Business Insider’s Joe Weisenthal interviewed Richard Koo last night. Regular readers will recognize Mr. Koo as the author of “Balance Sheet Recession.” For years Koo has been teaching the basic tenets of his famous theory: regular monetary policy is useless during periods of deleveraging. When people, whether they are governments or consumers or both, are singularly focused on paying down debt central banks have very little power to stimulate a weakened economy.
When asked about the situation in Europe, Koo responded:
Well, I think Europe is in a pretty grave situation. When their own banks don’t trust each other, and having funding problems, that’s a pretty serious situation already… bond [yields] have skyrocketed and that’s forcing the countries to cut budget deficit further, but these guys who are already experiencing a balance sheet recession, when the government tries to deleverage at the same time, the economy just gets worse and worse and worse… when the Maastricht Treaty was put together, the concept of balance sheet recesion didn’t exist in Europe, only in Japan. And the treaty is completely defective in the sense that it has no provisions for balance sheet recession.
It seems to me that the EU doesn’t even have the willingness to accept the fact that they are, indeed, facing a balance sheet recession. The austerity programs being put into place today will only make matters worse. Koo’s remedy requires governments to spend enough to make up for the drop in private sector spending. Without such a remedy an economy enters a death spiral (slowing growth means lower government revenues which force even greater austerity slowing growth further, etc.).
Europe is essentially a debt addict right now hitting bottom (we hope). The first step in any 12-step program is to first admit that there is a problem. In the case of Europe the problem is too much debt resulting in a balance sheet recession. European leaders have to come to an agreement on this before they can even begin steps two through twelve (beginning with modifying the Maastricht Treaty so that a Koo-style remedy can be implemented). Until this happens, I’m afraid very little progress will be made in the Euro Zone.