The prolonged recession in Japan (starting from the 1990s) could have been avoided if more emphasis was placed on credit creation (bank lending).
Instead, Japan focused on dramatically increasing fiscal spending at the onset of the recession, by issuing government debt to the non-bank private sector. This led to crowding out as the money injected via fiscal spending was absorbed via bond issuance.
Bank of Japan should have purchased non-performing assets from the banks at face value, in turn improving liquidity and strengthening banks’ balance sheets. Second, instead of financing spending through government bonds, the government should have done this through private loans (non-tradable) with banks.
The US economy recovered from the 2008 crisis ahead of the Euro area and the UK as it adopted QE early. However, the recovery would have been swifter if the credit creation entered the real economy rather than the asset markets. This is the one area where the focus has changed during the current pandemic via programs like Paycheck Protection Program (PPP).
One-way credit creation can enter the real economy is through having numerous small community banks who are more likely to lend to SME’s.
Yield curve should steepen since low-interest rate is detrimental for the banking sector. As it disincentivizes the creation of new banks (lowers margin), consequently limiting credit channels and hence reduces the credit creation within the economy.
[Bearish Rates]
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