The Post-Crisis World:
Evolution of the Economy, Economics, and Central Banks
Keynote Speech at "Nippon no Kakushin-ryoku" (Japan's Innovation) Symposium
Co-hosted by the Faculty of Economics, Keio University and Nikkei Inc.
Masazumi Wakatabe
Deputy Governor of the Bank of Japan
Introduction
It is my pleasure to speak here today at Keio University. As an alumnus and former
professor at Waseda University, an opportunity like this, given the longstanding fruitful
relationship between the two schools, is a great honor. Yukichi Fukuzawa, founder of Keio
University, Shigenobu Okuma, founder of Waseda University, and the Bank of Japan share
a long and intimate history together. The fact that Fukuzawa and Okuma were close friends
is a famous story. During the Meiji Restoration, Okuma sought to lead reforms with the
support of Keio's alumni but failed, only to be expelled from the government -- an incident
later known as the failed Meiji-14 coup of 1881. In the following year, Okuma, emulating
his friend Fukuzawa, built a school, which served as the predecessor of Waseda University.
The Bank of Japan was established that very same year. Truth be told, Okuma, back when
he was still a member of the government, proposed a plan for building Japan's first central
bank (Bank of Japan [1982], pp.77-79). Although his plan was rejected, it is not far-fetched
to consider part of his proposal as having been reflected in the Bank of Japan's charter in the
form of liquidity provision.
This year marks about 20 years since Japan's financial crisis and the 10th anniversary of the
Global Financial Crisis triggered by the collapse of Lehman Brothers. Milestones provide
us with ample opportunity to look back on the past.
In my speech today, I will begin with an overview of significant changes observed in
economic society today. I will then discuss the evolution of economics and the role of
central banks. My message to you is threefold: first, change holds the key; second, it is
important that we update our knowledge in response to change; and third, understanding the
basics is essential regardless of -- or because of -- changes.
I. Progress for Humankind and Challenges Ahead
Before reflecting on Japan's financial crisis of about two decades ago and the Global
Financial Crisis one decade ago, let me provide the even longer-term perspective of
centuries ago. As the saying goes, "no news is good news" -- people tend to focus on
unfavorable news including controversial incidents and natural disasters. In the long run,
however, humankind has been making steady progress. The 17th century philosopher
Thomas Hobbes once wrote, in his renowned work Leviathan, that "the natural condition of
mankind" was "solitary, poore [sic], nasty, brutish, and short" (Hobbes [1651], Chart 1). The
situation has changed drastically since then. There has been a dramatic reduction in wars,
violence, famine, and diseases, and people live longer so that it is now considered
reasonable to expect to live for 100 years. Poverty, although persistent, is on a declining
trend from a long-term perspective (Norberg [2017]; Pinker [2011, 2018], Chart 2).
What is the driving force behind these changes? First on the list are the effects of
Enlightenment-based thought since the time of Hobbes as well as the development,
accumulation, and spread of scientific knowledge. Economists in the 18th century such as
David Hume and Adam Smith made notable contributions in these areas.
Second, the market economy plays a considerable role in the development, accumulation,
and spread of such Enlightenment-based thought and scientific knowledge. The so-called
globalization has encouraged not only the exchange of goods and money but also the
interaction between people and the sharing of knowledge. We tend to assume that, in a
market economy, human relationships become cold and impersonal, based solely on
profit-seeking motives, and people become overly dependent on the market. In reality,
however, human motivation is complicated and diverse. The market economy in fact allows
for the coexistence of various motives as long as a certain level of profit is raised. Moreover,
mutual trust among people is indispensable for markets to function properly (Seabright
[2010]), and further, individuals become capable of supporting themselves through market
participation (Matsui [2018]). These insights are the very line of thinking that had been held
by distinguished economists in previous times, such as Hume and Smith.1 Globalization too
1
In his "Of Refinement in the Arts," Hume [1987] argues that industry and refinements in
mechanical arts would sophisticate the arts and science and humanity, stating "industry, knowledge,
and humanity, are linked together by an indissoluble chain" (p.271): "The more these refined arts
advance, the more sociable men become...They flock into cities; love to receive and communicate
knowledge; to show their wit or their breeding; their taste in conversation or living, in clothes or
furniture...and the tempers of men, as well as their behaviour, refine apace."
In his "History of Astronomy," Smith [1980] traces the origins of philosophical and scientific
thinking to the stability of social life: "Mankind, in the first ages of society, before the establishment
of law, order, and security, have little curiosity to find out those hidden chains of events which bind
when law has established order and
together the seemingly disjointed appearances of nature...But
often is associated only with the cross-border flow of goods and money, but it is the
cross-border exchange of knowledge among countless people all over the world that enables
us to create new knowledge atop what already has been built and to enjoy the benefits of
our lives today.
Having said this, we must not presume that the future is nothing more than simply
something that lies in front of us. In the short run, there is an extensive list of issues on our
agenda waiting to be tackled. Progress is in fact the by-product of unwavering efforts made
by humankind in order to address challenges confronted at each point in time. Put
differently, failing to keep up with these efforts will result in stagnation, or even worse,
retreat. Indeed, a wide range of issues, such as macroeconomic policy, stagnating
productivity growth, the impact of robotics and machine learning on employment,
environmental problems including climate change, income and wealth inequality, and the
rise of protectionism and the so-called populism, appear to have piled up. Although Japan's
economy is no longer in deflation, many people faced economic difficulties during the
period of prolonged deflation up until several years ago.
Financial crises are one such issue. While the market economy is built upon mutual human
trust, money -- the foundation of economic transactions therein -- is also dependent on trust.
Intrinsically, circulation of money requires social trust; individuals must have the
confidence that money will be accepted by a third party. A free and abundant flow of money
leads to economic growth through active exchanges and transactions. For example,
economic growth in emerging economies has been supported by global capital inflows. At
times, however, such flow of money triggers problems. When capital inflows tie in with
overly optimistic growth expectations, this may cause asset prices such as land prices and
stock prices to rise excessively and, ultimately, the asset price bubble to burst. In a time of
an abrupt reversal in global capital flows, countries experiencing capital outflows may be
forced to undergo large-scale economic adjustments. Furthermore, while developments in
financial products brought the benefits of providing greater options for asset management,
they also catalyzed the contagion of financial crises worldwide, as seen during the Global
Financial Crisis of 2008. The prolonged economic stagnation that followed amplified
people's doubts about globalization and the market economy itself.2
In addition, the data revolution, while significantly enhancing information sharing and
utilization, has led to the rise of a small number of big tech companies making full use of
data. This has caused voiced concerns about the increasing market power of such firms,
their effects on income and wealth inequality, and protection of privacy.3 What is more,
digitalization is increasing the perceived threat of cyber-attacks so significantly that some
claim that the next potential financial crisis could well be triggered by cyber-attacks on
global financial institutions.
II. Evolution of Economics
I would now like to talk about how an ever-changing economy leads to the evolution of
economics.
Let me introduce a satirical article about economists published in 1973. The article entitled
"Life among the Econ" was written in the style of an anthropologist's study on a tribe of
economists called the "Econ" (Leijonhufvud [1973]).4 In this article, the Econ live in the
far north and the status of the members is determined by their skill in making elaborated
"modls" (taken from "model" used in economics) of their "field" of study. But "most of
these 'modls' seem to be of little or no practical use." As for the "field" of study, the
"Math-Econ" is considered as ranking higher than the "Devlops," where Math-Econ and
Devlops respectively refer to scholars of mathematical economics and development
economics. The Devlops are ranked lower because they interact with other tribes such as the
Polscis (political scientists) and Sociogs (sociologists), and are suspected of having given
up modl-making. The article concludes, "The prospect for the Econ is bleak. Their social
structure and culture should be studied now before it is gone forever." It warns of the
situation of economics at the time, where economists were too focused on making
unrealistic "modls" and reluctant to collaborate with those outside the field of economics.
Notwithstanding whether such satire was on point at that time, the days in which it can be
applied are over. Nowadays, economic research has become increasingly founded on
empirical work and data science, along with the increase in computing power, spread of the
Internet, accumulation of and increase in data, and development of econometric techniques
(Hamermesh [2013]; Angrist et al. [2017], Chart 3). Data science methodology has been
adopted actively not only in economics, but also in social sciences in general and in some
fields of humanities. Through the sharing of methodologies, interaction of economics with
other fields of study is being accelerated.
This is not to say that economic theory has become extinct, however. In fact, there is now
greater variety to economic theory, as seen in the rise and establishment of game theory and
behavioral economics. We should say that the share of purely theoretical papers in
economics has decreased. What came of this was the rise in popularity of so-called applied
work (Backhouse and Cherrier [2017]).
With the development of economics acquiring a new character of data science and applied
science, the areas to which economics is applied have been expanding.
The first is applications to policy making. The term "evidence-based policy making," or
EBPM, has finally started to prevail in Japan, and the government is promoting EBPM as
part of its administrative reform. This is a movement that requires appropriate empirical
evidence in policy making. "The cost-benefit revolution" (Sunstein [2018]) is under way, in
which a balancing of costs and benefits based on empirical evidence is made use of in
policy making. Specifically, economics has been applied in the context of deregulation and
market designs such as spectrum auction and medical resident matching programs, for
example, which have started to prove successful (McMillan [2002]; Backhouse [2010];
Siegfried [2010]; Litan [2014]).
Second, economics has become a common language among policymakers. Without an
understanding of economics at the very least, you will have difficulty in communication,
especially at meetings of the Group of 20 (G-20), central banks, and international
organizations such as the World Bank and the International Monetary Fund (IMF).5
Third, economists are now working more in collaboration with other disciplines, and
engaging in research and education outside economics departments, especially in business
schools, law schools, and public policy schools. Economists also play an important role at
big tech companies (Chart 4). For example, it is said that the latest auction theory is applied
when online advertising space is sold (Athey and Luca [2018]).
In sum, economics has become increasingly empirical and useful in a practical manner.
Economists have been tackling the aforementioned issues facing humankind. However, this
does not mean that there are no issues to be addressed in economics itself.
In particular, the outbreak of the Global Financial Crisis in 2008 posed significant
challenges to economists. It is reported that, when Queen Elizabeth II visited the London
School of Economics and Political Science (LSE) in November 2008, she asked economists
regarding the turmoil in global financial markets: "Why did nobody notice it?" The
economists were not ready to comment.6
We have to admit that the outbreak of financial crises is essentially a very difficult issue to
address, and predicting it is a more difficult task. Also, as behavioral economics shows,
economists may sometimes have biases or make mistakes as humans.7 This does not mean,
however, that the insights gained in economics have become useless. Academic studies
progress as we learn from past experiences, including failures. The accumulation of such
processes leads to the selection of our knowledge; that is, our knowledge of economics is
constantly being upgraded. What you learn from textbooks is a result of this selection
process, forming the basic framework of the current economics. This holds great
significance in your lives, to which I will return later when I talk about financial and
economic education.
III. Changing Role of Central Banks
Central banks, operating at the intersection between the changing economy and economics,
have a long history toward becoming what they are today. In fact, the concept of central
banks itself has been shaped by history. Sweden's Riksbank was established in 1668, earliest
among currently existing central banks, but it originally differed from central banks we are
familiar with today, in that the institution's function included extending loans to the Crown
to finance war (Chart 5). Central banks have changed, evolving in a process of humankind
tackling economic problems that occurred thereafter, such as large price fluctuations and
financial crises (Edvinsson et al. [2018]). In the course of this evolution, a number of
contributions have been made by economists, from Henry Thornton, David Ricardo, Walter
Bagehot, Irving Fisher, John Maynard Keynes, and Milton Friedman to those today.
Having assumed my current position at the Bank of Japan, I am now better aware of the
wide-ranging roles that central banks play today (Chart 6). The Bank of Japan Act stipulates
that the Bank's purpose is to achieve price stability and maintain financial system stability,
thereby contributing to the sound development of the national economy. To achieve this, the
Bank engages in a wide range of operations, such as issuing banknotes, conducting on-site
examinations and off-site monitoring of financial institutions, operation of payment and
settlement systems, and coordinating with international organizations. Needless to say,
conducting research and studies through the application of economics also constitutes an
important central bank operation. At this point, I will briefly explain how the Bank has
responded to the two trends of the data revolution and globalization.
Starting with the data revolution, electronic payments have become increasingly common in
recent years. Although the so-called cryptocurrency is termed crypto-assets among central
banks, partly because of its highly speculative nature, cashless payments using, for example,
credit cards, electronic money, and QR codes have continued to increase. Central banks
have been paying close attention to these developments, as payment and settlement systems
are crucial infrastructures. Some central banks have begun research and deliberation on the
issuance of a central bank digital currency.8 In relation to the data revolution, economic
statistics play a significant role. Accurate real-time data are desired since it is required that
policy decisions, especially by central banks, be made swiftly based on data available at the
time (Nishimura [2012]).
With regard to globalization, not only financial and economic activities, but also knowledge
pertaining to policy conduct is becoming increasingly globalized through dialogue and
cooperation among central banks. Japan's financial crisis from 1997 to 1998 -- preceding
the Global Financial Crisis of 2008 that I mentioned earlier -- has been studied by central
banks all over the world as a lesson to be learned (Chart 7). In particular, the fact that Japan,
the world's second-largest economy at the time, experienced entrenched deflation and
prolonged stagnation after the crisis drew the attention of policymakers and economists
worldwide.
Let me sum up the lessons learned from Japan's experience. First, it has become clear that
an excessive rise in asset prices above fundamentals -- the emergence of the bubble
economy -- and its collapse triggering a financial crisis will exert a considerable negative
impact on the economy. Second, there are still discussions, however, regarding whether to
tighten monetary policy as a pre-emptive measure against a rise in asset prices. Although we
should not ignore asset price fluctuations completely, taking a strong measure to burst the
bubble could push the economy into a serious recession. Third, in the event of a financial
crisis, ex post policy response becomes extremely important. As downward pressure is
exerted on the economy in the wake of the crisis, it will be necessary to respond with
vigorous expansionary macroeconomic policies. If the response is inadequate or delayed,
the economy will fall into deflation and face difficulty escaping from it. Fourth, regarding a
financial crisis, however, there is no better way than to prevent it. In doing so, ex ante and
ex post financial regulation -- monitoring excessive risk-taking behavior of financial
institutions and setting up a resolution mechanism -- as well as macroprudential policy --
analyzing and assessing systemic risk in the financial system as a whole and taking policy
measures based on it -- play key roles (Wakatabe [2015], pp.142-147).
Regrettably, after Japan's financial crisis, policymakers across the globe could not prevent
the Global Financial Crisis. They did, however, succeed in preventing another Great
Depression by taking swift and bold policy responses after the crisis.9 For example, central
banks with inflation targets managed to keep their economies from falling into severe
deflation even after the crisis.10 Moreover, financial authorities including central banks
have proceeded globally with the development of financial regulations, so as not to repeat a
disaster like the Global Financial Crisis ever again. Through these efforts, in an
ever-changing economy, central banks must be vigilant and prepared for possible future
financial crises at all times.
IV. Promotion of Financial and Economic Education
Putting all this in perspective, we could gain a good sense of the most desirable qualities
and skills of people working in the financial industry. Let me start with simple examples. As
the data revolution proceeds, there likely will be greater demand for those educated in
9
Kuttner, Iwaisako, and Posen [2015] point out, "Although the United States and many European
countries were also hit hard by the collapse of the housing market in the late 2000s, most responded
decisively, partly because policymakers in those countries were determined not to repeat Japan's
experience in the 1990s" (pp.31-32).
10
Some economists argue that, if the 2 percent inflation target had been set in Japan during the
1990s, the subsequent deflation would not have occurred (Braun and Waki [2006]). However, since
the rate of growth in total factor productivity also declined during the so-called lost two decades in
Japan, it is also possible to say that there were problems on the supply side as well as on the demand
side. The past recession possibly had lasting negative effects on productivity growth of the economy.
The Bank of Japan has great interest in the mutual relationship between business cycles and
economic growth, on which research has been progressing recently. See the Bank of Japan Research
and Statistics Department [2018] and Kaihatsu et al. [2018].
science, technology, engineering, and mathematics -- the so-called STEM education. On a
similar note, globalization will naturally raise demand for those with a strong command of
English as a communication tool. Society as a whole, including the government, should
work toward better education and research in these areas. I personally believe that the
biggest advantage to learning English is that it enables you to learn about the world and
reminds you to not end up as a "frog in the well that knows nothing of the great ocean" -- a
Japanese proverb that describes a person who measures things only within his or her own
world. In relation to learning about the world, I would like to remind you that the economy
and economics have been changing significantly. Given this, education about the underlying
mechanism of society and the economy will only grow in importance, so as to help students
develop the capability to sense and understand such changes properly.
For the financial industry to recruit qualified talents, the key lies in whether they can
effectively demonstrate the advantages of working in the industry, since those with the
qualities I have just mentioned are in high demand across industries.
Whether or not you work in the financial industry, financial and economic literacy is
necessary for everyone. In this connection, let me introduce the Central Council for
Financial Services Information (CCFSI), an organization with the two main objectives of
(1) providing financial and economic information to the general public and (2) supporting
financial and economic education (Chart 8).11 Its secretariat office is located within the
Bank of Japan's Head Office; as Deputy Governor of the Bank, I serve concurrently as a
member of the CCFSI. The council, originally the Central Council for Savings Promotion,
subsequently was reorganized as the Central Council for Savings Information and renamed
as the CCFSI in 2001.
Especially today, when it is reasonable to expect to live for 100 years, asset formation is
gaining more and more importance. Here is a set of questions relating to financial and
economic literacy in this regard (Chart 9). I think that some of you here today are currently
studying economics. For those who have taken an introductory course in economics, this
should be a piece of cake -- at least, I believe so. Take question 1, for example. This
involves compound interest calculation. Compound interest calculation is a method in
which interest is added to the principal sum so that interest for the following period is then
earned on the principal sum plus the previously accumulated interest. With this knowledge,
you may see that one would be better off starting asset building from an early stage in life
and refraining from short-term transactions based on rash decisions. Let us next take
question 4. This teaches you the importance of diversifying your investment portfolio.
Diversifying rather than concentrating your portfolio allows you to control a certain kind of
risk. By combining these two ideas, you will find an asset formation plan of investing
steadily in a diversified portfolio from a long-run perspective. Basic knowledge of
economics is indeed useful, but there still seems room for improvement in financial and
economic literacy in Japan: The percentage of correct answers to these kinds of questions is
lower than those in the United States and European countries (Chart 10). Furthermore,
consumer fraud is being carried out recently in extremely artful ways, and an understanding
of economics is also helpful in determining the factors behind such fraud to seek preventive
measures against it (Fukuhara [2017]).12
Conclusion
Today, I have elaborated on the respective changes in the economy, economics, and central
banks. What they have in common are structural changes of the data revolution and
globalization. You cannot avoid these changes even by choosing a STEM career. According
to the findings of research conducted in the United States, compensation is high at the
outset of a STEM career; however, because rapid technological change leads to skill
obsolescence, there are many cases where wages of STEM workers start to level off at a
certain point and they switch jobs early on their career (Deming and Noray [2018]). Even if
you choose a different career, the basic knowledge I have described using the financial and
economic literacy questions will still be necessary, given that you may live for 100 years.
Whether or not you seek a career in the financial industry, you are required to have the
motivation and curiosity to regularly update your knowledge in response to change.
In concluding, let me share with you a quote from Julian Simon, an economist (Chart 11):
The main fuel to speed the world's progress is our stock of knowledge; the brakes
are our lack of imagination and unsound social regulations of these activities. The
ultimate resource is people -- especially skilled, spirited, and hopeful young people
endowed with liberty -- who will exert their wills and imaginations for their own
benefits, and so inevitably they will benefit the rest of us as well (Simon [1995],
p.27).
Thank you for your kind attention.
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The Post-Crisis World:
Evolution of the Economy, Economics, and Central Banks
Keynote Speech at "Nippon no Kakushin-ryoku" (Japan's Innovation) Symposium
October 25, 2018
Masazumi Wakatabe
Deputy Governor of the Bank of Japan
(Chart 1)
Leviathan (1651)
Thomas Hobbes (1588-1679)
"the life of man, solitary, poore [sic],
nasty, brutish, and short"
Progress for Humankind
Life Expectancy World Population in Extreme Poverty
(bil.)
(years)
90 8
World
7
80 Total population
Europe
6
70
Americas Population living in extreme poverty
5
Asia
60
Africa
4
50
3
40
2
30
1
0
20
1820 1850 1880 1910 1940 1970 2000
1760 1800 1840 1880 1920 1960 2000
CY CY
Source: Our World in Da