This story is part of an occasional series from The Globe's Brian Milner, who visited Japan to assess the results of dramatic efforts to revitalize the world's third-largest economy.
When the Bank of Japan stunned the markets on Friday by ratcheting up its already enormous stimulus spending by one-third, economist Richard Koo, Japan's best-known critic of quantitative easing, was at a conference in Shanghai talking about the considerable currency pressures, capital, trade and other difficulties faced by emerging markets as a result of such actions taken by central banks in wealthy countries.
What happens to these vulnerable markets probably isn't going to cause any sleepless nights for BoJ governor Haruhiko Kuroda or his counterparts in the U.S. and Europe. But they ought to at least be worrying more about the impact of their bold experiments at home, especially when it comes to inevitably unwinding them.
Quantitative easing is "easy on the way in and very difficult on the way out," Mr. Koo, chief economist with Nomura Research Institute, was saying Friday evening from his Shanghai hotel. "We don't know the outcome yet."
But as the Federal Reserve may soon discover, removing liquidity when the economy is recovering can be a tricky business. It means selling bonds at a time when private-sector demand for capital is heating up. Which is likely to drive up longer-term interest rates.
In an economy still recuperating from recession, that's a recipe for trouble. Higher rates "could weigh on economic recovery for years," says Mr. Koo, who warns that the U.S., Japan and Britain may be facing just such a QE "trap." And China may not be far behind.
Where central banks have stuffed their vaults with longer-term government bonds, long-term interest rates have declined more sharply than if there had never been any QE. Which, after all, was a key purpose of the exercise. But when the economy shows signs of life again, long-term rates climb just as sharply, because of market expectations that the central bank will be shedding its longer-maturity bonds to begin repairing its own balance sheet.
That, in turn, hits the sectors most sensitive to interest-rate changes, such as housing and autos, "and nips the recovery in the bud."
Mr. Koo, a one-time economist with the New York Federal Reserve, is widely known for his groundbreaking work on what he called balance-sheet recessions, which afflicted Japan in the postbubble 1990s and early 2000s, hit the U.S. and European economies in the wake of the global meltdown and now looms over China. When corporations and households are focused on reducing debt and cleaning up their balance sheets, monetary pump-priming like QE simply doesn't work.
Not even rock-bottom interest rates and vaults full of cash can tempt reluctant, debt-laden businesses to borrow or spend, especially when demand remains feeble. In such a state, "the economy never fully recovers because businesses and households live in constant fear of a sharp rise in long-term rates."
But let's get back to Japan, where the balance-sheet recession was largely cleaned up by 2005 and half of all publicly listed companies carry no debt, even with interest rates at zero. Yet they still show little inclination to spend or borrow.
One reason is lingering psychological trauma, Mr. Koo told me in an earlier interview at his office in central Tokyo. "People go through this huge de-leveraging under the most difficult circumstances. They say to themselves: 'Never again.'"
Japan's private sector is still saving nearly 6 per cent of GDP at zero interest rates, Mr. Koo pointed out. Someone has to borrow and spend that much to keep the economy from shrinking.
The central bank stepped into the breach. But it ought to have been the Abe government, with much bolder fiscal stimulus, Mr. Koo argues. "If there are no borrowers in Japan, the BoJ can do anything it wants and nothing will happen."
At the time, he said he hoped Mr. Kuroda would not push his luck by opting for even more aggressive monetary policy. "That would be a very dangerous thing to do."