Several notable economists prognosticated on what Japan should do to get out of their malaise in the 1990s but none of them understood the problem or the options available to the sovereign government. They all gave poor advice. The way Japan recovered after that decade of poor economic outcomes was through fiscal policy. Monetary policy had little to do with it, as Richard Koo has demonstrated in his recent book on the country.
Let’s eliminate a few misconceptions. Japanese households do not fund the deficit. A government default is not possible (unless Japan chooses to do it, which I suppose they could do as they are pretty clueless).We learned that interest rates do not sky-rocket and inflation does not accelerate when deficits and debt issuance are on-going and huge – quite the opposite. If the BOJ should want to increase the money supply, devotees of the money multiplier model (including numerous Nobel Prize winners) would have the BOJ purchase securities. When the BOJ buys securities reserves are added to the system. However, the money multiplier model fails to recognize that the added reserves in excess of required reserves drive the funds rate to zero, since reserve requirements do not change until the following accounting period. That forces the central bank to sell securities, i.e., drain the excess reserves just added, to maintain the funds rate above zero. If, on the other hand, the BOJ wants to decrease money supply, taking reserves out of the system when there are no excess reserves places some banks at risk of not meeting their reserve requirements. The BOJ has no choice but to add reserves back into the banking system, to keep the funds rate from going, theoretically, to infinity.
In either case, the money supply remains unchanged by the BOJ’s action. The multiplier is properly thought of as simply the ratio of the money supply to the monetary base (m = M/MB). Changes in the money supply cause changes in the monetary base, not vice versa. The money multiplier is more accurately thought of as a divisor (MB = M/m).
Their export model is dead, the Chinese are eating their lunch, so the Japanese have to switch to a domestic consumption based model. How do you do that without spurring lots of unemployment in the absence of government spending?
It is clear to me that the neo-liberal period in Japan has devastated the security of the middle class which accounted for more than 80 per cent of the population. A person could rely on retaining full-time employment on good wages for life as long as they completed secondary school. The 1991 recession which followed the real estate collapse and poor investments by the financial sector led to the “lost decade”. The Japanese government under the neo-liberal helm of Prime Minister Koizumi started deregulating things that had previously been integral to providing this security, including cutting back government spending. See Koo’s book. His evidence is very compelling here.
Around 30 per cent of Japanese workers are employed in low-paid, casual jobs that offer no security. While Japan enjoyed stable growth this was not a problem. But the numbers of temporary workers has risen as the revered life-time employment system that generate prosperity in the Post-World War II period for the vast majority of workers has been steadily dismantled under neo-liberal urging.
I can do no better than to relay discussions I had on this point with Professor Bill Mitchell of the University of Newcastle in Australia. Bill eloquently summarises the neo-liberal insanity which is destroying this country:
The neo-liberals are running rampant now and predicting a maelstrom. This dominance of neo-liberal thinking will be a major constraint on the new government and it is already showing a compliance to the views.
The family-first policy proposals are a sop to the intergenerational debate.
The decision to shift spending priority to welfare away from national infrastructure provision is an example. The new Prime Minister has already said he will raise taxes to “pay for” the new spending initiatives. He has also promised to cut spending on major infrastructure.
The private investment jackals who have been indulging in wasteful, inefficient yet highly profitable private equity projects in the West are poised to capitalise on this shift in Japanese sentiment. They see Yen-signs before their eyes and are on the move already.
One commentator in today’s Australian says Australia investors are “primed and ready, as Japan rebounds from the global downturn with more resilience and speed than expected …”
The upshot according to the Australian commentary (consistent for a News Limited journalist) is that there will be:
… a focus on public-private partnership projects – a new concept for Japan. They are now essential as government debt soars past double the country’s annual economic output, with public infrastructure spending totalling $7.5 trillion since 1991. And the latest central government stimulus package crowded out bond-raising opportunities for regional governments.
Infrastructure is emerging as a new “asset-class” in Japanese financial markets. We never learn!
If they really understood the fiat monetary system they could continue to provide public infrastructure and extend better safety net protection for the poor. The large deficits that the Japanese government runs is symptomatic of the huge saving desire of the domestic population. Not even the traditionally strong net export performance can offset the high saving ratio.
The saving ratio will also decline as more safety net provisions are extended to the population, who at present feel as though they have to provide for their own retirements. The introduction of a national superannuation scheme would also help.
In that sense, the deficit would fall anyway as consumption increased.