Friday, 18 August 2017

Japan and the burden of government debt

I don’t write enough about Japan, and now that some of my posts are very kindly being translated into Japanese I should try to remedy that. In fact there is currently a very good reason to write about the Japanese economy, and that is a very strong 2017 Q2 performance. Annualised growth was 4%, compared to 1.2% in the UK. What is particularly heartening about recent Japanese growth is that it is led by domestic demand rather than trade. In the past Japan seemed to have the opposite of the UK’s problem: growth was often led by trade, while domestic demand was weak.

This recent growth is not just making up for poor past performance compared to other countries. Comparisons of GDP growth are misleading for Japan because (unlike the UK and US) it has relatively little inward migration, so it is better to use GDP per head for such comparisons. (As Noah Smith points out, even this my bias comparisons against Japan because its population is aging.) Between 2006 and 2016, Japan increased GDP per head by a total of about 5.5%, compared to around 5% in the US and about 3% for the UK. Good compared to other countries, but all these countries should have had stronger recoveries from the recession.

Strong growth is good news because inflation is so low (around 0.5%): way below the 2% inflation target. The government is trying to stimulate growth using a modest fiscal stimulus and large scale quantitative easing (short and long interest rates are exactly zero) as well as implementing various structural reforms. But the striking thing about all this is that their net government debt to GDP ratio is 125% and rising (OECD Economic Outlook measure). This is higher than any other OECD country except Greece and Italy.

Does the conjunction of relatively strong growth and high government debt confound economic theory, as Bill Mitchell suggests? Like high powered money and inflation, any relationship between government debt and growth just does not work when interest rates are stuck at zero. High government debt could crowd out private investment (although some dispute this), but not when real long term rates are zero and inflation is near zero. Servicing high debt could discourage labour supply, but again not when interest rates are zero. Nor is debt a burden on future generations when the real rate of interest is well below the growth rate.

Of course most people think such high debt levels are a real concern because of ‘the markets’. But the markets will only stop buying this debt if they expect default or rampant inflation, and there is no way a government with its own currency can be forced to default. There is also no way it will choose to default with interest rates so low. This is the basic truth that our leaders in the UK choose not to tell us (and pretend otherwise).

But what happens when growth finally raises inflation, and interest rates rise. Will debt not be a problem then? Maybe, but only in the long term, so the government will have plenty of time to fix that roof when the sun shines. [1] Right now Japan does worry about its high levels of government debt, but it rightly worries about the combination of low growth and low inflation much more. In that sense it sets a good example to other countries.


[1] Fixing the roof while the sun shines is one of the Cameron/Osborne little homilies I approve of. The problem when they used it was the UK economy was actually in pretty poor shape, as we could tell because interest rates were so low.    

17 comments:

  1. Good post - knits together much else I've read about Japan recently.

    "...and there is no way a government with its own currency can be forced to default."
    True, unless it has debts held in a foreign currency? Not so for Japan of course but is the case for Venezuela.

    ReplyDelete
  2. UK annualised growth still at 1.2% in 2107! Surely people will see now that brexit has long term effects.

    ReplyDelete
    Replies
    1. Hello. This is the link to Japanese translation of Mainly Macro http://econ101.jp/category/translation/simon-wren-lewis/
      We've just started translating since this month so we haven't got many yet. Thanks! @chietherabbit

      Delete
  3. Thoughtful article as usual from SW-L. My only quibble is with this phrase: “But what happens when growth finally raises inflation, and interest rates rise. Will debt not be a problem then? Maybe, but only in the long term..”. SW-L gives no reasons why there might be a problem in the long term. Nor do I see why there should be much of a at all, short or long term. Reasons are thus.

    If markets suddenly raise the interest rate demanded for holding government debt, the bill for that does not rise immediately because the rate of interest on the debt is determined when it is first issued. As to debt due for roll over, government can just print money to pay off the old debt and then stick two fingers up at potential debt holders who want more interest, and tell them to go away. That will probably raise inflation, but that can be dealt with via raised taxes.

    In the case of a closed economy (to keep things simple) those taxes will not cut living standards. Reason is that those taxes simply aim to cut demand to a non-inflationary level. I.e. aggregate demand need not be affected. As to open economies, things are a little more complicated, but the end result is much the same. And in the case of Japan, that can be ignored as the vast bulk of its debt is held by Japanese natives.

    ReplyDelete
  4. One of the most interesting things about Japan is that it is in many ways a closed economy by which I mean it is able to tackle its own issues in ways it chooses, due to its relative independence.

    As an illustration of this you mention investment spending and one of the reasons this is rising strongly is that there is a boom in spending on AI and robotics. Going strongly down the robotics route is one way of countering the huge demographic issues faced by Japan, made more stark by cultural exclusivity and very low immigration.

    The Japanese appear to have a system of government and industry which favour a more collectivised approach to these issues and have done so for many years (the zaibatsu); in fact the moral and economic framework is quite different. In this they show an interesting counterpoint to the Western economies which are much more financialised, individual and market based and it is in these collective arrangements that they appear to be able to tackle these issues much better than we can. I would have much more faith in the ability of the Japanese government to mend the roof when the sun shines than I have in the UK government.

    ReplyDelete
  5. Perhaps Japan (and other countries too) would be best off just keeping the policy interest rate at zero indefinately and not using monetary policy to try and modulate inflation.
    I'm also interested in how you reconcile your very strong stance on the necessity for large scale mass net migration into the UK with your recognition of how well Japan does with so little imigration.

    ReplyDelete
  6. Well you have to take the sectoral balances approach to get the bigger picture to fully understand all of the fiscal flows.

    Alan Longbon does that beautifully below.

    https://seekingalpha.com/article/4096397-good-news-japanese-current-account-935b-surplus-july-2017

    ReplyDelete
  7. Seems like debt is only a problem if the % growth in revenues is less than the % interest rate on debt.

    BTW, governments should be able to earn an outsized return on debt, relative to corporations, if the money gets invested in things that generate positive externalities that the government can then tax.

    I used to do NPV calcs for policy decisions, is that sort of thing a big secret?

    ReplyDelete
  8. Apologies in advance for my layperson understanding, but is Japan really comparable to the UK when you consider the proportion of government debt that is held overseas (Japan very little, UK a lot)? An international investor in government debt is investing in both the bond and the currency it is denominated in. Although central banks can print money to avoid default this would devalue the currency and international bond holders would suffer losses regardless. Surely many would sell as soon as this seemed a likely course of action? This is not a problem for Japan as its debt is largely held domestically but the UK is more reliant on international creditors.

    ReplyDelete
    Replies
    1. Why does the nationality of the bond holder make a difference?

      Delete
  9. The US finances it government debt internationally. In Japan the government debt seems to be held most domestically. Should this not make a big difference? It makes Japanese government debt immune for depreciation and capital flows?

    ReplyDelete
  10. SWL's post here seems a bit of kilter to some of his earlier posts on the composition and duration of any fiscal expansion designed to contribute to escape from the UK's prolonged stagnation, e.g:

    It cannot be undone by the government spending more on infrastructure: public investment is not some magic instrument that can get you any GDP you want.No economic theory that I know of suggests you can safely ignore the public finances outside of a recession. In a world where monetary policy regulates demand (absent the lower bound) then a build up in government debt risks crowding out private capital, discouraging labour supply (because higher debt has to be serviced through higher taxes) and redistributing income between generations (followed up in a response to a comments to the application of the incomprehensible 'interlapping generations model' - i'd be grateful for reference that explains it in plain english.

    I am not clear whether SWL's view is that a fiscal expansion should be limited to public investment - desirable but not a panacea - as he points out; that investment-financed investment should that only be limited to a time up to when we escape the ZLB, which suggests stop-go cycle in public investment levels, which will be very difficult to time correctly, even if desirable, and, how the 'interlapping generation theory' fits the japanese situation.

    I am also not clear of the precise role that carefully designed injections of 'helicopter money' might play.


    ReplyDelete
  11. Do you have a link for posts that have been translated into Japanese? Thanks

    ReplyDelete
    Replies
    1. Hello. This is the link to Japanese translation of Mainly Macro http://econ101.jp/category/translation/simon-wren-lewis/
      We've just started translating since last month so we haven't got many yet. Thanks! @chietherabbit

      (I think I replied to a wrong comment previously...)

      Delete
  12. Simon, take a look at: Hoshi, Takeo, and Takatoshi Ito. 2014. “Defying Gravity: Can Japanese Sovereign Debt Continue to Increase without a Crisis?” Economic Policy 29(77): 5–44. http://econpapers.repec.org/article/blaecpoli/v_3a29_3ay_3a2014_3ai_3a77_3ap_3a5-44.htm (November 17, 2015).

    Their answer is "NO."

    You probably know both of them from the conference circuit; I haven't seen them since the East Coast Japan Economic Seminar collapsed (as has the Washington and Southeast Japan Seminar). I've switched my own research from Japan to the (global) auto industry and to China.

    Since they wrote their paper, the policy of kicking the fiscal can down the road has continued. The margin of safety is very small. I didn't spot any holes in their paper, though I didn't try to put together my own spreadsheet. In particular, there's the net debt / gross debt distinction. Their argument is that doesn't really matter.

    ReplyDelete
  13. "In fact there is currently a very good reason to write about the Japanese economy, and that is a very strong 2107 Q2 performance."

    Makes note for my descendents to invest heavily in Japan 90 years from now... (I jest).

    ReplyDelete
  14. One quarter of good growth, whoopee. It's a little premature to be declaring victory.

    ReplyDelete

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time.