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Scholes: Japan’s “three arrows” policy has central banks quivering

May 06, 2013

Japan’s new agenda for economic growth is of global interest and importance, Nobel Laureate Myron Scholes said at Chicago Booth’s Economic Outlook 2013 in San Francisco.

The “three arrows” policy, introduced in January by Prime Minister Shinzo Abe, is characterized by aggressive monetary policy, fiscal stimulus, and structural reform.

Scholes, MBA ’64, PhD ’70, Frank E. Buck Professor of Finance, Emeritus, at the Stanford University Graduate School of Business, said the first and second arrows – financial stimulus and government stimulus – are being accomplished by so-called helicopter money being printed by the Bank of Japan and a massive government stimulus program.

“They’re trying to move $17 trillion of savings out of bonds and into investment equities, and depreciate the yen dramatically,” he said. 

The third arrow, structural reform—meaning getting rid of “corruption, collusion, and cronyism” in favor of competition and private investment—is necessary to clear the way for growth, Scholes said.

“Whether they can get that third arrow working, we will see,” he said. “There’s a lot of vested interests, and vested interests don’t like change—especially if you take money from them.”

“If Japan is successful, the US Treasury, which is already getting calls from the automobile industry, and central banks will start to worry about trade wars, restrictions, and the like,” Scholes said. He added that the policy resembles that of Takahashi Korekiyo, who brought Japan out of the Great Depression that began in 1929 with positive economic growth.

Scholes said the global financial crisis is not yet over. “It seems to me that we’re still in the middle of this,” he said.

“Every central banker wants to say that we had a liquidity crisis and are going to return to the normal trend. If they said it was a solvency crisis—the housing prices were inflated or it was a bubble or there was too aggressive lending by the banks—and they missed it, they don’t want to say that.”

“They’re going to do everything to think of it as a liquidity crisis,” Scholes said. “It’s their intention to print money,” he said.

Scholes drew a distinction between GDP and wealth as measurements of economic success, giving China’s 2008 stimulus as a cautionary example of increasing GDP without increasing wealth.

“They spent $1.5 trillion on stimulus by directing provincial governments and cities to spend money. They spent money, but all that money disappeared,” Scholes said. “And so even though the GDP of China went up, the wealth of the society went down.”

—Chelsea Vail