Structural Factors and Central Bank Credibility Limit Inflation Risks

By Gita Gopinath After ending last year with unexpectedly strong vaccine success and hope that the pandemic and economic distress it caused would recede, we woke up to the reality of new virus variants and the unpredictable, winding road that it can lead the world down. Something similar has happened with the discourse on inflation. […]

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A Race Between Vaccines and the Virus as Recoveries Diverge

By Gita Gopinath In just three months since we released our last forecast in October, recorded COVID-19 deaths have doubled to over 2 million, as new waves have lifted infections past previous peaks in many countries. In these same three months, multiple vaccines have seen unexpectedly strong success and some countries have started ambitious vaccination […]

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Lesson of Abenomics

With the recent resignation of Shinzo Abe, there have been a number of articles analyzing the record of Abenomics. There seems to be pretty general agreement on two points:

1. Japan’s economy improved after Abe took office at the beginning of 2013. Deflation came to an end, nominal GDP began rising, the public debt was brought under control, and unemployment fell to just over 2%.

2. The policy was not completely successful. Most notably, inflation continued to run well below the 2% target set by the Bank of Japan.

I believe that summary is correct. Where I part company with other pundits is in the lessons that Abenomics offers for monetary and fiscal policy. The Economist is fairly typical:

The first lesson is that central banks are not as powerful as hoped. Before Abenomics, many economists felt Japan’s persistent deflationary tendencies stemmed from a reversible mistake by the Bank of Japan (boj). It had combined fatalism with timidity, blaming deflation on forces outside its control, and easing monetary policy half-heartedly. In 1999 Ben Bernanke, later a Fed chairman, called on the boj to show the kind of “Rooseveltian resolve” that America’s 32nd president showed in fighting the Depression. . . .

The central bank is doing everything it can to revive private spending. Until it succeeds, though, the government has to fill whatever gap in demand remains. The shortfall in private spending is what makes government deficits necessary.

This seems to be the consensus as to the “lessons” of Abenomics.  Monetary stimulus is not enough; you also need fiscal stimulus.  And yet if you look at the actual record of Abenomics, there’s not a shred of evidence to support this claim, indeed the opposite seems to be the case.

For nearly two decades before Abe took office, Japan ran perhaps the largest combined monetary/fiscal stimulus in human history, at least during peacetime.  Remember, combined fiscal/monetary stimulus is the new consensus, the policy that most pundits in academia and the media now favor.  And what was the result of this massive stimulus?  Basically zero growth in nominal aggregate demand for almost two decades, a record even worse than seen in slow growing Italy.  If you’d told economists in the early 1990s that over the following 20 years Japan would mostly hold interest rates close to zero and increase the national debt from less than 70% of GDP to roughly 230% of GDP, and still have virtually no growth in nominal GDP, they would have responded that we need to abandon the standard textbook model of economics, as what we are teaching our students is clearly wrong.  Instead, we responded to this amazing analytical failure by doubling down on the very same flawed theory.

The massive fiscal stimulus came to an end with Prime Minister Abe.  Taxes were raised several times and the national debt leveled off at just over 230% of GDP.  Instead of a combined monetary fiscal stimulus, Abe relied on monetary stimulus and fiscal austerity.  And the Japanese economy actually improved!

I must admit that I am perplexed as to how my fellow economists draw their “lessons” from this record.  When people question monetary stimulus by pointing to the fact that Japan fell short of its 2% inflation target under Abe, I respond, “so do more”.  This doesn’t seem to convince anyone.  People seem to think I’m cheating, coming up with a theory that’s unfalsifiable.  “Yeah, you can always say they didn’t do enough.”

But when it comes to fiscal policy, this skepticism goes right out the window.  If I point out that the huge Japanese fiscal stimulus of 1992-2012 failed boost aggregate demand, they say the Japanese should have done even more fiscal stimulus, as if boosting the national debt from less than 70% to 230% of GDP is not enough.  When I point out that the Bush tax cuts of 2008 failed, they say the tax cuts should have been even bigger.  When I point out that the Obama stimulus of 2009 led to an unemployment rate that was far higher than proponents predicted even in the absence of stimulus, they say the stimulus should have been even bigger.  When I point out that the economy actually sped up in 2013, despite widespread Keynesian predictions that it would slow due to austerity, they say that without austerity it would have improved even more.  When I point out that the economy did not fall off the cliff at the end of July when Congress failed to renew the fiscal stimulus, they say it would have improved even more with additional stimulus (even though the fall in unemployment in August was the second largest in history.)

Now it’s certainly possible that I’m wrong and the Keynesians are right about fiscal stimulus.  Counterfactuals are tricky.  Maybe in all of these cases if they had only done more the results would have been better.  But in that case I’m honestly confused as to why I’m not allowed to argue the BOJ should have done more monetary stimulus.  Especially since while fiscal stimulus might become costly in the future if interest rates rise above zero, monetary stimulus is actually profitable, as central banks earn income on the assets they purchase with zero interest base money.  It’s monetary policy that seems to have truly unlimited “ammunition”, not fiscal policy.

Nonetheless, I’ve been beating my head against the wall for so long on this issue that I feel I need to change the argument.  Thus I’ve recently focused not so much on the claim that Japan needed to do more, rather that Japan needed to do different.  The ultra-low rates and massive QE are actually a symptom of previous tight money mistakes.

For example, the yen was about 124 to the dollar in mid-2015.  Today it’s roughly 105 to the dollar.  If Japan had simply pegged the yen to the dollar at 124 back in 2015, Japanese interest rates actually would have been higher over the following 5 years, mirroring the rise in interest rates in the US during this period (due to interest parity).  Monetary policy would have looked tighter to the Keynesian skeptic who (wrongly) feels that the actual Japanese monetary policy was highly expansionary, and ineffective.  And yet because the yen would have been far weaker, Japan would have actually experienced higher inflation than otherwise.  Indeed Lars Svensson made essentially this argument back in 2003, when he described a “foolproof” way for Japan to escape a liquidity trap.  He also noted that the higher nominal interest rates would be nothing to worry about, as this policy would have reduced the real interest rate in Japan, due to higher inflation expectations.

There are political difficulties with pegging the yen to the dollar, but Japan could have achieved a similar result by setting an aggressive price level target combined with a “whatever it takes” approach to QE.

So today I say to Japan, “don’t do more, do different.”

And I say to my fellow economists, “use the same criterion for drawing lessons from monetary policy as you use for drawing lessons from fiscal policy.”

PS.  Some economists do econometric tests of fiscal policy efficacy.  Elsewhere, I’ve criticized those tests for ignoring monetary offset.




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Guilt, Gender, and an Inclusive Recovery: A Lesson from Japan

By Chie Aoyagi Japan’s voluntary month-and-a-half shutdown of the economy in April due to COVID-19 has had a higher cost for women than men. A key reason: a “guilt gap” between women and men, where women often feel compelled to take on more professional sacrifices. Close to one million women—the majority of whom worked in […]

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Japan’s new leader

I’ve long held the view that pundits pay far too much attention to American elections and not enough attention to elections in foreign countries. It’s not that US elections are unimportant—we are the world’s dominant power—rather the relative importance of the US is generally exaggerated. The US is more important than the world’s 3rd largest economy, but surely it’s not 100 times more important.

How many people know that Japan just picked Yoshihide Suga as its new leader?  How many know that his policy preferences differ somewhat from those of Prime Minister Abe?

After graduating, he became secretary to a Yokohama politician, where his real education began. His boss was minister of transport in the early 1980s, heavily involved in the privatisation of Japan Railways. “I think that’s the basis for Mr Suga’s politics,” said Isao Mori, his biographer. “It’s something like Thatcherism or Reaganism.” Whereas Mr Abe is a conservative, Mr Suga belongs more to the free market wing of the LDP, aiming to shake off the shackles of Japan’s regulatory state.

One thing I’ve noticed is that the view of the media on issues such as deregulation are very much dependent on context. When discussing deregulation in the US, there’s often a high degree of skepticism. In contrast, there’s generally a tacit assumption that deregulation is a positive development when discussed on other countries—something that would boost efficiency. I’d be interested in knowing if other people have noticed the same pattern.

PS.  Of course most media outlets do not even discuss deregulation in foreign countries.  Here I’m focusing on outlets such as the Financial Times, the New York Times, The Economist, the Wall Street Journal, the Washington Post, the South China Morning Post, etc.


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What does it mean to say a debt is “unsustainable”?

I often warn against countries running up excessively large public debts. Some people interpret my worry as a prediction of a future financial crisis, perhaps including default and/or very high inflation. They point out that countries such as Japan have run large deficits for many decades, with interest rates on long-term bonds remaining near zero. So are these worries overblown?

For developed countries with their own currency my actual fear is not outright default, or even hyperinflation. Rather I fear that an excessively large public debt will eventually force painful changes in fiscal policy, such as benefit cuts or more likely large tax increases. The most efficient fiscal policy is one that smooths tax rates over time, as high taxes are a drag on the economy.  Furthermore, the effect of tax increases is not linear. A doubling of the tax rate will lead to a roughly fourfold increase in the deadweight loss, without even doubling tax revenue.

By the mid-1990s, Japan’s budget deficits were on an unsustainable path while the US budget deficits were still on a more sustainable path.  At this time, Japan had a 3% national sales tax whereas the US had no national sales tax.  Both countries had overall tax burdens that were below average for developed countries.

In 1997, Japan raised its national sales tax to 5%.  In 2014 they raised the tax to 8%.  In 2019 they raised the tax to 10%.  These increases were intended to address the debt problem.  Meanwhile the US continued to have no national sales tax.  Thus the very thing I was worried about did actually occur in Japan.  Furthermore, more tax increases are almost certainly on the way.  Unfortunately, the US budget deficit situation also became unsustainable during the late 2010s, due to a highly expansionary fiscal policy.  Thus the US is likely to be forced to raise taxes (or cut benefits) in future years.

To summarize, it is true that Japan is likely to be able to avoid default on their public debt.  But this does not mean that those who warned the deficits were unsustainable were wrong.  Indeed, Japan was forced to repeatedly raise taxes precisely because the path of the public debt was unsustainable without future tax increases.

PS. The FRED data site shows net debt for Japan (blue line) and gross debt for the US (both as shares of GDP.)  So the actual gap is even larger than it appears:



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