Here's a very powerful paragraph from Nomura economist Richard Koo:
I have pointed out previously that mini-bubbles can occur during a balance sheet recession. During a usual monetary policy-driven market, money created by an accommodative central bank typically spreads throughout the economy and lifts markets. During a balance sheet recession, however, the private sector is a net saver, which means only the financial sector is flooded with funds that are generated by private sector saving and deleveraging.
Let's unpack this a little bit.
Richard Koo is the primary believer in what people call a "balance sheet recession", a recession caused by mass deleveraging either by households or by businesses. Koo formed these ideas based on the bust in Japan, as he watched policymakers try in vain to stimulate the economy while businesses continued to cut down on debt. His solution is that fiscal policy — direct government spending — is what's needed to lift the economy. Cheaper money, he believes, doesn't work when nobody wants to take on debt.
In the US he still sees evidence of the private sector being more inclined to save than take on debt, so again he largely views monetary policy as impotent to stimulate the economy. But he does believe than in the absence of the inclination to spend or invest in real things, the Fed's cheap money can and will create financial bubbles. He doesn't necessarily see a big bubble now, but is concerned about "mini bubbles."
Koo's comments (which were published in a note yesterday) come following a recent speech from Larry Summers, about how the economy has been impaired for awhile, and that only bubbles have been getting us to full employment in recent cycles. That's a bit different than Koo's idea, though the bigger concern that we're getting bubbles instead of real growth is an increasingly hot topic for economists.
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