Monetary policy and overinvestment in East Asia and Europe


The paper analyzes the role of monetary policy for cyclical movements of investment and asset markets in East Asia and Europe based on a Mises-Hayek overinvestment framework. It is shown how the gradual global decline of interest rates has triggered wandering overinvestment cycles in Japan, Southeast Asia, and China. Similarly, it is shown how a one-size monetary policy within the European Monetary Union has not preserved the European Monetary Union from idiosyncratic economic development and crisis because of uncoordinated fiscal policies. With monetary policy crisis management being argued to impede financial and economic restructuring, a timely exit from ultra-expansionary monetary policies is recommended for both East Asia and Europe to reconstitute economic stability and growth.

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  1. 1.

    This would be regarded by Hayek (1974) as “pretence of knowledge.”

  2. 2.

    Hayek (1929) and Wicksell (1898) had different concepts of the natural interest rate. According to Wicksell (1898), the deviation of the central bank and capital market interest rates from the natural rate of interest disturbs the equilibrium between ex-ante savings (S) and investment (I) plans. This leads to inflation (I > S) or deflation (S > I). Hayek (1929) explained the natural interest rate as the interest rate which aligns saving and consumption preferences with the production structure over time. In contrast, Woodford (2003) defines the natural rate of interest as the real interest rate that prevails if output is equal to its steady state value given fully flexible prices. This implies that in the Woodford setting the natural interest rate can be negative, for instance if saving structurally increases, while investment structurally declines. In the view of Mises (1912) and Hayek (1929), the natural rate (albeit empirically unknown) has to be positive, because it reflects time preferences in consumption, which is assumed to be positive for human beings.

  3. 3.

    In the dynamic stochastic general equilibrium models (Woodford 2003, Galí 2008), time-dependent asymmetric policy action is excluded by assumption.

  4. 4.

    In addition, the liberalization of capital markets and the resulting erosion of bank-based lending are identified as important reasons for the bubble economy.

  5. 5.

    The Japanese current account balance as the target of the yen appreciation remained more or less unchanged, because not only exports but also imports declined (McKinnon and Ohno 1997). Therefore, Japan was urged to stimulate the domestic economy via fiscal expansion to reduce the current account surplus via the import channel (Funabashi 1989).

  6. 6.

    The five Southeast Asian countries have all individual country-specific characteristics. Nevertheless, they have similar structural similarities with respect to the pre-crisis build-up of vulnerabilities and the course of the crisis. This is also acknowledged by the literature (see, e.g., Corsetti et al. 1999).

  7. 7.

    From the mid-1990s, the depreciation of the Japanese yen had started to undermine the competitiveness of the exports of the Southeast Asian countries to Japan and in third markets such as the USA and Europe.

  8. 8.

    Therefore, China’s move towards a gradual appreciation path after July 2005 up to the year 2014, with a major interruption between July 2010 and July 2012, is an important determinant of this overinvestment boom.

  9. 9.

    The window guidance (madoguchi shidô) was a way of allocating credit during the catch-up process of Japan. It allowed a preferential treatment of specific sectors and enterprises such as the automobile industry (Hamada and Horiuchi 1987, pp. 244–246).

  10. 10.

    The resulting increase in capacities could ceteris paribus not be fully absorbed by domestic demand. By keeping the price level of Chinese manufacturing products low via sterilization policies cum low cost-credit provision, the real exchange rate of the Chinese yuan was kept undervalued. This helped to clear the overcapacities in the international markets (McKinnon and Schnabl 2012).

  11. 11.

    The scale of the new Japanese overinvestment and speculation boom is, however, substantially smaller than in the second half of the 1980s despite the much larger scale of monetary expansion (see Fig. 3).

  12. 12.

    In some countries such as Ireland and Spain, fast-growing tax revenues generated government surpluses despite fast-growing expenditures. This implies that the Maastricht deficit criterion did not fulfill its information function concerning unsustainable government expenditure.

  13. 13.

    After the introduction of the euro also, the general government budget deficit increased beyond the −3% of GDP Maastricht limit, as the reforms slowed down growth and thereby reduced tax revenues.

  14. 14.

    The main financing rate was set below the Taylor rate for the whole euro area, whereas for Germany, the main refinancing rate remained above the Taylor rate (see Schnabl 2017).

  15. 15.

    As the reduction of future pensions was paired with incentives for private provisions for retirement, savings of households increased. In addition, growing demand for German export products contributed to higher profits of enterprises and thereby enterprise savings. The resulting dramatic rise of aggregate savings over investment contributed to the significant rise in capital outflows, which finances purchases of German products.

  16. 16.

    Also, many central and eastern European countries, Iceland, the UK, and the USA, became target destinations of large capital inflows originating in Germany.

  17. 17.

    The Mises-Hayek-based interpretation of the boom in the southern and western European later crisis countries is opposed (or complementary) to the widely accepted convergence scenario which attributes the declining interest rates in the later crisis countries to their entry to the European Monetary Union (which made interest rates converge) (see Sinn and Wollmershäuser 2012). The convergence hypothesis neglects, however, the fact that similar booms took place in non-euro area countries such as the Baltic countries, Iceland, and the USA.

  18. 18.

    Therefore, the share of Germans living in their own flat or house is small compared to southern European countries, where inflation has been traditionally high.

  19. 19.

    Like in the current crisis countries prior to the crisis, now in Germany tax revenues are inflated.


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Schnabl, G. Monetary policy and overinvestment in East Asia and Europe. Asia Eur J 15, 445–462 (2017).

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