Friday, January 29, 2010

BoJ rescinds war on deflation: Part II

Marshall Auerback will be featured from time to time here on News N Economics. He is a dedicated author at the New Deal 2.0 (see his biography here). Take some time to read his postings at the New Deal 2.0 – he gives interesting perspective on the European Union, Emerging Europe, Chinese and U.S. policy/politics, and more.

Marshall has some comments about my previous post, Japan rescinds war on deflation.

By Marshall Auerback (posted by Rebecca)

But Japan is also starting to be far more aggressive on the fiscal front.

The Times article on Japan from last December – 'Debt-laden Japan shocked by £630bn spree to save lives’ reports that:
Yukio Hatoyama, the new Japanese Prime Minister, has stunned a nation already mired in huge public debt by unveiling the country’s biggest ever postwar budget: a 92.3 trillion yen (£630 billion) spending spree aimed at “saving people’s lives”.

The unprecedented budget, which supposedly shifts Japan’s fiscal spending focus “from concrete to lives”, comes amid rising concern about the solidity of sovereign debt in the world’s second-largest economy.

The new budget will require additional debt issuance of Y44.3 trillion — within the Government’s expected band, but still at a level that will raise Japan’s debt-to-GDP ratio to nearly 195 per cent.
It's quite a significant amount of spending. The fact that new debt exceeds tax revenue is irrelevant from the solvency perspective; it's only interesting insofar as it illustrates how depressed aggregate demand remains in Japan. As you rightly note, there is no risk of sovereign debt default in Japan because Japan can always issue as much debt as it wants in its own freely floating non-convertible currency. As Bill Mitchell has noted
"the interesting part of the story is that there is now a discrete policy shift going on as a result of the political changes in Japan that arose from the last election – that is, the ascendency of the Democratic Party of Japan (DPJ). The shift will see the government reduce its obsession with public infrastructure development as a vehicle for huge fiscal injections and instead put the spending power into poor households. " This is very supportive of aggregate demand and income growth.
The BOJ's actions, by contrast, are nothing more than moving numbers around on a spreadsheet. Arguably, the 0% interest rate policy in Japan has exacerbated the deflationary pressures in the economy. Virtually all of the debt held by the Japanese non-government sector is public, rather than private, so the loss of the so-called "fiscal channel" via sharply lower interest rates, has been very significant. Additionally, low rates impart a deflationary bias because they reduce the holding costs of inventory and reduce the required returns of capital. These are wonderful from a supply side perspective, but disastrous from the demand side.

The important point as Bill Mitchell, Warren Mosler, Richard Koo and I have argued previously is that it recognizes its on-going role to plug the spending gap left by non-government saving (and the export collapse) and it recognises it has the capacity as a sovereign issuer of its own currency to run large deficits. In this sense, the Japanese government is placing a premium on keeping unemployment low and is resisting pressures from the deficit hawks, the neo-liberals, and the horribly incompetent ratings agencies (all of which should be abolished).


  1. Hi Rebecca,

    Can you explain the "...there is no risk of sovereign debt default in Japan because Japan can always issue as much debt as it wants in its own freely floating non-convertible currency" part?

    Someone has to be willing to buy that debt and the savings rate in falling in Japan so there are less the potencial buyers are shrinking...

    Thank you,

    Dax Speculator

  2. Hi Dax,

    Japan's status as a reserve currency provides it with built-in external demand for the debt.

    However, Japan issues an overwhelming amount of debt in local currency (not much external debt at all). Theoretically, one could simply inflate their way out of debt, given that it is denominated in the home currency. And there is built in demand domestically, too, via pensions and domestic savers.

    Thanks for your comments, Rebecca

  3. Hi Rebecca,

    "Theoretically, they could simply inflate their way out of debt"? How do they do that? Raising interest rates sharply and increase their debt servicing bill??

    And for their domestic demand for debt, Japan has very poor demographics: domestic savers may begin using their savings to fund their retirements.

    Anyway, I think the market will force them to repair their balance sheet...

    Thank you,

    Dax Speculator