Why Japan needs debt monetisation
by Etsuro Honda
Shinzo Abe, the Japanese prime minister, has achieved one notable success in lowering the budget deficit. His economic policies – Abenomics – have resulted in improved tax revenues and reduced spending, and this budgetary regime change is set to be maintained.
Now, four years after Abe was elected to his second term in office in December 2012, it is time for a further change in applying Abenomics. When he took office, Abe and his officials believed that only monetary policy could effectively tackle deflation, although it was by no means a panacea. The stage is now set for developing policy further, and using fiscal means to play a significant role.
I favour continued fiscal expansion through the issuance of new Japanese government bonds worth ¥35tn-¥40tn, which will be purchased by the Bank of Japan.
This process of debt monetisation could prove to be the most effective means of overcoming the deflation trap which has beset Japan for the past 20 years.
Monetary easing is already in place and the BoJ has achieved strong results in many fields. The transmission of monetary policy has been particularly successful, and banks are adopting increasingly accommodative lending policies for both large and small enterprises. Unlike in other large economies, there has been no ‘credit crunch’ in Japan.
There is a consensus among government officials and monetary policy-makers that Japan requires further bold measures to escape its deflation trap. The priority must be improving macroeconomic strength. This feeds through to increased tax revenue, which is preferable to raising domestic tax rates.
Abenomics has set the economy on course for steady recovery. For the company sector, this recovery has already been demonstrated through increased profitability, in part because of a depreciating yen which is boosting exports. Corporate strength is improving employment conditions. Unemployment has fallen substantially. The output gap has narrowed and is close to zero, according to BoJ estimates.
More robust fiscal stance
In line with the 2% inflation target, and with the shift to tightening in the US, a more robust fiscal stance through monetary financing would allow the BoJ to redraw monetary policy, especially in adjusting monthly government bond purchases.
However, the BoJ should start tapering only once the inflation rate looks likely to stabilise above 2%. It is important to show investors that the rate will be maintained and sustained in the long term. When tapering occurs it will, by necessity, be a very careful process.
Sustainability of growth remains the most important factor for Japan, and a new operational framework will provide room for fine-tuning. To achieve sustainability, however, the real issue is how to change the mindset of corporate investors and managers.
Better coordination is needed between the government and the BoJ in terms of Japan’s balance sheet. This arrangement has been far from perfect so far, taking as one example the increase in Japan’s consumption tax in April 2014. The adoption of this measure was premature, and at the time worked against monetary easing.
Eventually the consumption tax will need to be raised to bring Japan in line with other advanced economies, particularly as it becomes an increasingly cashless society. Overall, however, a real estate or inheritance tax might prove more beneficial than a consumption tax. This is especially true given the backdrop of rising economic inequality, as real estate and inheritance taxes can act as a means of redistributing wealth among elderly people and help support middleincome household growth.
Etsuro Honda is Japanese Ambassador to Switzerland, Ambassador for Economic and Financial Affairs in Europe, and a former economic adviser to Prime Minister Shinzo Abe. Back