Structural Traps, Politics and

Monetary Policy

Robert H. Dugger and Angel Ubide

Tudor Investment Corporation.
Abstract
Structural conditions pose a challenge to monetary policy, as the example
of Japan shows. In this paper we develop the concept of structural trap,
where the interplay of long-term economic development incentives,
politics, and demographics results in economies being unable to ef-
ciently reallocate capital from low- to high-return uses. The resulting
macroeconomic picture looks like a liquidity trap low GDP growth and
deation despite extreme monetary easing. But the optimal policy
responses are very different and mistaking them could lead to perverse
results. The key difference between a liquidity trap and a structural one is
the role of politics. We show how, in the Japanese case, longstanding
economic incentives and protections and demographic trends have
resulted in a political leadership that resists capital reallocation from
older protected low-return sectors to higher-return newer ones. If the
Japanese case is instructive, in a structural trap, extremely loose
monetary policy perpetuates deation and low GDP growth, because

The authors are respectively Managing Director and Director of Global Economics, Tudor
Investment Corporation. A version of this paper was presented at the Central Bankers
Symposium organized by Nomura Securities in Kyoto, Japan, in May 2002. The authors are
indebted to two referees, an associate editor, Alberto Musalem, Yuri Okane, Koho Nakatake
and several people who provided valuable comments on earlier drafts. The views expressed
are entirely personal and do not represent the views of Tudor Investment Corporation. The
errors are wholly the responsibility of the authors.
rBlackwell Publishing Ltd. 2004, 9600 Garsington Road, Oxford OX4 2DQ, UKand 350 Main Street, Malden, MA 02148, USA
International Finance 7:1, 2004: pp. 85116
unproductive but politically important rms are allowed to survive and
capital reallocation is prevented. By preventing the needed reduction in
excess capacity, a structural trap condemns reationary policies to failure
by making the creation of credible ination expectations impossible.
Faced with a structural trap, an independent central bank with a price
stability mandate should adopt a monetary policy stance consistent with
restructuring. If political resistance is high, monetary policy decision
makers will need to keep nominal rates high enough to ensure that capital
reallocation takes place at an acceptable pace.
I. Introduction
Structural conditions pose an enormous challenge to monetary policy, and
Japan is perhaps the clearest example. Japans problems are the result of
large, long-term factors, including economic development and demographic
and political forces that have been at work for many decades. This paper
develops a relationship among these forces into the concept of structural
trap, shedding light on why Bank of Japan policy does not appear to be
working and pointing to some lessons other industrialized economies could
learn from Japans experience.
A. Subsidies, Aging, and Politics
Japan may be the rst of the industrialized economies to feel the full weight
of post-Cold War economics, aging citizens, and a political system that is
either unaware of or unable to overcome their effects.
By post-Cold War economics, we mean the adjustments needed to wean
an economy away from the incentive subsidies and protections that, in
Japans case, enabled it to rebuild after World War II, develop world-class
manufacturing capabilities, keep its population employed and its politics
stable. Though they differed, all the economies in the Western Alliance had
incentives, subsidies and protections that contributed to success in winning
the Cold War.
By aging we refer to our scientic success in reducing infant mortality and
lengthening lives and its economic and political consequences; see, for
example, Williamson (2001). European, American, and Japanese lifespans
are all lengthening. Because the voting participation of older citizens is so
much greater than that of younger citizens, the needs and priorities of older
voters increasingly shapes politics and government policy disproportio-
nately. Because the peak age of Japans baby boom is ten years older than the
USAs and fteen years older than Europes, Japan may simply be the rst of
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 86
the industrialized countries to manifest the effects of aging on politics and
policy.
1
See Figure 1.
With regard to political forces, the combined effects of old subsidized and
sheltered economic sectors and aging citizens seem to be very powerful.
Year-by-year, following World War II, the incentivized and protected sectors
grew and, as they did, their workers and managers, bankers, and government
representatives, came to dominate politics and policy. Current older voters
naturally tend to be still working in or retired from old-sector companies.
The well-being of these older voters and their families is closely linked to
that of old-sector companies and nancial institutions.
2
In times of economic
weakness, given old-sector political power, it should not be surprising to see
governments try to prop up the old sectors with every available resource.
Because the return on capital in these sectors is generally low, government
efforts to pump them up tend to weaken the economy, not strengthen it. The
human and real capital in these sectors needs to be allowed to move from
their current low-return uses to higher-return ones. This is the essence of
what is meant by restructuring reform and is the heart of the debate in Japan.
B. Reation and Restructuring
Two points of view are at war in Japan over what should be done to get
the economy going again. The two opposing views can be termed reationist
1
In this regard, we make two observations. First, if the effects of elderly over-representation
consistently impair economic and social performance, it may be because current democratic
processes developed and became quite xed during the past two centuries when lifespans
were generally shorter and population distributions assured that younger voters were well
represented. Ways to correct the resulting policy distortions may be needed. Second, it is
probably true that when an economy has a large, energetic, risk-accepting population,
economic growth increases. If a large population of healthy, well-educated young adults is
critical, it should not be a surprise that Japans economic leadership surged in the 1980s and
the USAs in the 1990s. It was then that both economies had an unusual number of young
baby boom adults able and willing to take exceptional risks. The result, I believe, was Japans
global trade leadership in the 1980s and Americas information technology leadership in the
1990s. The fact that the stock markets of both economies peaked when their baby boom
populations reached their early 40s, a time when most people have children, aging parents,
and decreased risk appetite, should perhaps not surprise us. What this might mean for
Europe is not clear. Europes remarkably successful unication effort may be the counterpart
to 1980s Japanese success in trade and 1990s US success in technology.
2
The risk aversion of the Japanese society is a well-known fact, as is the entrenchments of
this attitude among older cohorts. The modern life-cycle paradigm (see, for example,
Faruqee and Laxton 2000) models precautionary behaviours as a positive function of age,
and thus less inclined to undertake job changes, seek employment in newer industries or
invest in riskier assets.
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 87
and restructionist. It is easy to tell one side from the other. Reationists
always put deation at the top of a list of Japans problems. Restructionists
instead put structural rigidities at the top of the list. Both sides agree the
others perspective is very important. The key is their emphasis.
2000 1990
11 COUNTRY EURO ZONE POPULATION 19902000
0
2,000,000
4,000,000
25,000,000
20,000,000
15,000,000
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0
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10,000,000
5,000,000
0
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10,000,000
12,000,000
2000 1990
2000 1990
JAPAN POPULATION BY AGE 19902000
US POPULATION BY AGE 19902000
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Figure 1: Japan, USA, and EU Baby Boom Population Peaks
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 88
Reationists stress the need to break deationary expectations. They
describe Japans problems in liquidity trap terms and emphasize Bank of
Japan policy and the need to set an ination target with a time limit for
attaining it. Restructionists argue that capital immobility is the core problem
and, for some, it is the cause of undesirable deation. They emphasize
raising nominal interest rates to allow markets to close unprotable rms
and move labour and capital into more productive uses.
On this question, we tend to side with restructionists. A liquidity trap does
not tell the whole story. Most importantly, the issues liquidity trap explana-
tions ignore are the most important for bringing about a return of growth
and job creation. Just as Keynes rejected monetary policy and turned to
scal spending to escape his liquidity trap, policy makers attempting to
escape a structural trap have to consider non-monetary policy solutions.
Restructuring reform and scal policy focused on enabling capital and
labour to reallocate are what is needed. In this paper, we argue that for
central banks this means that, if political resistance to reallocating capital is
great, monetary policy has to be tighter than if political leaders support
reallocation. If politicians actively address an economys structural rigidities
and unfunded entitlements, the central bank can ease more aggressively.
II. Structural Traps
When political and historical factors are considered, Japans current
circumstances importantly differ from what liquidity trap economics
suggest. A framework that incorporates the effects of past policies and
current politics opens the way for consideration of a structural trap, and is
possibly a richer way to think about Japans policy challenge.
3
In brief, we say an economy is in a structural trap when its government is
politically unable to permit the capital reallocation needed to generate
growth and job creation. Japan, in our judgment, is in a structural trap.
In a structural trap, political leaders use scal policy to support GDP
mainly by directing national resources back into the older, sheltered sectors,
which provide the main sources of political support. Political leaders also
put pressure on the central bank to do what it can through interest rate
policy to keep old-sector companies from failing. The spending and low
interest rates support companies that otherwise would fail. The mounting
burden of non-competitive companies depresses growth and job creation
and eventually puts the government on a path of ever-growing decits and
debt.
3
This concept was rst introduced in Robert Dugger (2001a).
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 89
A. The Political Economy of Structural Traps
When an economy develops for many years within a set of economic
incentives external conditions and spending, tax and market policies that
promote some economic sectors and constrain others the promoted
sectors, in time, become major contributors to national GDP and reect
the composition of the incentives. Infrastructure building and export-
production are examples of promoted sectors in Japan. (Home building
and consumer-retail are examples of promoted sectors in the USA.) All were
multi-decade beneciaries of an incentive structure, which consists of
institutional and tax subsidies, market protections, and geopolitical impor-
tance.
If the economic incentive structure (external conditions and domestic
subsidies and protections) weakens as a result of changed conditions (such
as globalization), the economy is vulnerable to a slowdown. The previously
supported sectors will tend to contract, and the unsupported sectors may not
expand enough to keep GDP rising satisfactorily. This asymmetry causes
GDP growth to weaken and is the initial tilt toward a structural trap.
If political leaders do not understand that the economic slowdown is the
result of longer-term structural changes and are not familiar with the
effectiveness of private market decision making, they may attempt to protect
to an inappropriate degree the promoted sectors from needed reallocations
of capital. They may use government spending and credit guarantees to keep
capital committed to the promoted sectors in an effort to protect business
and employee constituents from restructuring pain.
If the spending and guarantees serve to cushion constituents from
unnecessary short-term disruption, but delay needed longer-term realloca-
tions of capital from low-return uses to high-return ones, the policy actions
put the country at risk of falling into a structural trap. The litmus test of
whether policy actions are leading a country into a trap or not is whether the
actions facilitate or obstruct capital reallocation.
B. The Politics of Structural Traps
The core political problems in a structural trap can leave a legislature unable
to implement needed reforms. Two problems are critical. First, the time-
frame for achieving needed capital reallocations is longer than the re-
election cycle faced by politicians. And, second, it is easier to block change
politically than to achieve it.
Usually when sector protections and subsidies have been in place for a
long time, the sheltered sectors constitute a large share of GDP and sector
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 90
constituents make up a majority of the electorate. But even if they do not,
they can block rollbacks in subsidies and protections and continue to divert
national resources to their benet for many years. US agriculture is as clear
an example of this as any. The mechanics of democratic government make
the timeframe for achieving needed capital reallocation and the ability of
sector advocates to block reform the core problems to be addressed in
escaping a structural trap.
The political incentives that face elected leaders are important. If
economic incentives are successful over a long period of time in achieving
good economic growth based on steady expansion of the promoted sectors,
the political leadership that designed and implemented the incentives
becomes stronger. Relationships among business executives, worker groups,
bureaucrats, nancial institutions, and political parties developed to frame
and execute the incentive policy deepen and shape political activity. The
governing political parties come to dominate the political scene year after
year.
When economic incentives change and the economy weakens, political
leaders have a difcult choice. They can use the tools of macroeconomic
policy to ease the capital reallocations necessitated by the incentive changes,
or attempt to keep capital allocated to the promoted sectors. Fiscal and
monetary policies can cushion the short-term effects of a restructuring
economic contraction and provide time for private decision makers to adjust
and for policy makers to implement reforms that facilitate capital realloca-
tion, reduce the depth of the downturn, and quicken the return to growth.
When used to preserve control of the government, however, scal policy
including widening credit guarantees can quickly become an instrument for
resisting capital reallocation and new sector development.
In a structural trap, it is not irrational for elected ofcials to resist reforms.
By resisting reforms that increase private investment returns, ofcials can
preserve the governments ability to nance itself. Because the guarantees
and decit spending are invariably allocated to old-line promoted sectors
and support the banking system, elected ofcials can also assure themselves
of continued political support. The song to voters is always the same one
more stimulus package and growth will return and this economic pain will
stop.
Political leaders who resist capital reallocation do so mainly to ensure re-
election. For them, the short-term political costs in terms of rising business
failures and unemployment exceed the longer-term economic benets. The
economic choice: short-term pain for long-term gain does not apply. For
politicians the choice is short-term pain for long-term extinction. Hence,
politicians constrained by short-term re-election concerns will not usually
choose economically benecial longer-term options.
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 91
Political incentives are strong to persistently oppose reforms that would
enable private investment returns to attract domestic savers and investors,
especially at zero interest rates.
4
In Japan, deation and currency strength
provide positive returns on government-backed investments. Goods and
services deation enables household savers to earn a higher real return as a
result of their ability to buy more with their savings. Investors who do not
benet from price deation (because consumption is not a major part of
their budget) are rewarded by a rising currency. Even at zero-interest rates,
there is an amount of deation and currency strengthening that will satisfy
savers and investors.
Whether a country is in a structural trap depends on whether the politics
of preserving the promoted sectors in the face of changing external and
domestic conditions are stronger than those which would allow capital to be
reallocated. If an examination of government policy reveals a steadily
expanding reliance on scal spending and credit guarantees to prevent the
contraction of older promoted sectors, it is almost certain the country is in a
structural trap.
C. The Economics of Structural Traps
In a liquidity trap, liquidity preference is the villain. In a structural trap,
liquidity preference may be at play but the true villain is political resistance
to structural reform. In IS-LM terms, economists will generally agree that
structural constraints push the IS curve downward and to the left, but they
will quickly ask about government spending wouldnt an increase in G lift
the IS
0
curve back up toward full employment? The answer is, yes, of course,
and this is the nub of the issue. If an economys weakness is not due to
structural rigidities, scal spending may enable the economy to get through
the downturn with minimal discomfort. If structural problems are a major
reason for the weakness, scal spending may initially bring the economy
back to full employment, but until human and real capital reallocates to
higher-return uses, the positive effects of spending will be short-lived.
We can distinguish a structural trap from a liquidity trap and presents
some insights into its relationships with monetary policy and economic
growth by using a conventional IS-LM framework. In standard textbooks,
investment and saving are functions of interest rates. As interest rates rise,
4
A recent example is the Ministry of Finances effort in 2000 to delay again allowing
companies to report income on a consolidated basis. Consolidated reporting would enable
companies to net losses against income, reduce their tax liability and increase return on
equity. Fortunately, Prime Minister Koizumi himself intervened and has succeeded in getting
the reform back on track.
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 92
the amount of investment declines and saving rises as shown in Figure 2. The
points where investment and saving equal each other for each level of
aggregate demand gives us the familiar IS curve. The level of aggregate
demand is determined by the intersection of the IS curve and liquidity
preference and money reected in the LM curve. In a liquidity trap, the
intersection of the IS and LM curves occurs at an output level point below
full employment as shown in Figure 3.
Clearly this is a textbook oversimplication. In addition to interest rates,
investment is a function of structural factors such as labour and capital
market efciency, regulatory and legal conditions, sector protections, taxes
and subsidies, and political commitment to market processes. Similarly,
saving is a function of demographics, savings and consumption tax
incentives, public trust in government-promised pension and healthcare
benets, expectations regarding government decits, debt and future taxes,
and other structural factors, as well as the income and interest rate variables
cited in standard textbooks.
Structural rigidities and inefciencies are costs that reduce the amount of
investment at any given interest rate and raise amount of savings. Looking at
Figure 2 again, the I curve is moved to the left (I
0
) by structural constraints
there is less investment at any given interest rate. The saving curve is moved
to the right (S
0
) by structural constraints fear, distrust and uncertainty
cause people to save more at any given interest rate.
5
The effect on the IS curve is critical it is pushed down and made steeper
the IS
0
curve in Figure 3. In structurally constrained economies, every given
interest rate is associated with a lower level of output, and if structural
problems worsen, the associated level of output falls.
6
In a textbook liquidity trap, Figure 3, monetary policy is ineffective
because no amount of conventional central bank easing can cause the IS-LM
intersection to occur at or near full-employment output. The difference
between the IS curve r-axis intercepts r
1
and r
2
is a measure of the structural
5
This result may appear inconsistent with the fact that Japanese investment to GDP ratio is
rather high. This can be explained by the fact that Japanese savings are so high for a given
interest rate that, even with a constrained I curve, the intersection results in a low interest
rate and a high level of investment.
6
The slope of the IS curve steepens because the marginal propensity to consume c declines in
r C

G NX=a Y1 c=a, where the following expressions have the usual

meanings:
Y C I G NX
C C

cY
I I

ar
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 93
reform needed in the more constrained economy. The difference between Y
1
and Y
2
is a measure of the economic cost of the absence of restructuring.
Paul Krugman, for a while the leading US advocate for Japanese reation,
said, ythe problem is not that there is no real interest rate that will make
savings and investment equal at full employment; it is that the full-employ-
ment real interest rate is negative. And monetary policy therefore cannot get
the economy to full employment unless the central bank can convince the
public that the future ination rate will be sufciently high to permit that
negative real interest rate (Krugman 1998). Regarding monetary policy
Krugman stressed, Ination targeting is not just a clever idea a particular
proposal that might work in ghting a liquidity trap. It is the theoretically
correct response that is, ination targeting is the way to achieve in a
r
S,I
I
S
S
I
0
Figure 2:
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 94
sticky-price world the same result that would obtain if prices were perfectly
exible (Krugman 1999).
Incorporating structural constraints (IS
0
curve) leads to the conclusion: In
structurally constrained economies, the real interest rate that will make
savings and investment equal at full employment is more negative than in
unconstrained ones and, if structural problems worsen, the full-employment
real interest rate will become even more negative.
A central banker who is not alert to the depth of the negative interest rate
that equilibrates private I and S in a structural trap will underestimate the
amount of monetary easing needed to trigger an inationary expectation and
an increase in consumption. If the central banker concludes from the
r
Y
IS
LM
IS
0
Y
2
Y
1
Y
f
r
1
r
2
Figure 3:
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 95
ineffectiveness of his monetary easing that he is in a liquidity trap, he may
attempt more aggressive easing and only deepen the structural trap.
Whether an economy is in a structural or liquidity trap is critically
important for monetary policy makers. If an economy is in a liquidity trap,
policy makers probably should quickly follow the advice of thinkers such as
Takatoshi Ito (2002) to aggressively ease and trigger inationary expecta-
tions. If it is in a structural trap, the options are more complex; see Nakamae
(2001). Aggressive easing will certainly be economically supportive in the
short term, but it will also keep companies in business that should be
allowed to fail. If this happens, easing will slow the reallocation of capital
from older, low-return uses to newer, higher-return ones and delay the point
in time when sustainable recovery begins.
7
We discuss at length the
implications of structural traps for monetary policy in Section IV.
The economic indications of a structural trap are: absence of capital
reallocation, economic dependence on government spending and guarantees
and, in Japans case, goods and services price deation and currency strength.
The structural trap concept highlights the political dimensions of an
economys inability to generate growth. It asks the question: Is economic
weakness the result of monetary and scal policy failure, or the result of
actions by established elected ofcials attempting to maintain political
control of the government?
The economic aspects of a structural trap are understood and increasingly
accepted. Harold Cole and Lee Ohanian (2001) describe how a monetary
shock was turned into a ten-year depression by scal policies that obstructed
effective capital reallocation. Christina Romer (1992) goes so far as to
explain the end of the US 1930s depression as resulting from the way World
War II forced the USA to abandon ineffective scal policies. Marvin
Goodfriend (2001) examines how scal policy efforts can become counter-
productive in the specic case of zero-interest rates. Bank of Japan Policy
Board Member Kazuo Ueda (2001) commented on the linkages between
scal and monetary policy when structural issues are important.
The dynamics of a structural trap typically follow a nonlinear pattern. A
country risks entering a structural trap when its political leaders attempt to
avoid needed restructuring by resorting to decit spending, government
7
Echoes of the debates between Keynesians and Hayekians in the 1930s are not accidental.
Apart from coining the phrase structural trap, there is little new in pointing out that, under
some conditions, monetary policy easing can postpone recovery. This idea is central in the
thinking of those who see Austrian features in the Japanese expansion and contraction the
1980s and 1990s and to a degree in the US 1990s boom and more recent slowdown. They
warn that expansionary policies in recession may postpone necessary structural adjust-
ments, delay recovery and perhaps make subsequent corrections more severe. For an
excellent review, see Stefan Erik Oppers (2002).
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 96
credit guarantees, and extreme monetary ease. Without the restructuring
that would enable capital to ow from low-return uses to high-return ones,
the economy continues to weaken. Political leaders resort to more spending
and guarantees, the economy becomes more dependent, and the govern-
ments share of the economy steadily increases.
Month by month, more and more of the economy becomes frozen and, as
it does, national income, consumption, investment, and savings decline.
Government borrowing (direct and contingent) grows relative to domestic
saving. In Japans case, the current account shifts toward the red, real
interest rates rise and the currency strengthens.
Rising volumes of non-performing bank loans (NPLs) and falling stock
prices are nancial market evidence of deteriorating private sector prot-
ability. The NPLs consist mainly of companies and households in the old
supported sectors. Their ability to avoid outright default depends on
continued government support, without which the businesses would fail
and the banking system would collapse.
III. Japans Structural Trap
Though the Japanese government is bringing about needed changes in many
areas of economic activity, Japan is in a structural trap. Excess capacity and
labour data indicate that capital is not being effectively reallocated. Market
processes are not working.
8
Eisuke Sakakibara, the former Ministry of
Finance ofcial and one of the architects of the 1998 Financial Big Bang
reform, points to the political-bureaucracy complex as the main source of
resistance to capital reallocation (Sakakibara 2002). The role of this com-
plex in Japans structural trap arises from the sources of its political power.
This complex is sustained by the overrepresentation of rural and older
voters in the Diet, which in turn preserves the sectoral status quo. The most
serious consequence of the overrepresentation and the clearest evidence of
the depth of Japans structural trap is the crushing generational burden on
young Japanese.
A. Democracy and the Diet
Until recently, there was a clear disconnect between Prime Minister
Koizumis record-breaking voter popularity and the lack of Diet action on
8
One difculty is not enough professionals to handle the transactions needed in an efcient
market economy. Japan has about 19,000 lawyers and 18,000 accountants. The USA by
comparison has about 350,000 lawyers and 330,000 accountants. In per capita terms, Japan
has about one-tenth the number of legal and accounting professionals.
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 97
restructuring reform. A careful review of the polling data and Diet voter
representation reveals why. Prime Minister Koizumi was enormously
popular among young and urban voters, but not among older and rural
voters and they control the Diet. In the Upper House, rural voters are
represented 3.4 to 1 over urban voters. In the Lower House, rural voters are
represented 1.7 to 1 over urban voters among the 300 single-seat members
and equally among the 180 proportional-seat members. See Table 1.
Though the overrepresentation is not large numerically, the effect is
politically huge. The average age of rural prefectures is ve years older than
urban ones, and the voter participation of older voters is signicantly higher
than younger voters. Voters 50 to 70 years old vote about 75% of the time.
Those who are 30 to 50 year-olds vote about 63% of the time. See Figures 4, 5
and 6. Younger and urban voters are more likely to divide their votes to
support minority parties. Rural and older voters tend to stick with the LDP.
LDP support in rural prefectures is about 42%. In urban prefectures, the
support is 34%. The combined result of rural overrepresenation, older voter
participation and LDP loyalty, is a consistent pattern of support sufcient to
assure LDP Diet majorities.
The voting patterns affect taxes and transfers. In every case, taxes are
lower for older and rural voters, grant transfers are higher, and public works
spending is greater.
9
See Figures 7, 8 and 9. The political dominance of rural
and older voters assures consistent majorities for old-line LDP leadership
and a solid blocking majority opposing restructuring reforms that would
adversely impact these voters.
B. Generational Burden
Older voter election participation is greater and their votes count more in
the Diet. As a result, the needs of older voters are given priority over the
needs of younger voters. As a partial consequence of this, the burden on
Japans young people is the heaviest in the world.
This burden can be talked about in two ways in generational accounting
terms and in terms of the cost of reducing Japans debt to GDP ratio to a
sustainable level.
In generational accounting terms, the present-value of the expected taxes
that younger Japanese voters will have to pay to fund the retirement and
healthcare expenses of currently living older voters, (the generational
burden) is the highest in the world. The implied tax burden discourages
9
It could be argued that the transfers system was put in place at a time when age differences
were less pronounced. The fact remains, however, that when the time arrived to reform this
transfers system, the widening age differential has made this reform impossible.
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 98
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r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 99
productive new investment, encourages talented young Japanese to leave
Japan (Dugger 1999), reduces family formation and birth rates, and leads to
higher percentages of people who neglect to make required pension
contributions which of course increases the generational burden.
There have been pension and healthcare entitlement cutbacks in recent
years that reduce the burden on younger Japanese and these reforms should
35.64%
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55-59 60-64 65-69 70-74 75-79 80-
Figure 4: Age and Voting Rate (Nationwide, Election 2000 of House of Representatives)
Figure 5: Voting Power and Average Age of Voters by Prefecture
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 100
be applauded. Accordingly, the numbers below may slightly overstate the
burden on young Japanese; however, we do not think the overstatement is
signicant. In any case, the Japanese burdens are so great in comparison to
other countries that they put Japan at a serious competitive disadvantage.
Figure 6: Voting Power and Percentage of Population Over 65 Years Old by Prefecture
Figure 7. Voting Power and Grants from the Central Government Per Capita
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 101
The most recent year for which we have generational burden accounts
across all major industrialized countries is 1995. Table 2 shows the expected
value of the net tax burden on individuals at different age levels in three
Figure 8: Voting Power and National Taxes Paid Per Capita
Figure 9: Voting Power and Construction Spending Per Capita
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 102
countries.
10
For a Japanese 10-year-old child, the lifetime burden is $135
thousand. Though less than the German burden, it is almost twice the
burden of a US 10-year-old child. The key number is the Imbalance in
Percent. This number says how much in percentage terms the expected
taxes on future citizens will have to increase if currently living citizens do
not pay more. Because Japans pension and healthcare systems were so
profoundly under-funded even in 1995, the amount of taxes future Japanese
will have to pay if living Japanese do not pay more, is 338% more than
twice the increase for future US and German citizens.
It is difcult to get a sense of how the generational accounting burden has
changed since 1995. A very rough insight can be obtained by looking at the
increase in national indebtedness since then and ask how much would it cost
each citizen to reduce the debt ratio to say 60%, the limit for Europe set by
the Maastricht Treaty. Table 3 and Figure 10 show the present value burden
on individuals in different age groups of bringing down Japans debt to the
60% of GDP limit over 30 years (like paying off a mortgage), beginning three
Table 2. Generational Accounts: Japan, Germany, and USA in 1995
Generation
Lifetime Burden in $1,000s Of US Dollars Per Capita
Japan Germany USA
Age in 1995
10 135.4 179 71.4
20 257.4 313.6 159.3
30 297.8 271.8 168.7
40 263.8 160.1 135.6
50 171.1 4.2 56.4
60 11.9 183.6 51.7
Future Generations 319.4 248.8 73.9
Imbalance
Absolute 246.4 151.7 45.3
Percentage 337.8 156.1 159.0
10
See Auerbach et al. (1999). As the authors explain, the data in Table 2 reect the fact that
when, people are young, they receive transfers (e.g. child benets or educational allowances)
and pay consumption taxes. During their working lives, they continue to pay consumption
taxes but also pay taxes on their labor and capital income in the form of personal income
taxes and payroll taxes. The present value of a generations remaining lifetime net tax
payments its generational account is generally highest for generations at the beginning of
their working spans, as it does not include child and educational benets received in youth.
When workers reach older ages, the sum of future net tax payments tends to decline as future
transfer receipts (e.g. pensions) gain in importance compared with future tax payments.
(p. 77)
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 103
years from now.
11,12
In our judgement, it is enormously important that the
burden on, for example, a Japanese 10-year-old child is about 10.5 million
yen, or about $81,000 at current exchange rates.
Table 3. The Present-Value Burden Per Capita of Paying Off Government
Debt in Excess of 60% of GDP Amortized over Thirty Years
Age in 2002 Burden in Yen Per Capita
10 10,563,762
20 15,974,168
30 15,334,708
40 12,914,550
50 9,442,741
60 7,980,570
70 5,645,738
80 3,313,486
90 1,772,871
Figure 10: The Present-Value Burden Per Capita of Paying Off Government Debt in
Excess of 60% of GDP Amortized over Thirty Years
11
Debt/GDP estimate based on results from Asher and Dugger (2000).
12
A similar analysis was done to show the demographic distribution of NPL costs in Robert
Dugger (2001b).
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 104
If we add the 1995 intergenerational and post-1995 government indebted-
ness burdens, with apologies in advance for adding apples and oranges, and
recognizing that we do this only to get some idea general magnitudes, the
result is a very rough estimate of overall burden in present value terms. For a
Japanese 10-year old child, the burden is about 28 million yen or about
$216,000 at current exchange rates.
However it is measured, the scal burden on Japans young people reveals
the depth of Japans structural trap. Young people are the most important
capital resource of any society. The burden on Japans young people is its
most serious structural problem.
Clearly, the burden on Japans young people is not something the Bank of
Japan can address with monetary policy. Even massive yen weakening, the
goal of some of those who advocate ultra-extreme easing would not help
younger people. Such yen weakness would reduce the real value of the 1,000
trillion yen of household net nancial wealth and diminish the ability of
families to nance their childrens future. Once again, it is clear that the
solution to structurally based weakness is reform, not money growth.
13
C. Japans End Game
We think Japan entered a structural trap in roughly 1997. Since that time
Japans nominal GDP has been falling, and real interest rates and the trade-
weighted yen have been rising. Reformers have succeeded in instituting
many important changes beginning with the Big Bang nancial market
reforms in 1998. However, the overall policy situation has been one of
successful old-guard political resistance to allowing capital to move from
low-return sectors to high-return ones.
Interestingly, Japans outlook now depends on the nancial votes of cash-
rich businesses and wealthy families who hold large very liquid yen bank-
balances. If they decide later this year to diversify their holdings outside of
Japan in response to rollbacks in deposit insurance or declines in ofcial
commitments to a stable yen, the yen will weaken as capital ows out.
Nominal interest rates on non-government borrowings will rise triggering
failures of unprotable companies and market-driven restructuring.
With a strong yen, the Japanese government has been able to keep
domestic savings at home despite near zero interest rates. In summer
2001, however, the yen became too strong and, by the autumn, a policy of
containment had to be implemented. The Ministry of Finance intervened
13
In fact, structural reform broadly dened will be unavoidable because the social security
system is actuarially bankrupt. How and when this reform will be achieved is another matter.
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 105
seven times in September and October to ensure that the dollar and euro will
not fall below 115 dollar/yen and 106 euro/yen.
Afuent families and protable businesses who did not benet from price
deation saw an opportunity to invest safely abroad and earn yields 5 or 6
times those available on yen securities of comparable risk. MOF intervention
showed them that they need not be afraid that new purchases of dollar and
euro investment grade securities will fall in value.
When markets are convinced that the currency has plateaued, foreign and
domestic investors (those who do not benet from the steady fall in
consumer goods and services prices) will begin to move capital out to
capture the higher nominal returns available on foreign investments.
14
The capital ight most likely at rst will be mild, and because it is mostly
hedged, the weakening effect on the currency will be small. As markets
become more condent in the nance ministrys seriousness, the unhedged
ight will grow and, as it does, domestic nominal interest rates will rise. And
as interest rates rise, businesses that could survive only in a zero-rate
environment will fail. Government revenues will decline and interest
expenses will rise causing the scal situation to deteriorate further. At this
point, the risk of a globally destabilizing sudden stop will become
signicant.
15,16
IV. Implications for Monetary Policy
How can central bankers tell whether a persistently weak economy is in a
liquidity trap or in a structural trap and what should they do? The answer to
both questions is in the actions of political leaders.
If politicians are actively implementing restructuring reforms, then a
liquidity trap, not structural trap, is more likely. If an economy is only in a
liquidity trap, we will expect to see its political leaders actively zeroing-out
old subsidies and special tax treatments, breaking down market barriers, and
14
Signicant ight may require evidence that the government is considering expropriating
capital via taxes or ination. One experienced market expert commenting on an earlier draft
of these remarks observed that current account could move into strong surplus, so strong it
offsets the yield-directed portfolio outows. He concludes that: In essence, the capital
outows are unlikely to become a driving force for the currency until the risk free asset is
someone elses currency, and history shows this occurs when investors believe assets in local
currency are likely to be expropriated, either via ination (Latin America) or seizure
(Indonesia).
15
See, for example, Calvo (1998).
16
Potential strategic interactions become critically important in this context. See for
example, remarks from the Deputy Governor of the Bank of Japan, Yamaguchi (2002).
r Blackwell Publishing Ltd. 2004
Robert H. Dugger and Angel Ubide 106
reducing burdens on young people and family formation. Fiscal spending
will be directed away from older sheltered sectors and toward providing
unemployment support and training in the skills needed in a market
economy. Stimulus will take the form of tax cuts that maximize individual
choice and market processes and efciency. Polling data will show political
leaders to be unpopular among some old-sector constituents.
If political leaders are not pursuing restructuring reforms and instead are
shaping policies to try to preserve the status quo, and if previously sheltered
sectors continue to be the beneciaries of government spending and polling
data show politicians to be popular among constituents in these sectors, the
economy is almost certainly in a structural trap.
If the economy is structurally trapped, the central bank cannot simply
implement an aggressive easing policy focused on triggering an inationary
expectation in the context of its price stability mandate. It has to take into
consideration that its easing could make the situation worse.
A. Central Bank Institutional Traits
How a central bank deals with a structural trap depends on its policy
mandate, independence from political inuence, and the degree of political
support for restructuring and capital reallocation. In general, the greater the
political resistance for restructuring in the economy, the less aggressively the
central bank should ease.
Independence
Independence is a function of several factors. The longer policy board
member terms are and the harder it is to get members removed, the more
independent a central bank will likely be. An aspect of independence is the
enabling law itself. The harder it is for political leaders to amend the
enabling law, the more independent the bank is. The more legislative
approval a central bank must obtain for its budget, the less independence
it has. The more general and non-individual the accountability is and the
more secret the policy boards deliberations are, the more independent the
central bank will be.
Of the three industrialized economy central banks, probably the ECB is
the most independent. Its members are appointed for eight-year terms, are
removable only by a vote of the ECB board, and their terms are not
renewable. The ECB enabling law is the Maastricht Treaty, a legal foundation
that almost certainly would be more difcult to amend than the national
statutes underlying the BOJ and the Federal Reserve because it would need
the unanimous approval of the twelve member states of the ECB.
r Blackwell Publishing Ltd. 2004
Structural Traps, Politics and Monetary Policy 107
The BOJ is perhaps the least independent. Policy board members are
appointed for renewable ve-year terms. The Cabinet and the Minister of
Finance appoint top bank ofcials, executive auditors and executive direc-
tors, respectively. And the BOJ enabling law is a national statute that can be
amended by the Diet at any time.
Mandates
The BOJs policy mandate is given by Article 2 of the Bank of Japan Law
Currency and monetary control shall be aimed at, through the pursuit of
price stability, contributing to the sound development of the national
economy.
17
The Federal Reserve by statute is directed to promote effec-
tively the goals of maximum employment, stable prices, and moderate long-
term interest rates.
18
As specied in the Maastricht Treaty, the ECBs
primary objective is to maintain price stability.
19
The mandates are different in potentially important ways. The BOJs
mandate is to foster the sound development of the national economy
through price stability. The reference to sound development could be
used as a basis for tilting monetary policy actions so as to facilitate
restructuring despite its political unpopularity. This is especially so given
the absence of scal restraints on the government.
The ECB mandate is narrowly focused on price stability. Unlike Japan and
the USA, the European Union has limits on national debt and decits and
therefore on the ability of governments to resist structural change by
propping up older, sheltered sectors with scal spending. In a structural
trap, these scal limits could result in enormous pressure being put on the
ECB to resort to unconventional monetary easing measures such as
purchasing private equity shares and interests in real assets. In the extreme,
unconventional open-market operations have the character of scal spend-
ing by another means. (The scal spending character of ultra-extreme easing
is arguably a major reason the BOJ has so far resisted engaging in such
unconventional policies.)
The ECB appears to be more supply-oriented. For the ECB, markets are
expected to clear neoclassically in a context of price stability. Structural
policies are expected to foster growth by enhancing supply. In this frame-
work, GDP can only grow signicantly if potential output growth is
increased, because demand-induced growth (for example through govern-
ment spending) would create inationary pressures that would prompt the
17
Bank of Japan Law, available at www.boj.or.jp/en/about/bojlaw1.htm
18
Full Employment and Balanced Growth Act of 1978 (Humphrey-Hawkings Act).
19
Maastricht Treaty, Part 3, Chapter 2, Article 105, Section 1, www.europa.eu.int.
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Robert H. Dugger and Angel Ubide 108
ECB to tighten rates. The ECB can cut rates to zero so long as ination does
not pose a threat. In fact, it would be expected to do so if the price level is
falling. If Maastricht debt and decit limits are adhered to, however, old-
sector companies would fail from the lack of government support, and
capital would be reallocated in a creative-destruction process. In this respect,
the ECB is institutionally Hayekian though it describes itself in Keynesian
terms.
20
The sound economy component of the BOJs mandate would
appear to put it close to the ECB.
The Federal Reserve mandate is the most troublesome. The Federal
Reserve appears to be more demand-oriented with a mandate shaped by
Keynesian views arising out of the 1930s depression and the 1970s recession
and reected in the 1978 Humphrey-Hawkins Act. If the USA were to
descend into a structural trap, the FOMC would be under extreme and
statutorily justiable political pressure to do whatever necessary to support
employment in the near-term. An argument that restructuring is needed and
that unemployment will rise for an indeterminate time but thereafter decline
as growth returns would not likely be a defence against political attack. If the
FOMC thought that zero rates were not best for attaining sustainable long-
term growth, it would have to demonstrate persistent toughness. Because
American political philosophies are more accepting of restructuring argu-
ments, especially after the S&L crisis, the FOMC would likely prevail.
The parallel experience would be Chairman Paul Volckers battle against
ination in the early 1980s. In that ght, the FOMC raised the federal funds
rate to 18%. Political criticism was horric, but the Reagan administration
was pro-restructuring, and Volcker prevailed. Another example would be the
nal battle in the early 1990s to establish the euro by ending market
scepticism toward the franc-fort policy. Jean-Claude Trichet at the Bank of
France working with Hans Tietmeyer at the Bundesbank, maintained the
French francDeutsche mark parity despite heated criticisms from every
corner and adverse short-term effects on the French economy. The franc-fort
policy prevailed and the result is the euro.
B. The Monetary Policy Paradox: Price Stability and Capital
Reallocation
Structural traps pose a paradox for monetary policy. A central bank that
pursues price stability by aggressive easing may miss the point. Keeping
nominal rates at a level that causes unprotable companies to fail and labour
and capital to reallocate may be the best path to price stability. Getting
20
See Issing et al. (2001), especially, Chapter 4, The ECB Strategy: Dening Price Stability,
Mandate of the Treaty.
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Structural Traps, Politics and Monetary Policy 109
around this paradox is critical because most economists think policies that
force restructuring are necessarily anti-growth. They recoil from the idea
that a central bank would cause companies to fail and unemployment to rise
for even the briefest time. Despite their fears, it is clear empirically,
theoretically, and politically, that restructuring raises the IS curve.
The empirical evidence is scant. However, in Texas during the depths of
the S&L crisis, once restructuring got underway and companies were closed
down and their assets sold, growth and job creation got underway. Figures
11 and 12 show how Texas GDP and job growth exceeded US growth once
restructuring got underway.
21
Once a building or other business went from
debt-strapped owners who could do nothing with it, to new owners who
could, there were jobs for masons, carpenters, painters, builders, lawyers,
accountants, and other goods and services providers of every kind. Yes, the
old owners and employees became unemployed, but they were effectively
unemployed anyway and soon they were re-employed in gainful work for
which they and their families could feel proud, energized and optimistic.
When restructuring gets underway, economic life gets underway again too.
As we suggested in the IS-LM discussion in Section II, if a country is in a
liquidity trap and nominal rates are near zero, the natural real rate of
interest is negative: the return on capital in the economy is negative, and
there is too much savings and too little investment. If in addition there is a
structural trap perpetuated by political resistance, then the natural rate of
interest is even more negative the IS curve has shifted even further to the
left.
The traditional advice would be: create ination expectations that are high
enough to make real rates as negative as necessary to clear the I/S balance. If
a structural trap is present, the conclusion is that the ination necessary to
clear the IS balance is even higher.
The presence of a structural trap not only makes the traditional solution
harder (need higher ination), it may make it impossible absent a currency
crash. The reason is, the nature of a structural trap is such that it makes the
creation of credible ination expectations impossible. Deation is the result
of massive excess capacity, and economic agents know this. Unless the
excess capacity is eliminated, no credible ination expectation can be
created. Extreme monetary ease without excess capacity reduction perpe-
tuates deation, because it prevents restructuring from happening.
But there is an alternative solution: restructure the economy so that the
natural rate of interest becomes positive. If the excess capacity that is
perpetuating deation is eliminated, and if the reasons for oversaving (for
example, the distrust in the political system) are eliminated, then a given
21
Federal Reserve Bank of Dallas, Financial Industry Studies Department.
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Robert H. Dugger and Angel Ubide 110
interest rate will produce less saving and more investment, shifting the IS
curve upwards.
How could this be achieved? Two options: (1) a comprehensive govern-
ment programme that, through the cleaning up the banking sector, also
Figure 11: Texas Economic Growth and Failed-Institution Resolution Activity
Figure 12: Texas Job Growth and Failed-Institution Resolution Activity
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Structural Traps, Politics and Monetary Policy 111
cleans up the corporate sector, or (2) higher nominal interest rates. The very
nature of the structural trap makes the rst option impossible, for it would
amount to a collective suicide of the political establishment. The only
alternative is option (2) through the actions of an independent central
bank that is not itself entrapped and that reects the true preferences of the
median voter. This would be particularly true in the Japanese case, where the
voting distribution in the Diet is heavily biased in favour of rural and older
voters.
Increasing nominal interest rates would eliminate inefcient rms and
trigger a process of creative destruction that would lead to an increase in the
natural rate of return. The IS curve would shift upwards as a result of the
increase in nominal rates, and would eventually return the economy to a
normal state with positive rates of return. It is important to understand that
the process of evergreening (rolling over loans so that zombie companies are
kept alive) and the zero interest rate policy are mutually reinforcing: banks
are saddled with bad loans while the at yield curve prevents them from
making money in their intermediation activity. Thus banks cannot afford to
call the bad loans and record the loss, for they do not have capital to absorb
that loss. A rate hike that would steepen the yield curve could provide banks
with a stream of prots that could change the incentive structure and reduce
the propensity to evergreen loans, thus contributing to the process of
creative destruction.
Thus, the restructuring solution is similar to the standard one: the IS curve
has to shift upwards. But the way of achieving it is paradoxical: no
conventional scal expansion, no extreme monetary loosening, rather a
monetary posture that allows the deep parameters of the economy to change
and put the economy back into a productive mode.
Liquidationism vs Restructionism
Condemnations of policies that encourage creative destruction often begin
by calling the policies liquidationist a reference to Andrew Mellons
approach to addressing the 1930s depression in the USA. Liquidationism
and Says Law have much in common. Both assume that markets clear
frictionlessly thus supply creates its own demand. Says error and the
liquidationist error are the same. Markets, especially labour markets, do not
clear frictionlessly, and that is both the central problem and the reason scal
and monetary policy have stabilization roles.
Liquidationism as a policy recommendation is clearly awed. This does
not mean however that policies that encourage creative destruction are
awed. The idea that economic health involves the presence of an ongoing
creative destruction process is orthodoxy. No one raises and eyebrow at
recommendations to raise rates to moderate asset bubble growth and
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Robert H. Dugger and Angel Ubide 112
prevent or minimize post-bubble deationary pressures. They reason they
do not is because it is entirely orthodox to allow or encourage a bit more
creative destruction as a way to prevent the damaging crash and ensuing
deation if the bubble were allowed to expand to its bursting point.
The issue is degree. Extreme creative destruction, or liquidationism,
makes no policy sense. However, some creative destruction is necessary
for economic health. The problem Japan faced was an insufcient amount of
creative destruction to enable it to recover. Hence, policies that encourage
the reallocation of capital from low return to high return uses were needed.
The obstacles were political old sector political interests were successful in
opposing needed economic restructuring. Solutions lay in approaches out-
side conventional scal expansion and extreme monetary easing.
BOJ in 2000
The possibility that extreme monetary easing could delay needed capital
reallocation and recovery was an important component of the Bank of
Japans decision in mid-2000 to raise its administered rate to 25 basis points.
BOJ Governor Hayami said publicly, risk should be priced that is,
businesses should not be able to get credit for nothing. Governor Hayamis
intent was clear: businesses that cannot pay a minimal interest rate should be
allowed to fail and the real and human capital employed by them should be
reallocated to higher-return uses. The rate hike, however, was a failure. A
return of economic weakness, evident in data one month after the rate
increase, triggered thunderous criticism from Japanese parliamentarians
who claimed the downturn was the result of the hike. Some supporters of
Hayamis approach of pricing very weak businesses out of the market saw
the downturn as an expected effect of increased market efciency. This was a
decidedly minority view, however; and under pressure from nearly every
source, the Bank of Japan returned to the zero rate policy and in time
broadened it into the most aggressive quantitative easing policy seen in
modern times.
Now, four years later there is virtually no one who disagrees with the view
that Japans economic performance is due to structural problems of the most
profound sort. The new management of the Bank of Japan has nally
implemented the extreme easing measures advocated by the reationist
school. Base money has increased massively, but broad liquidity and bank
lending remain at record lows after two years of massive monetary
expansion. The multiplier, the key to gauge the success in Japan, has not
recovered. Japans economy is recovering on the heels of the Chinese boom,
but the jury is still out as to whether reation without reform can return
Japan to a sustainable growth path.
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Structural Traps, Politics and Monetary Policy 113
Reation, Restructuring, and Currency Depreciation
This paper starts the discussion by saying that there are two points of view
reation and restructuring. Before concluding we need to point out that the
two points of view converge in a very important way. A rise in nominal
interest rates can be achieved in two ways. The central bank can keep its
administered rate at a sufciently positive level to generate a steady rate of
creative destruction or the central bank can pursue ultra-extreme easing.
An ultra-extreme policy seeks to create ination expectations either directly
(causing savers to ee their bank deposits and government bonds in favour
of durable goods and commodities) or indirectly through a major currency
weakening (causing savers to ee their own capital markets in favour of
foreign currencies and investments).
Most reationists are honest enough to point out that signicant currency
weakening is a major goal of their ultra-extreme policy recommendations.
And, some restructionists advocate ultra-extreme easing because they
believe the resulting capital ight is the only way to obtain the nominal
interest rate increases they believe are necessary. The remaining difference
between the two views is faith in government policy. Reationists have faith
they seem to believe that maybe people will spend their savings and the
government will implement reforms before the capital ight sets in.
Restructionists for the most part have given up hope that the government
will respond. For them, ultra-extreme policies have merit only if they result
in market-driven restructuring.
We object to ultra-extreme easing because it risks a currency collapse that
transfers restructuring costs to other economies. Other countries may be
willing and able to absorb the costs, but rst we need to make sure. An open
discussion among all affected economies should be open about the costs of
restructuring and if and how they should be shared.
V. Conclusion
What should a central bank do about a structural trap? The standard recipe,
extreme easing, is based on a false belief that pushing on a string with no
result means a country is in a liquidity trap. But, as we have explained in this
paper, the critical difference between a liquidity trap and a structural trap is
the political inability of the government to allow capital reallocation to
restructure the supply side of the economy, not a lack of demand per se.
Unless the production structure of the economy changes, and excess
capacity is eliminated, deation will persist. Faced with this scenario, an
independent central bank with a price stability mandate should adopt a
monetary policy stance consistent with restructuring. If political resistance is
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Robert H. Dugger and Angel Ubide 114
great, monetary policy decision makers will need to keep nominal rates high
enough to assure that capital reallocation takes place at an acceptable pace.
When central bankers face a structural trap, they have to act on the fact
that their responsibilities and appointments by statute intentionally span
many election cycles. They must do what politicians cannot do and look
beyond the next election cycle, in fact beyond many election cycles, and not
let resistance determine outcomes. Legislatures are designed to be inef-
cient. Central banks should not be.
Robert H Dugger and Angel Ubide
Tudor Investment Corporation
800 Connecticut Avenue, Suite 810
Washington DC 20006
USA
Robert.dugger@tudor.com and angel.ubide@tudor.com
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