing Director of the GFRI
University of Geneva- Michel GirardinLecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
University of Geneva- Kerstin PreuschoffAssociate Professor of Neurofinance and Neuroeconomics
University of Geneva- Olivier ScailletSFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
University of Geneva- Philip ValtaSFI Assistant Professor of Finance
