Home > The Economy > Will Japan lead the path away from the fiscal cliff?

Will Japan lead the path away from the fiscal cliff?

from Dean Baker

An event that has received far too little attention in the United States was the election of a new prime minister in Japan. Last month the people of Japan voted overwhelmingly to throw out the governing party and to support the return of the Liberal Democrats headed by Shinzo Abe.

Electing Liberal Democrats is not new in Japan; they have held power for most of the period since World War II. Even putting in Abe as prime minister is not new. He had earlier served a brief stint in this position from 2006-2007. Abe is a well-connected party boss who has worked his way to the top ranks of the party in the same way as other party leaders.

What is new is Abe’s stated agenda. Abe wants to get Japan off its two-decade-long path of near stagnation, promising a policy of vigorous stimulus. There are two main parts to this policy. First, he promises to embark on another round of infrastructure spending, with the goal being the direct creation of tens of thousands of jobs. 

Perhaps more importantly, he wants Japan’s central bank to explicitly target a higher rate of inflation. If they follow Abe’s recipe, the central bank will commit itself to raising the inflation rate to 2.0 percent, buying as many Japanese government bonds or other assets as necessary to bring about this result. The goal is to reduce the real interest rate: the difference between the nominal interest rate that people actually pay on borrowed money and the rate of inflation.

Given the weakness of the Japanese economy it would be desirable to have a negative real interest rate; however, nominal interest rates will never fall below zero. People will not pay banks to hold their money. Since Japan was actually seeing modest rates of deflation, this meant that the real interest rate still remained considerably higher than would be desired.

However, if people actually come to expect the 2.0 percent inflation targeted by the central bank then it will mean that the real interest will turn negative. Firms that are able to borrow at near zero interest rates will have more incentive to invest when they expect that the items they are producing will sell for 6 percent more money in three years or 10 percent more money in five years.

The idea of deliberately targeting a higher rate of inflation was first put forward by Paul Krugman in a famous 1998 paper. While many prominent economists, including Federal Reserve Board chairman Ben Bernanke, endorsed Krugman’s position, no central bank has had the courage to actually test the theory by making it explicit policy. Inflation-phobic central banks found it impossible to accept the idea that a higher rate of inflation could actually be a desirable policy goal.

This is why Abe’s agenda is so impressive. While Japan does have an independent central bank, Abe has made it clear that he will use his control of parliament to take away this independence if the central bank does not agree to carry out his inflation-promoting agenda. Unless he is derailed in this effort, we will be able to see a clear test of this prescription.

It is also worth noting one other way in which Japan is already a model. The deficit chicken hawks that dominate Washington policy debates are warning us that financial markets will panic if we don’t soon get our debt under control, with investors fleeing the dollar and interest rates soaring. Japan’s ratio of debt to GDP of 240 percent is more than twice that of the United States, yet the interest rate on long-term government bonds is hovering near 1.0 percent and the government’s main concern is that the yen is over-valued.

If Abe is allowed to carry through his policy and it proves successful, it will provide a great example for the United States, Europe, and other regions still suffering the effects of the economic collapse in 2008. Of course these countries have not always been able or willing to learn lessons from other experiments.

The eurozone countries proved that deficit reduction in the middle of a downturn leads to recessions and higher unemployment, just as textbook Keynesianism predicted. The United Kingdom provided an even better proof of the Keynesian model since it did it to itself in the context of a country with its economy that was not suffering from a crisis of confidence.

In spite of the overwhelming evidence that these examples provide of the foolishness of deficit reduction in the middle of downturn, austerity remains very much in fashion in elite Washington circles. If our leaders can’t learn from other countries’ failures, there is still the hope that they make be able to learn from success.

If Abe carries through his Keynesian agenda and manages to restore Japan to a healthy growth path perhaps it will put an end to austerity economics in the United States. As President Bush always used to say, “is our leaders learning?”

See article on original website

  1. January 9, 2013 at 10:28 pm

    There is a bit of nonsense (i.e., the quantity theory of money) in the view that by merely buying government bonds and thereby creating bank deposits (i.e., money), the central bank can assure any given rate of inflation.

    This is sheer nonsense. As Keynes pointed out (as I note in my book THE KEYNES SOLUTION), there are two types of inflation: (1) Commodity Inflation, and (2) incomes inflation.

    Incomes inflation will occur only when input factor prices (basically labor income) rises faster than the rate of productivity growth –so labor costs of production rise. Given the almost unlimited source of cheap foreign labor (in China Vietnam, etc) and the outsourcing by Japanese as well as American companies we can not expect incomes inflation until close to full employment domestically is realized.

    Clearly the Federal Reserves QE experiments demonstrate that increasing money supply per se does not create incomes inflation.

    Commofit Inflation occurs only when globally traded commdities come under speculative pressure — and these commodities can not be rapidly increased in production.

    • January 15, 2013 at 5:14 am

      Agreed. The quantity theory of of money. his move by the Japanese is a kind of reverse Friedman, and should be expected to work no better than the straight Friedman. The quantity theory was bankrupt as far back as the Treatise on Money, yet it never dies. The difference between an explicit purpose for QE’s and an implicit purpose does not seem to me to be so great. However, re commodity inflation, it seems apparent the QEs, by increasing the source of speculative capital, are pushing on commodity inflation.

  2. sergio
    January 10, 2013 at 3:55 am

    How would firms in highly competitive markets react to increase of money supply?
    Is there a clear explanation of a mechanism which links increase of money supply to increase in prices and output?

  3. Garrett Connelly
    January 10, 2013 at 3:39 pm

    “The idea of deliberately targeting a higher rate of inflation was first put forward by Paul Krugman in a famous 1998 paper.”

    This was also cute table talk in the 1950’s.

  4. Ingemar
    January 10, 2013 at 3:51 pm

    The Swedish central bank has a inflation target at 2%.

  5. Jorge Buzaglo
    January 12, 2013 at 6:11 pm

    The several ”quantitative easings” by the Fed already seem to implicitly have the aim of generating higher inflation, diluting debts and increasing overall demand. In particular, an important aim seems to be the depreciation of the dollar, in order to increase exports, reduce the trade deficit and the huge, exploding US foreign debt — see note (*).
    If Japan, the US and other big economies enter the mode of “competitive inflation,” this method of competitive devaluation might entail an increasingly internecine global economic climate.

    It doesn’t seem to be available a standard economic policy Prozac which could easily be ordained to depressed economies. The problem seems to be political, or institutional, and ideological, in the sense of the general prevalence of an economic paradigm which was already obsolete in the time of Keynes. A theoretician on the long waves of capitalist development such as Ernest Mandel would say that within the paradigm of capitalism, the “solution” of the problem is war. Mandel’s interpretation is exceedingly pessimistic, I hope.

    (*) US net foreign indebtedness was over 4 trillion in 2011, about twice annual exports (3 times annual exports is a common risk threshold indicator). The accelerating US foreign debt was in 2011 more than two times what it was 5 years before, and three times what it was in 2000. See E. Nguyen, “The international investment position of the United States at yearend 2011,” Survey of Current Business, July 2012, Bureau of Economic Analysis, U.S. Department of Commerce.

  6. sergio
    January 13, 2013 at 3:10 am

    Unfortunately, quantitative vision of how economies work is essential part of both neoclassical and keyenesians approaches. In this sense they seem no different at all. The problem is not with tweaking interest rates, money and other tweakable variables. The problem is with capitalism itself. Who can say what is capitalism? No one can say it clearly. Because no one knows what is capitalism as social order, about its institutions and ideology.
    That is what policymakers, forget. All of them agree that capitalism is still the only best possible economics system and government and CB only need to tweak it. If that can be called as capitalism at all is quite doubtful. Capitalism by its nature is unsustainable, unless government and CB sustain it.
    Solution will ultimately be not tweaking capitalism, but designing completely new social order, for which new economic vision needed. Not quantitative one.

  7. January 15, 2013 at 9:54 pm

    Perhaps,just perhaps you should take a real good look at ” QE 3″ a/k/a “QE INFINITY”.

    Justaluckyfool comments,”Ben Bernanke should receive the Noble Prize in Economics.”

    A Monetary Sovereignty can not run out of money for purchases of assets.
    Solid proof; QE 3 (Infinity-for as long as needed and in whatever amount desired)
    BUT justaluckyfool asks,
    ” WHY NOT do it for the people ? Stop doing it solely to benefit the “Private For Profit Banks” (PFPB).
    Just an example: Purchase all residential real estate loans and modify them at 2% for 36 years. This would allow for stabilization of the housing and construction sectors, increase jobs and the bettering of all citizens. And at the same time raise revenue, lower taxes, and fund “for the general welfare. A simple solution; if $100 trillion is needed ,what happens ?All that it does is take away from the PFPB a revenue(profit) of $5.5 trillion a year and turns into an income for the US Treasury.

    Read More: QE 4 The People. How about some help, do a rewrite on “Justaluckyfool” Challenge , improve, correct a theory that could lead to prosperity and pursuit of happiness for all. http://bit.ly/MlQWN

  8. January 15, 2013 at 9:57 pm

    Please, with all due respect consider the following questions, since I am a professed fool,I beg for your due examination as to the validity of this opinion as well as improvement by way of any profound responses.

    Great work on the “Trillion Dollar Platinum Coin”
    Frederick Soddy would have been proud to stand with you. As in his “The Role of Money”
    Soddy states, “Money now is the NOTHING you get for SOMETHING before you can get ANYTHING”
    What if a quadrillion dollar coin were to be minted and placed as a deposit in the US Treasury account being designated as “The present total wealth of this sovereignty as of 2013” This is the present amount (value) of the combined “goods and services of the social society known as the American people, a/k/a “We the People”

    Money=nothing=something = anything=money.
    A quadrillion dollar coin = all the goods and services of the sovereign nation.(SOMETHING).
    A quadrillion dollar coin=what you can use to get anything.
    Money is merely a way and means of distributing the wealth
    (goods and services ) of the sovereignty.

    This account is to be controlled by the Monetary Sovereignty by means of a Central Bank.
    This Central Bank (CB) is to be the the sole and only source of currency issuance, and must control the quality and quantity of the sovereign currency.
    The CB is the only source of distribution of the wealth of the sovereignty. As it is the sole guardian
    of that wealth ,it alone must guarantee “all the “money” backed by the “goods and services” shall be redeemable for “any goods or services”.
    The government of a monetary sovereign nation is a social business corporation. We are fortunate the the USA has been established ” to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…”

    It is for this reason that We the People are willing to allow our government the right of taxation.

    Taxation allows our government to APPROPRIATE part of the wealth of the social community in order to pursue its mandated goals.If the whole is $1 quadrillion , that is the amount that is the wealth of the whole community and that is the amount they are to receive when redemption is demanded, even the government should not be allowed to take away the right of each citizen that places their wealth in the trust (storage) and “good faith” of its government that their wealth “shall be redeemed”.

    “How can a government use a taxation “…to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…”” at the same time NOT APPROPRIATE any of the wealth of the social community while at the same time control the quality and quantity of its currency?
    What if :
    The Federal Reseve Bank (almost all agree can make unlimited purchases of assets)
    were to purchase ALL residential and commercial real estate loans outstanding and rather than
    continue the stupid practice of being guarantor to actually become the lender of these and future loans.
    Correct QE3 (Infinity) stop bailing out the foxes in the hen house, stop foreclosures (85% of which the homeowners wish to stay and pay), start curing the crisis in housing, create millions of jobs.
    Immediately , modify all loans at 2% for 36 years.What would that do for the “people” , put an end to the crisis and fix what went wrong ?
    Force the banks to comply by doing what the Fed failed to do in 2001-demand 100% reserves and 100% capital requirements..
    How great would it be if the banks needed $200 trillion to be at 100% reserve- 100% liquidity ?
    At 2% for 36 years that would produce $11 trillion a year in “RAISED REVENUE INSTEAD OF TAXES”.
    “The Wealth of a Nation is in How it Redistributes That Wealth” by justaluckyfool.
    Excerpts contain quotes by Steve Keen, Michael Hudson, and others but most important
    theory of Frederick Soddy “The Role of Money. 1926,1933″.
    What if:
    As Soddy thought, “A Monetary Sovereignty must be the sole issuer of its currency”
    The currency is a representation of all the goods and services of that Sovereignty and that currency
    be it paper, metal or whatever form of transmission is used for the system of distribution and or redistribution.

    A reply received:
    ****“Immediately , modify all loans at 2% for 36 years.What would that do for the “people”? justaluckyfool.
    Your plan does nothing for non-debtors except perhaps indirectly thus it is not politically feasible…” ***
    First, justaluckyfool must thank you for your challenge because “only after due examination” should a concept be accepted.
    If all the loans on land and improved land value were to be made by the Monetary Sovereignty instead of simply guaranteed that the loans would be backed by 100% currency , it would only change the direction of who would receive the benefits of the action-Instead of PFPB the revenue raised would go to the US Treasury. Let’s say for example for a sum of $36 trillion (makes the math easy ) at 2% for 36 years would produce a “revenue, or income in place of an income tax of $2 trillion per year.
    How good is that for all the people?
    For the individual homeowners, especially the 85% that want to stay in their homes, it makes their homes affordable.A home with a mortgage for $120,000 would have a monthly payment of $556 per month and since the mortgage would be assumable it would guarantee the remainder price value of the residence at whatever $556 per month can exchange for “credit,goods and services.”. With the intended consequence that they would be paying INTEREST instead of income taxes!
    Plus the added benefit that they will gain value as the price of the home may increase because the assumable mortgage with its fixed rate will allow the homeowner to capture that gain, while at the same time the governing people will receive double, yes, double the amount of the asset.
    Or what if, this small move which would produce $2 trillion per year revenue (since all income to the Fed Reserve shall go to the US Treasury) , how about then we drop FICA.
    What would that do , (Ask Dr. Wray as in “Job Guarantees”, Ask Warren Mosler? )
    *Lower real estate (commercial buildings) cost= lower production cost.
    *Lower tax with holdings = raise in pay.
    *Lower cost of wages (No corp FICA co-pay)= increase in profit.
    or improve.
    I am just a fool in search of profound answers.
    Please, anyone with a voice that is heard, please “after due examination”
    promote that which you find to be of a benefit to all mankind.
    If I , a fool, who has but only for such a very short time found from “due examination”
    articles from Steve Keen,William Black, Michael Hudson, L Randell Wray, Warren Mosler and taken from them
    what I ,just a lucky fool, found to be an opinion, added to that some of my non expert opinion of what Frederick Soddy wrote in
    “The Role Of Money””Virtual Wealth”.
    Please,please by the grace of an “Invisible Hand” join forces to do what Lincoln did for
    those who knew they were slaves;you can now help set the American people free from possible servitude and turn them on to a path of prosperity.

    A Monetary Sovereignty can issue its currency in unlimited amounts, any restraints would be self imposed.
    A Monetary Sovereignty must be the only source of issuance of its currency.
    A Monetary Sovereignty must use that currency as a system of distribution of its wealth.
    A Monetary Sovereignty must “by the good faith and credit of its people”
    guarantees that no matter what physical form its currency is
    it is redeemable in “goods and services” by the Sovereign Nation”
    A Monetary Sovereignty must have in place ways and means to protect the quality and quantity of its currency.
    As Frederick Soddy wrote, “Money now is the NOTHING you get for SOMETHING before you can get ANYTHING”.

    ***** “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha
    Examine: http://bit.ly/MlQWN

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