The views expressed in this presentation are the views of the author and do not necessarily reflect the

views or policies of the Asian Development Bank Institute (ADBI), the

Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and
accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.

University of Leipzig
Institute for Economic Policy
Prof. Dr. Gunther Schnabl
Ultra-Low Interest Rates and Growth in Emerging
East Asia from a Hayekian Perspective
ADBI 19th Annual Conference
, 2nd December 2016

December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 1
 Table of Contents
1. Introduction
2. A Mises-Hayek Framework for Closed and Open Economies
3. Boom-and-Bust-Cycles in Emerging East Asia
4. Growth and Redistribution Effects of Crisis Therapy
5. Economic Policy Implications

Schnabl, Gunther 2016: Exchange Rate Rate Regime, Financial

Market Bubbles and Long-term Growth in China: Lessons from
Japan. CESifo Working Paper 5902. Forthcoming in China & World
Economy 25, 1.
Hoffmann, Andreas / Schnabl, Gunther 2016: Monetary Policy in
Large Industrialized Countries, Emerging Market Credit Cycles,
and Feedback Effects. Journal of Policy Modeling 38, 3, 1-19.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 2
 1. Introduction
In their classic study of U.S. monetary history, Friedman and
Schwartz (1963) presented a monetarist interpretation of these
observations, arguing that the main lines of causation ran from monetary
contractionthe result of poor policymaking and continuing crisis in
the banking systemto declining prices and output." (Bernanke
1995, 3) "You're right, we did it. We're very sorry. But thanks to you,
we won't do it again." (Bernanke 2002)

"To combat the depression by a forced credit expansion is to attempt to

cure the evil by the very means which brought it about. (Hayek 1933,
20)

"If (...) voluntary decisions of individuals are distorted by the creation of

artificial demand, it must mean that part of the available resources is
again led into a wrong direction and a definite and lasting adjustment is
again postponed. (Hayek 1931, 98)
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 3
1. A Mises-Hayek Framework for Closed Economies:
Upswing
Starting points: Innovation (Schumpter, Hayek), central bank mistakes
i Hayek), financial market competition (Hayek).
(Wicksell, Mises,
I2
I1 S

I2 > S2

in2 S2
in1 = icb1=ic1
positive interest margin
= icb2 = ic2 I2

I1 = S 1 I, S
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 4
 Downswing
Starting point: interest rate increase / changing mood of banks
i
I2
I3 S

negative interest margin

icb3=ic3
in3
I3

I, S
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 5
 The Global Trend in Prime Interest Rates (G3)
15
80
13 Nominal Real Japan

Percent of GDP
60 Euro Area
11
United States
40
9
Prozent p. a.

20
7
0
5 1980 1987 1994 2001 2008 2015

3
1
-1
-3
1980 1985 1990 1995 2000 2005 2010 2015
Source: IMF.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 6
 A Mises-Hayek Framework for Open Economies
International Capital Market Debtor
Creditor
(Center) (Periphery)

December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 7
 3. Boom-and-Bust-Cycles in Emerging East Asia
Pre-Asian Crisis Setting (Hoffmann and Schnabl 2008)
Bursting bubble in Japan leads to BoJ interest rate cuts (push).
Carry trades contribute to overinvestment booms in Southeast Asia.
Exchange rate pegs and self-fulfilling prophecies further encourage
capital inflows (pull).
Asset price bubbles, inflation and real appreciations path the way
towards crisis.
Triggers of the Asian Crisis (1997/98) and Consequences
Yen depreciation against the dollar (McKinnon and Schnabl 2003).
Increasing currency and maturity mismatches (Eichengreen and
Hausmann 1999) within an asymmetric world monetary system
(McKinnon and Schnabl 2004a,b).
Asian crisis triggers capital flight into the safe havens of the
industrialized countries.
Dotcom bubbles emerge, of which the bursting is the starting
point for further monetary expansion in the industrialized countries.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 8
 The Moderated China Bubble
Lessons Learned (?)
More exchange rate flexibility: gradual appreciations of East Asian
currencies (Fischer 1999).
Capital controls (China, Malaysia).
Sterilization of monetary effects of accelerated foreign exchange
interventions (Lffler, Schnabl and Schobert 2010).
State-directed capital allocation (China).
New Policy Mistakes
Predictable appreciation paths encourage additional speculative
capital inflows (McKinnon and Schnabl 2009).
Capital controls are allowed to be circumvented (redistribution
effects).
In China window guidance leads to overinvestment with
overcapacities being cleared via real exchange rate stabilization.
In China real estate market speculation encouraged by financial
repression via shadow banks.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 9
 Foreign Reserves of Emerging East Asia
6.5
6.0
5.5 Hong Kong
5.0 Taiwan
4.5 South Korea
4.0 Vietnam
USD Trillion

3.5 Thailand
3.0 Indonesia
2.5 Malaysia
2.0 Singapore
1.5 Philippines
1.0 China
0.5
0.0
1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Source: IMF.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 10
 Overinvestment Cycles in East Asia
0.36 0.50
0.34 0.45
0.32 0.40
Percent of GDP

0.30 0.35
0.28 0.30
0.26 Japan (l.h.s.) 0.25
0.24 Emerging East Asia (l.h.s.) 0.20
China (r.h.s.)
0.22 0.15
Vietnam (l.h.s.)
0.20 0.10
1980 1984 1988 1992 1996 2000 2004 2008 2012
Source: IMF.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 11
4. Growth and Redistribution Effects of Crisis Therapy
Expansionary Monetary Policy as Crisis Therapy
Stabilizes the financial sector and employment in the short term.
Has in the long-term negative effects on banks as credit-deposit
spreads as depressed (Yoshino and Taghizadeh-Hesary 2016).
Low-cost credit provision paralyses incentives for innovation and
productivity increases (Hayek 1944).
Low productivity growth is an unintended side effect of monetary
policy rescue measures (Sekine, Kobayashi and Saita 2003:
forbearance lending, Peek and Rosengreen 2005: evergreening, Caballero
et al. 2008: zombie firms, Kornai 1993: soft budget constraints).
Redistribution Effects
From poor to rich via asset prices and financial repression.
From young to old via nominal wage repression and real estate
prices.
Political destabilization due economic frustration.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 12
 Credit Growth in China and Japan
2000 2003 2006 2009 2012 2015 2018 2021 2024 2027 2030
1000 110

900 90

Trillion in Chinese Yuan

Trillion in Japanese Yen

800
70
700
Japan, l.h.s., lower axis 50
600
China, r.h.s., upper axis
500 30

400 10
1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015
Source: OECD, IWF.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 13
 Productivity Growth, G3 and China
12

10

8
Germany
6 Japan
United States
%

4 China

-2
1980 1985 1990 1995 2000 2005 2010 2015
Source: OECD, IWF.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 14
 5. Economic Policy Implications
Monetary Policy, Financial Exuberance and Distortions
"If (...) voluntary decisions of individuals are distorted by the creation of
artificial demand, it must mean that part of the available resources is again
led into a wrong direction and a definite and lasting adjustment is again
postponed. (Hayek 1931, 98)
"To combat the depression by a forced credit expansion is to attempt to cure
the evil by the very means which brought it about. (Hayek 1933, 20)
Monetary Policy and Sustained Economic Recovery
Expansionary monetary and fiscal policies (in combination with
tighter financial regulation) help to stabilize output and
employment in the short-term (Keynes 1936).
They paralyze, however, growth in the long term (Hayek 1937,
1944).
A lasting recovery can be only achieved if an exit from ultra-low
interest rates occurs, which requires international policy
coordination.
December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy 15
 Thank your very much for your attention!

December 2016 Prof. Dr. Gunther Schnabl, Institute for Economic Policy