Renew the Pact for Collaboration between Fiscal and Monetary Policies

Program Director and Faculty Fellow, RIETI

With respect to future macroeconomic policies, I would like to introduce readers to the essence of the paper by the Reiwa National Conference, commonly known as “Reiwa Rincho,” which presents an urgent set of recommendations (issued on January 30, 2023), and state my argument based on it. The current situation of the Bank of Japan (BOJ), which supports the massive burden of the public debt by continuing to purchase government bonds without limit, is not normal. At present, a significant change in that situation is starting to occur.

First, as major countries move to raise interest rates amid global inflation, the oddness of Japan’s monetary policy has become conspicuous and started to prompt people to associate the rising interest rates with fiscal deterioration.

Second, because of the series of announcements of steep increases in expenditures on defense, childcare support, and green transformation (GX), awareness has grown about fiscal risk.

Third, among Japanese households and investors, the preference for yen-denominated assets (home bias) is beginning to weaken as seen by the spread of savings methods using foreign currency-denominated assets. Moreover, the market turmoil in the United Kingdom in the autumn of 2022 indicated that even a country that is considered to maintain sound policy management could easily lose market confidence, which has been a very significant lesson for Japan as well.

As I mentioned in the column on October 12, 2022, continuing accommodative monetary policy has the negative side effect of aggravating the secular stagnation. Concerns over future fiscal soundness may have lowered the growth rate by deterring economic activity. The BOJ’s “unconventional monetary policy” may also have undermined the business environment for private enterprises and facilitated the survival of many low-profitability businesses that otherwise could not have continued to operate (zombie businesses).

Gaining public confidence in the sustainability of the government’s fiscal and monetary policies will ease concerns over the future and revitalize the economy for the immediate moment. In other words, fiscal sustainability and economic growth are policy challenges that should be addressed simultaneously and in a coordinated manner.


As the starting point of its recommendations, the Reiwa Rincho Recommendation Paper proposed a renewal of the policy pact between the government and the BOJ that is enshrined in their joint statement (issued on January 22, 2013). The essence of the report is this: now that Japan’s fiscal and monetary policies have been trapped in a vicious circle of mutual harm, the government and the BOJ should explicitly announce their willingness to engage in policy coordination through a new official statement.

The Reiwa Rincho Recommendation Paper’s argument is as follows. At the moment, under the unconventional monetary policy, the BOJ is supporting the expansion of government expenditures–virtually without limit–through the purchase of government bonds. As the long-term interest rate has been fixed at near zero, an increase in the issuance amount of new government bonds is not reflected in interest rate movements. As a result, the sense has spread among politicians and policymakers that the government can borrow any amount of money without risk, so it has become difficult to restrain profligate fiscal expenditures.

Under the government-BOJ policy pact of the 2013 joint statement, the government’s role was to carry out the structural and regulatory reforms that are essential to increasing Japan’s growth potential. However, the reforms have been in effect put off because the priority has been placed on expanding expenditures as an economy-stimulating measure due to the weakening of discipline over the issuance of government bonds.

As a result, the Japanese economy has remained on the path of low growth, with the rejuvenation of the economy making little progress and productivity and wages remaining stagnant. The economy has become trapped in a vicious circle of economic stagnation, preventing the normalization of monetary policy. This vicious circle must be broken.

The Reiwa Rincho Recommendation Paper includes the following recommendations as key points of the joint statement which will be newly proposed.

First, the government should examine the factors that have limited the effects of the policy measures taken to date and aim to increase productivity and wages by accelerating structural reforms, including strategic and effective fiscal expenditures and thorough digitalization. In addition, the government should create an effective system and organization for restoring public confidence in its fiscal policy.

Second, the BOJ should make efforts to restore the interest rate mechanism and normalize the government bond market within a certain time span while keeping close watch on the progress in the policy measures taken by the government. Stabilizing the inflation rate at 2% should again be set as a long-term goal, and appropriate policy management should be conducted in accordance with the monetary and economic conditions.

Third, it is necessary to develop an institutional system that strongly promotes policy implementation by periodically reviewing policies that are intended to advance sustainable fiscal and monetary reforms.

If the prospect of the normalization of monetary policy within a certain time span becomes realistic because of the implementation of those measures, fiscal expansion will be restrained. Such a prospect will provide momentum to the implementation of reforms for increasing Japan’s growth potential by depriving the government of the option of falling back on fiscal expansion. It will also stir up the private sector’s appetite for innovation, which has weakened because of their easy access to low interest rates. However, I would like to emphasize that macroeconomic policies can do no more than improve the market environment and that, ultimately, innovation led by the private sector is the driving force of growth.

Although the policy measures so far taken may have raised stock prices and lowered the unemployment rate, there have been limits to what can be achieved. Textbook economics assumes that fiscal and monetary policies merely bring forward future demand to the present in order to cover a temporary demand shortage, but do not have the effect of increasing the economic growth rate.

Fiscal and monetary policies do not increase the economic growth rate
Fiscal and monetary policies do not increase the economic growth rate

Among the vast volume of research literature written on unconventional monetary policy since around 2000, there have been few papers that argue that monetary policy can increase the long-term economic growth rate. The mainstream idea is that the goal of monetary policy is to temporarily resolve a demand shortage that has occurred for some reason or other.

On the other hand, several research papers have argued that implementation of the right fiscal policy increases the economic growth rate, but the premise for that argument is that the government knows the right way to use fiscal funds. In other words, if the government is smarter than the private sector, it can lead the way toward growth, but, as we all know, the reality is different.

The best option is that a smart government would make aggressive investments, but if an unwise government does that, the results will be disastrous. The second-best option is that an unwise government spends sparingly. It goes without saying that efforts to create a smart government to realize the best option are imperative.


Perhaps because fiscal discipline has weakened due to low interest rates, Modern Monetary Theory (MMT) has remained popular, maintaining that a government can issue any amount of government bonds denominated in domestic currency without suffering consequences. MMT is correct in arguing that if government bonds are issued, new credit is created in the form of private-sector deposits, enabling the purchase of the bonds that are issued. However, this theory does not predict how the inflation level may change due to unlimited issuance of government bonds, nor does it offer an assessment as to, or provide solutions for, the risk of the occurrence of high inflation or economic turmoil. Moreover, although MMT argues that if inflation goes too far, a tax increase can be used to restrain it, raising a tax rate is a process that could take years, so that is an unrealistic policy option.

A theory like this has a certain degree of appeal, but it is unlikely that the popularity of MMT in Japan is unrelated to the stagnation of the Japanese economy, which has lasted for the past three decades.

In the case of the bad loan problem that occurred in the 1990s, the policymaking authorities resorted to quick fixes and lacked the resolve to consider a comprehensive strategy for putting the economy back on its feet from a long-term perspective. Policy leaders continued to put off the problem in order to evade responsibility for the moment, and that situation continued for nearly 10 years.

At that time, I felt that behind that attitude was the Japanese people’s unwillingness to accept reality, rooted in the sense that Japan’s postwar regime was imposed on them by the United States, so it was not worth risking their lives to protect. I still feel that a similar attitude exists today.

We, the current generation of Japanese people, should overcome that kind of attitude and bear responsibility for mapping out and executing a long-term, comprehensive strategy in order to leave Japan to future generations as a truly sustainable country.

>> Original text in Japanese

* Translated by RIETI.

February 15, 2023 Nihon Keizai Shimbun

April 26, 2023

Article(s) by this author