Why do so many economists favor fiscal stimulus in Japan?
By Scott Sumner
It seems like hardly a week goes by without me running into another article suggesting that Japan needs to do fiscal stimulus. Today there’s one discussing the recommendations of Nobel Laureate Christopher Sims, using the “Fiscal Theory of the Price Level” (FTPL):
To revive Abenomics, he [Sims] calls for a co-ordination between monetary and fiscal policy to tackle Japan’s deflation problems and urges the Japanese government to declare that it will not raise the consumption tax in the future.
Now some may wonder why we need a new theory like the FTPL. Wouldn’t it be the same conclusion as an old Keynesian economics? There is a concept called “liquidity trap” where monetary becomes ineffective and fiscal policy would be effective when the interest rate reaches zero.
Well, yes and no. The conclusion may look similar, but the FTPL adds at least three new aspects to the old consensus.
First, the FTPL incorporates the role of expectations. What matters is not the current budget surplus or deficit, but the future path of budget surplus or deficit. In this regard, the government has to commit itself to run fiscal deficit to generate inflation.
Second, the FTPL negates the usual distinction between fiscal and monetary theory. This is a theory for a consolidated governance combining both the government and the central bank of a country.
I am perplexed by this, for a number of reasons:
1. Japan did exactly what Sims recommended from 1994 to 2012, and failed as miserably as a policy can possible fail. It combined the largest fiscal stimulus (in peacetime) that the world has ever seen—by far, with the worst performance for aggregate demand that the world has ever seen in a major country—by far. Indeed nominal GDP actually fell. That’s right, even in nominal terms aggregate income was lower in 2012 than in 1994. (The population increased over that period). Here is Japan’s net debt, blowing past Italy to be the highest for any major economy:
The debt ratio soared from 20% of GDP in 1994 to 140% of GDP in 2013. Some people would complain that you can’t just look at the actual debt or deficit; you need to look at the cyclically-adjusted figures. But in Japan’s case that won’t make much difference, except for the period around 2009, as its unemployment rate is only 3%. Japan has a secular growth problem, not a cyclical problem.
But it gets even worse, Japan has recently been doing better than before 2012, even though its fiscal policy has become more contractionary:
As I have argued, Abenomics has delivered some good results, especially in employment, and inflation rate has been higher than that before the launch of Abenomics. Prime Minister Abe likes to say that deflation is over for Japan, but it is still early to declare that.
Unfortunately I don’t have net debt data post-2013, but the gross debt ratio data shows that Japan’s fiscal policy has indeed become less expansionary under Abe. Debt is still rising, but at a slower rate:
This reflects the sales tax increase that Abe implemented. Notice that Japan’s gross debt has now reached an astounding 250% of GDP, far higher than even Greece (number two on the chart.) These are levels that economists used to view as being quite dangerous. Admittedly, the debt ratio is not currently a problem for Japan, as interest rates are quite low. But what if they rise in the future? Greece’s debt situation looked manageable, until it wasn’t.
Of course the other difference is that Japan has its own currency, and could inflate its debt away in an emergency. But should we be reassured by that?
In the end, my biggest problem with recommendations of fiscal stimulus for Japan is not that it will lead to bankruptcy, but rather that it simply makes no sense. Again:
1. They tried massive fiscal stimulus and it failed miserably.
2. When they cut back on stimulus after 2012 the economy did better. Most economists expect Japan to have about 1% inflation going forward. Prior to Abe they had mild deflation. NGDP has risen 9% since Abe took office. That’s not a lot for 3.75 years, but recall that Japan’s NGDP fell over the previous 19 years. And also recall that this 9% rise occurred during a period of falling population, whereas the previous decline occurred during a period of rising population.
3. Unemployment is 3% and falling, and Japanese companies complain they can’t find workers. Immigrants are being brought in to do menial jobs. Unlike the US, the Japanese economy has a high and rising labor force participation rate.
What am I missing here? I understand that Japanese interest rates are zero, but that’s been true for many years. Why do western economists expect a policy that failed for several decades, to suddenly start working? What happened to the view that governments should be responsible, and not push the debt/GDP ratio endlessly higher? And what happened to the view that fiscal stimulus was only appropriate, if at all, during a temporary recession?
The calls for fiscal stimulus in Japan make no sense on so many levels that I’m almost speechless. The assertion seems not just wrong, but preposterous. It would be like claiming that the press doesn’t pay enough attention to terrorism, or the Kardashians.