An article written by Koichi Hamada, a Yale University professor emeritus and economic adviser to Prime Minister Shinzo Abe, for the January 2017 issue of the Bungei Shunju magazine is drawing much attention as a possible clue to where Abenomics is headed. In the article (entitled "Abenomikusu: Watashi wa Kangae Naoshita [Abenomics: I Have a Second Thought]"), Professor Hamada revised his view that deflation is a monetary phenomenon and argued for mobilizing fiscal policy to complement the monetary policy, insisting that the Bank of Japan (BOJ) has been unable to generate inflation because its easing policy is not accompanied by complementary fiscal policy.
♦ ♦ ♦
A paper presented by Princeton University Professor Christopher Sims at a symposium hosted by the U.S. Federal Reserve Bank of Kansas City at Jackson Hole, Wyoming, in August 2016 was a direct cause that prompted Professor Hamada to change his view. In the paper, Professor Sims states, "Fiscal expansion can replace ineffective monetary policy at the zero lower bound, but fiscal expansion is not the same thing as deficit finance. It requires deficits aimed at, and conditioned on, generating inflation. The deficits must be seen as financed by future inflation, not future taxes or spending cuts."
This argument of Professor Sims is based on the fiscal theory of the price level (FTPL), on which he is a leading authority (see a 2002 paper by Takeshi Kimura of the BOJ for an outline of the theory). In essence, the theory says that inflation and deflation are fiscal—not monetary—phenomena. The equation shown below describes the intertemporal budget constraint of an integrated government, which combines the government as administrative authority and the central bank, and regards it as defining the price level:
Nominal government debt / Price level = Discounted present value of current and future real fiscal surplus (including seignorage)
This is a constraint equation describing that government debt must ultimately be financed by budget surpluses including seignorage. How the government, the central bank, and the private sector interact with one another to satisfy this equation is a key determinant for the price level. The FTPL assumes that neither the government nor the central bank but rather the private sector is the first to act to satisfy the budget constraint equation shown above, with individual consumers and companies adjusting their spending behavior and thereby resulting in changes in the price level. In this case, the price level goes up to satisfy the equation, for instance, when the government makes permanent tax cuts to reduce fiscal surpluses permanently, instead of pursuing a Ricardian budget-neutral fiscal policy under which a cut in current taxes will have to be financed by higher future taxes. The mechanism behind this is that greater spending by consumers who perceive the permanent tax cuts as a permanent increase in income drives up the price level.
Therefore, we must be aware that the logic behind a fiscal expansion in this context is completely different from the one that calls for expanding fiscal expenditures in a Keynesian context, as monetary policy is not working. The logic here is that encouraging consumers to free ride and not making any commitment to fiscal austerity in the future contribute to the government's goal of ending deflation.
♦ ♦ ♦
Unfortunately, however, it may be unlikely for the price level to go up via this route under the current situation where there is no denying the possibility that anxiety about the future, including social security, may be negatively affecting consumption. Rather, the problem with such deflation-fighting policy is its effect of irreparably undermining fiscal discipline.
Needless to say, monetary policy measures under Abenomics—be it quantitative and qualitative easing (QQE) or a negative interest rate policy (NIRP)—have significantly contributed to an unintended implicit easing of fiscal discipline. When the BOJ makes such massive purchases of Japanese government bonds (JGBs) and long-term interest rates have fallen to a near zero level, Japan's debt-to-gross domestic product (GDP) ratio is bound to decrease before the fiscal primary balance turns positive. Not surprisingly, warnings of the possibility of a sudden surge in long-term interest rates have found no ears to be heard, and austerity advocates including myself have been labeled as "boys crying wolf."
Pursuing the FTPL policy under this situation may end up providing a theoretical endorsement to an intended explicit easing of fiscal discipline, such as giving up on the goal of achieving a primary surplus in 2020 and postponing—for the third time—the planned consumption tax rate hike.
Both the current monetary policy and the FTPL policy are unquestionably abnormal policies applicable only in abnormal times. They are both conditioned on the government's firm commitment to a drastic policy shift or an exit strategy upon seeing that the end of deflation or the normalization of interest rates are on the horizon.
When the time comes, and if the BOJ is unable to sell JGBs and the government fails to return to normalcy and make commitment to future taxes or spending cuts, hyperinflation and havoc in the financial and currency market would become inevitable. Having no idea about when and how to exit from various unconventional policies, including the current monetary policy, is the biggest problem with the current government.
♦ ♦ ♦
What does it take to restore fiscal discipline? Public opinion is what drives politics, and if so, what is important from a long-term perspective is to change the public opinion. As part of a RIETI research project, I have been working with a group—including Koichi Kume of Recruit Works Institute, Chiba University Associate Professor Shinpei Sano, and Aoyama Gakuin University Associate Professor Kengo Yasui—to analyze factors affecting people's choice regarding the benefits and burdens of social security, using our original survey data.
In this research, we first considered four possible combinations of policy choices concerning taxation and social security: "no higher taxes and reduced social security (small government)," "no higher taxes and expanded social security (free riding)," "higher taxes and reduced social security (fiscal sustainability)," and "higher taxes and expanded social security (big government)." Then, we examined how the attributes and mindsets of individuals affect their choices.
Our findings, albeit preliminary, show that the lower the level of education and the lower the income per hour, the greater is the propensity of respondents to opt for the "free riding" policy or look to greater social security without any increase in their tax burden, as compared against those who selected either the "small government" or "big government" policy. The two policies used as a standard for comparison are fiscally neutral in terms of looking to social security to commensurate with the tax burden.
Meanwhile, when we focus on individuals' attitudes, we can see that the propensity to free ride is relatively strong among: (1) those who have little trust in the government and other people; (2) those who exhibit a low degree of civic mindedness, having little consciousness of the impropriety of such acts as the fraudulent receipt of pension benefits, fare cheating, tax evasion, bribe-taking, littering, and purchase of stolen property (see Figure); and (3) those who are heavily dependent on the government and skeptical of the market economy. This is consistent with research findings by Yann Algan, professor at the Paris Institute of Political Studies (Sciences Po) and others, which I introduced in my article published in this column on May 21, 2012. Algan et al. showed that low civic-mindedness has a positive impact on people's support for welfare states.
Therefore, in order to improve fiscal discipline, it is necessary to make persistent efforts to change the attitudes of free riders over time. In addition to enhancing public confidence in the government, it is also important to raise the level of education in a broad sense, including the fostering of civic mindedness and the promotion of understanding of the market economy. As we are now living in a world where populism rules, it is all the more important to remind ourselves of the principle that there is no free lunch, and to make extra efforts to remain stoic and maintain various norms and orders.
* Translated by RIETI.
January 6, 2017 Nihon Keizai Shimbun
