Commentary / World

Can MMT be Japan's savior?

by Sayuri Shirai

Modern Monetary Theory (MMT) has become a hot issue, especially after U.S. Rep. Alexandria Ocasio-Cortez stressed its importance in boosting public spending for education and medical services. The global economic slowdown, rising inequality and limited opportunity for additional monetary easing support a fiscal expansionary policy.

MMT claims that governments never default on their own currency-denominated debt because they have a monopoly on supplying the currency. Thus they should increase public spending to achieve full employment and price stability. Neither taxes nor bond issuance are necessary to finance public spending. Expansionary fiscal policy can be sustained until substantial inflationary risk emerges, which in turn can be controlled through a tax hike.

MMT claims that fiscal policy is powerful with the ability to directly increase employment through various projects and the ability to adjust inflation through taxes. In contrast, monetary policy is ineffective for several reasons. Interest rate cuts do not generate sufficient credit demand when the outlook on firm profitability and household income is weak. Reduced interest income also discourages private sector spending.

Moreover, monetary easing may promote private sector debt, thus reducing private sector net wealth and potentially leading to the financial and private sector debt crises. Therefore, monetary policy should play the passive role of making fiscal policy as effective as possible by setting interest rates at around zero percent persistently. This leads to the provocative conclusion that monetary policy can only control interest rates, not inflation, which poses a major challenge for modern central banking practices.

Professor Stephanie Kelton of Stony Brook University, an MMT proponent, says Japan has been conducting MMT for some time — a contention rejected by Prime Minister Shinzo Abe and BOJ Gov. Haruhiko Kuroda because of the government’s commitment to getting its fiscal house in order.

What will be the implications of MMT for Japan if it is adopted? Japan’s household consumption has remained weak over the past two decades, reflecting stagnant real income growth — mainly arising from low productivity growth. Households’ nominal disposable income has remained below the 2000 level. Weak consumption is also related to the aging society. Many people have doubts about the sustainability of the national pension system — as evidenced by the relatively low non-payment ratio of compulsory pension premiums (about 30 percent currently) — especially among the young generation.

This is attributable to inter-generational equity problems where current pensioners receive more benefits than they paid while the younger generation is expected to pay more than current pensioners but receive less benefits than current pensioners since the national pension is basically a social insurance “pay as you go” plan (partially funded by taxes and reserves).

Given these backgrounds, MMT proponents might recommend that Japan’s government increase pension and other social security benefits generously, and postpone the consumption tax hike scheduled for October. Also, the government should increase productivity by spending more on information networks, occupational training and computer science-intensive education, as well as R&D related to health care, new drugs and medical treatment methods.

What are the blind spots in applying MMT in Japan? First, little economic slack is left due to the labor shortage caused by unfavorable demographics. Increased government spending may only exacerbate the labor constraint and squeeze private sector economic activities. The recent liberalization policy to accept more temporary foreign workers is welcome but will not be enough to offset the labor shortage.

Second, the government needs good communication skills to convince households that the social security system will always be sustainable despite mounting aging-related costs and the generous provision of pension benefits and health/elderly care services. However, should inflationary risk emerge, the government might be compelled to cut social security benefits as the sustainability of such a generous social security system diminishes. If households anticipate this event, concerns about aging problems and the sustainability of the social security system will always persist.

Third, substantially low interest rates may be sustaining zombie firms and discouraging vital corporate restructuring, exerting downward pressure on productivity growth. Japan’s potential economic growth has already declined from 1 percent in 2014 to less than 0.7 percent today mainly due to a decline in total factor productivity growth. The adverse impacts of unconventional monetary easing on financial repression and market distortion are also not well covered by MMT.

Major challenges center on the implementation of MMT in Japan, which may not be able to solve the nation’s complicated long-standing structural problems.

Sayuri Shirai is a visiting scholar at the Asian Development Bank Institute, a professor at Keio University, and a former Bank of Japan board member.