Throughout history state-led money creation has been the norm, rather than the exception. Here’s why Japan was able to kick-start growth in the middle of a global recession.
History has many examples of governments successfully growing their economies through state-led money creation. While none of these policies were called, “QE for People”, “Sovereign Money Creation”, or “Helicopter Money”, they shared the common trait of using newly created state money to finance government spending, rather than relying on commercial banks to create new money through lending.
The times when this state-led money creation has resulted in high inflation or even hyperinflation (inflation of over 50% a year) have been well documented. However, the times when governments have created money in a careful and responsible manner to grow the economy are usually ignored or overlooked. At Positive Money, we want to set the record straight and bring to light the many case studies where state-led money creation has successfully boosted the economy without leading to economic disaster.
In our previous posts on this topic, we showed that theory and analysis have been dispensed with at the expense of this widespread misconception. We showed that misleading conclusions have been drawn from the case studies of state-led money creation in Zimbabwe and the Weimar Republic and we highlighted some lessons from state-led money creation under the Roman and Chinese empires. In our most recent post, we showed that QE for People has happened in the places you would least expect it, the former British colony of Pennsylvania and the island of Guernsey. In today’s post, we will consider the case study of Japan in the 1930s.
Japan (1932-1935)
Between 1919-1929 Japan had endured a difficult decade, with output growing at less than 1% per year. Numerous bank runs and financial panics continuously hampered economic activity. The state of the economy was only worsened when Japan returned to the gold standard in 1930. The Yen was significantly over-valued, prompting trade deficits and an external drain of gold.In 1931, when Finance Minister Korekiyo Takahashi took office, one of his first actions was to take Japan off the gold standard. Indeed, many countries had taken the same action (i.e. Britain). Yet, the policy decision made to take Japan off the gold standard was unique in so much as it allowed Takahashi to jump-start the economy by allowing the central bank to create money to fund public works.
Indeed, in March 1932, the Japanese Minister of Finance put forward a policy proposal that would allow the Bank of Japan to buy freshly issued public sector bonds with newly created central bank reserves. While the Finance Minister did have the legal mandate to instruct the central bank to purchase government bonds; there was more support than resistance from within the central bank.
Three months later, Takahashi put forward a supplementary budget for increased public spending (primarily for agriculture and military expenses). This was to be financed by issuing new bonds, which the central bank would purchase outright. All the existing regulations that limited the Bank of Japan’s ability to buy public sector bonds outright were virtually eradicated. Originally, legislation only permitted the Bank of Japan to have 120 million Yen of un-backed currency in circulation. With this measure, the Bank of Japan was able to circulate 1 billion un-backed Yen.
As Eichengreen (2015) explains, “The expectation, clear in light of Takahashi’s actions and statements, was that the Bank of Japan would do its part to help finance deficits. The government and central bank would be working in harness to actively bring deflation and depression to an end.”
Accordingly, the results of the Takahashi endeavour were impressive. In a small space of time, the rates offered on short-term lending declined from 15% to 1%. The value of the Yen depreciated versus the price of other currencies (as intended); by approximately 40% and 60% against the pound and dollar respectively. Prices increased as expected, but industrial production expanded at a greater rate. Most importantly, real GDP grew by 7% in 1932 and 8% in 1933. By 1935, Japan was believed to be back at full employment.
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