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With Japan’s economy following a recovery path, how fast it should grow in coming years is a subject of vigorous debate in the government and the ruling parties. The debate, however, is being conducted largely in numerical terms, with the focus on how to set target levels for nominal growth rates (excluding the effects of price changes) and long-term interest rates. The broad policy question of how to achieve sustainable growth is left more or less on the back burner.

With the long spell of deflation now coming to an end, or so it appears, a key objective of future economic policy is to rebuild debt-ridden public finances. The government’s Council on Economic and Fiscal Policy is looking to bring the budget into “primary balance” (excluding bond issuance and debt service) in the early 2010s. The council is expected to give details of this “road map” in its blueprint for “integrated reform of revenues and expenditures” to be published in June. The central question is how much taxes should be increased.

The debate on desirable nominal growth rates and long-term interest rates is welcome, since the setting of such numerical targets provides certain parameters for tax increases. The discussion, though, could end up as a numbers-juggling exercise if targets are set artificially at levels based on politically calculated tax increases “acceptable” to the general public. The economy may or may not perform as targeted. If it misses the mark, more realistic targets will have to be set, and people will suffer the consequences of readjustment.

Balancing the budget requires a combination of spending cuts and tax increases. Perhaps the public knows well that the “either/or” approach of cutting spending or raising taxes is unrealistic. With the fiscal 2006 budget now before the Diet, politicians appear reluctant to discuss tax hikes. That may be why they are focusing on numbers, instead of debating more substantial ways of reducing the budget deficit.

The “numbers game” pits politicians who favor “solid” growth against those who’d like to see more “positive” growth. On the face of it, the logic seems simple: the higher the nominal growth rate, the more tax revenues can be expected to increase without tax hikes. Moreover, if long-term interest rates lag growth rates, the cost of government borrowing can be limited; tax increases, if necessary, can be carried out at lower rates; and government debt as a percentage of gross domestic product can be reduced. The opposite will happen if long-term interest rates exceed nominal growth rates.

A leading advocate of higher growth is Mr. Hidenao Nakagawa, chairman of the Liberal Democratic Party’s Policy Research Council, who asserted recently in a session of the Lower House Budget Committee that the economy had the nominal potential to grow 4 to 5 percent. Faster economic expansion, he emphasized, is needed to prevent the gap between the rich and the poor from widening as a result of structural reforms.

Echoing his position is Mr. Heizo Takenaka, minister of internal affairs and communications, who is in the forefront of Prime Minister Junichiro Koizumi’s push to privatize postal services. Both Mr. Nakagawa and Mr. Takenaka argue that long-term interest rates should be set lower than growth rates.

By contrast, Mr. Kaoru Yosano, minister for economic and fiscal policy, and Mr. Sadakazu Taniguchi, the finance minister, maintain that the economy should be able to expand 3.2 percent in fiscal 2011. They favor tackling fiscal reform in more “responsible” ways, meaning that long-term interest rates should be set higher than nominal growth rates and that taxes should be increased on a larger scale.

Long-term interest rates and nominal growth rates are related to the rate of inflation. Therefore, if prices are forecast to rise higher, the expected inflation rate will rise as well, making it more likely that long-term interest rates will exceed nominal growth rates. Conversely, with lower price rises, nominal growth rates will drop.

Therefore, setting a specific level of price increases under an inflation target in order to keep long-term interest rates below nominal growth rates could put the onus of controlling long-term interest rates squarely on monetary policy.

The Bank of Japan appears to be moving toward lifting its money policy of “quantitative easing” now that the economy is showing growing signs of a solid recovery. It would be good if the nominal growth rate went up as stepped-up economic activity pushed up the potential growth rate. Painting a false picture of the real economy by juggling numbers or mismanaging policy could put the cart before the horse.

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