Prime Minister Shinzo Abe’s administration has a habit of co-opting Nobel Prize-winning economists when it lays the groundwork for contentious policy decisions.
It’s not surprising then that the visit of Christopher Sims, a professor at Princeton University, has ignited speculation in Japan that the government may be looking to soften its deficit reduction targets or yet again postpone a hike in the consumption tax.
Sims sees monetary policy as constrained by interest rates having hit rock bottom and advocates that the government step into the breach with expansionary spending.
Since his visit early last month, lawmakers have peppered the government and the Bank of Japan with questions about his policy prescriptions, and his “fiscal theory of price levels” has featured in research reports by private economists in Tokyo.
With a government debt load that’s more than double the size of the gross domestic product and the heaviest burden of any major economy, the stakes could hardly be higher for Japan.
Policymakers seeking to rein in the problem face conflicting choices: raise taxes and limit spending, which could cripple the economy and choke the government’s revenue stream; or risk spending more in the hope this generates enough growth and inflation to pay down the liability later.
When interest rates can’t go any lower, fiscal policy has to step in and “start being contingent on inflation,” Sims said in an interview last week. “This is not a policy that says debt doesn’t matter. It’s a policy that says that we’re not going to rely on taxes and spending cuts to do all of the debt resolution.”
Speaking by telephone from the U.S., Sims repeated his position that Japan’s consumption tax, which is scheduled to increase by 2 percentage points to 10 percent in late 2019, should stay where it is until consumer price gains reach the government’s 2.0 percent target. The most recent reading of the core consumer price index is 0.1 percent.
Sims is by no means the first American economist to have a major impact on debate over Abenomics. Fellow Nobel laureates Paul Krugman and Joseph Stiglitz were both closely linked to decisions by Abe to delay hiking the consumption tax, after an increase that went ahead in 2014 threw the economy into recession.
Sims’ view could also provide cover for the government to delay or abandon its 2020 target for achieving a surplus in the primary balance, which weighs revenue against spending, excluding bond sales and interest payments.
Even under the most optimistic scenario put forward by the Cabinet Office, this looks unattainable and Abe recently told the Diet that he isn’t a “primary balance supremacist.”
Finance Minister Taro Aso said earlier this month that economic growth is more important than the fiscal balance, then about a week later reaffirmed his commitment to the 2020 target.
Bank of Japan Gov. Haruhiko Kuroda sees little practical appeal in Sims’ prescription. In response to questions in the Diet, Kuroda described Sims’ thesis as academic and said he “doesn’t think it’s a realistic or meaningful policy theory in Japan or the U.S. or Europe.”
Kuroda, Abe and Aso also need to be mindful of a 2013 joint statement in which the BOJ pledged to do its best to beat deflation while the government would “steadily promote measures aimed at establishing a sustainable fiscal structure.”
If taken to the extreme, Sims’ ideas can be read to imply that the government can create inflation if it “credibly promises to be irresponsible,” BNP Paribas economists led by Ryutaro Kono wrote in a report.
Kono, a 2012 nominee to the BOJ Policy Board whose appointment was blocked by Abe’s Liberal Democratic Party while it was still in opposition, wrote that Sims’ ideas can’t be counted on to produce results but could be used to justify spending.
Koichi Hamada, an economic adviser to Abe, sees it very differently. He said a speech Sims gave at a symposium for central bankers in Jackson Hole, Wyoming, last year provides “a clear diagnosis of the Japanese economy’s problems — and points to solutions.”
Hamada accompanied Sims to various meetings in Tokyo last month. While Sims met officials at the central bank and the Finance Ministry, he didn’t see Kuroda or Abe.
But he would be pleased to come back and put his theory forward once more, and thinks the government shouldn’t wait too long before deciding whether to delay the consumption tax again.
“I don’t want to give unsolicited advice if people don’t want it,” Sims said, while adding, “I’d certainly be happy to come back to Japan and talk to anybody that wants to talk about this.”