Masaaki Shirakawa gives another superb speech covering many issues.

He suggests three research agendas for future:

Against the backdrop, I put a bubble and a resultant financial crisis at the top of the research agenda. Beyond a variety of discussions prompted by the global financial crises, we need to make further progress on this front. The second issue is economic and social consequences of sizeable demographic changes, such as a declining population and ageing.The third issue is repercussions of natural disasters on economic activity.

The second and third issues may look remote to financial systems and monetary policy, but it is a prima facie impression as I will flesh out later. A declining population gives rise to an outright reduction in the natural rate of interest and this could constrain monetary policy via the zero lower bound. If the guaranteed return of pension policies did not adequately reflect the anticipated decline in the natural rate of interest due to a decline in the population, the misalignment could spur the search-for-yield which would sow the seeds of a bubble.

On research on bubbles and agendas he points how in both Japan and US there was a similar experience of crash and slow recovery. In both central banks cut rates sharply and pumped in a lot of money. But did it help? If inflation is always and everywhere a monetary phenomenon, what about deflation?

In this context, I would highlight the subtle distinction between money and credit in a period of deflation. Professor Milton Friedman once noted that inflation is always and everywhere a monetary phenomenon, the well-known Friedman’s proposition on inflation.4 With my respect for Friedman whose last class that I took at the University of Chicago, I would suggest asking whether the proposition holds if we replace the term, “inflation,” by “deflation” in the proposition. Elaborating on the validity of this seemingly symmetrical proposition would provide a clue to better understanding how a financial crisis interacts with deflation. You may argue that replacing inflation by deflation would simply flip a plus to a minus, but the issue is not as simple as it appears. Whether this deflation version of Friedman’s proposition holds or not would depend on how we interpret it.

He says there are two aspects to this question. One if we look at financial sector and other the overall money and inflation. In first one can say Friedman proposal applies to both inflation and deflation. In second it does not:

The proposition holds if the proposition means that destabilized financial systems shrink money stock noticeably, thereby resulting in deflation. In retrospect, we can reaffirm that severe deflation was accompanied by financial crises.5 Friedman pointed out in his own writing, “A Monetary History of the United States,” that during the period of 1929-1933, money stock shrank by 31 percent and the price level declined by 25 percent primarily because the Fed failed to act as the lender of last resort. In sharp contrast to the U.S. experience in the 1930s, helped by such lessons from history, the Bank of Japan acted very aggressively as the lender of last resort. As a result, contraction of money stock was forestalled and the price level dipped by only 0.5 percent per annum at the maximum. It could also be noted that since 1998, the price level has dropped slightly larger than three percent, which is quite different from the U.S. experience in the 1930s (Slide 7). In sum, the experiences of the U.S. and Japan confirm that the proposition holds in line with the aforementioned interpretation.

On the other hand, if we interpret the proposition in a way that central banks can raise the price level at will by flooding the economy with the monetary base, the proposition is, at least, not compatible with the recent experiences in Japan as well as in the U.S. In Japan, between 1997 and 2010, the monetary base soared by 90 percent while money stock increased by 30 percent. Likewise, the U.S. experience between 2008 and 2010 clearly shows that the monetary base soared by 140 percent while, by contrast, money stock increased by only 10 percent. Despite the flooding monetary base, Japan’s consumer price level dipped by 3.7 percent for the thirteen years by the end of 2010. The U.S. core CPI inflation rate has decreased by more than one percent point despite the increase in monetary base. To sum up, significant increases in the monetary base neither gave rise to an equally significant rise in money stock nor inflation, let alone proportional increases.

Regarding second economists differ. Some like Krugman say monetary policy does not work when policy rates at zero. Scott Sumner says the monetary stimulus was too little. Then others like John Taylor do not agree to the stimulus bit at all.

I am not talking about demographic changes as have covered it regularly. Though he points how Keynes had analysed the implications of demographics way back.

Third one is natural disasters. After the great Japanese earthquake and triple crisis, role of inventories becomes crucial. The problem is if we start planning for natural disasters premiums are huge. Firms cannot run just in time systems and people will have to pay huge insurance premiums to survive in case the mishap happens. This then leads to probabilities and trade-off between today’s premium and tomorrow’s disaster costs:

Superb insights as always…