January 22, 2013
The Guardian Unlimited, January 22, 2013
Economists like to say there’s no such thing as a free lunch – this was even the title of a 1975 book by Milton Friedman. But sometimes there is a free lunch – in a vitally important sense – and now is one of those times for a lot of countries suffering from unnecessary unemployment and in some cases, recession.
Adam Posen doesn’t want to recognize that this is the case for Japan at present. Posen is president of the Peterson Institute for International Economics, which is probably Washington’s most influential think tank on international economics. Posen is not an “austerian” economist – in the second half of the 1990s he supported expansionary fiscal policy in Japan; and more recently, as a member of the Bank of England’s Monetary Policy Committee from 2009-2012, he supported expansionary monetary policy, including quantitative easing and very low interest rates.
So it is worth looking at his argument, because it may help us understand how the mainstream of the economics profession can sometimes be an obstacle to global economic recovery, as well as to important social goals such as reducing unemployment and poverty.
The Japanese government of Shinzo Abe recently announced a large stimulus program; the exact size is not clear but the government is seeking to boost GDP growth by 2 percentage points. That would seem to be a good idea, since the Japanese economy is currently in recession, and the world economy to which it exports is not doing so well either. Japanese inflation is currently negative, which means that the government can create money to pay for the stimulus without having to worry about increasing inflation. In fact, deflation is the much greater worry, and the government wants the central bank to target a 2 percent inflation rate. (Deflation tends to discourage consumption, because purchases will be cheaper in the future; and investment, because investors are looking at shaky demand in the future, especially with the economy already in recession).
This is what I mean by a free lunch. In fact, it’s a free lunch and a five-course dinner plus dessert. It costs the central bank nothing to create this money for the government to spend; and any resulting increase in inflation actually helps get the Japanese economy out of its slump. It also means that the government doesn’t have to add anything to its net debt – so, no increase in the public debt burden for the future.
But Posen argues that it’s an idea whose time has past. Here is the crux of his argument:
Stuffing bank balance sheets with JGBs [Japanese government bonds] has constrained commercial lending by those banks – even during the recovery of 2003-08 – which harmed small and new business development. The persistently low returns on Japanese savings have further squandered investment opportunities, thereby creating a negative feedback loop with deflation and older savers’ risk aversion. The absence of external pressure has fed the combined long-term appreciation of the yen and stagnation of Japanese stock market returns, both severely distorting the economy. Needed public investment and funds for adequate healthcare and disaster recovery have been crowded out by debt payments …
I find it difficult to believe that Japanese government debt payments are crowding out public spending, much less private investment. Net interest payments on Japan’s public debt are less than 1 percent of GDP. (This is also true for the U.S., incidentally, for those who have debt-phobia here.) This is quite small. I am also skeptical about the other problems that he attributes to Japan’s debt accumulation, such as the long-term appreciation of the yen and low stock market returns. These have multiple causes, as does the amount of commercial lending by banks – which is more likely to be constrained by a weak economy than by government spending.
In any case, it’s difficult to see how a new stimulus program, financed by money creation, would worsen any of these problems – even if the potential for such an effect were possible — since it doesn’t add to the country’s net debt burden or reduce banks’ lending capacity.
And a big chunk of the stimulus is targeted toward “needed public investment” and disaster reconstruction that Posen is worried about being crowded out by public debt.
From a public interest perspective, the only worries about a stimulus program like this one would be if the money were poorly spent, e.g. on environmentally destructive rather than constructive activities; and – to a much lesser extent, if the government were to finance it through borrowing from the public, rather than the central bank (i.e. the free lunch).
Posen also argues that the stimulus won’t fix Japan’s “real problem” which is “a return to deflation and an overvalued currency.” But it’s more likely to reduce these problems than to make them worse. Indeed press reports have noted:
The expectation of aggressive monetary easing and a much bolder BOJ [Bank of Japan] since Abe, who was prime minister in 2006-2007, returned to power has sparked a bull run in Japanese markets.
Tokyo’s benchmark stock index, the Nikkei 225, has soared more than 20 percent since mid-November, while the yen has fallen roughly 11 percent in anticipation of aggressive monetary easing. The Nikkei hit a fresh 23-month high on Friday following the release of the stimulus package.
I would also take issue with a certain “false equivalence” regarding the alleged dangers of fiscal stimulus (in this case involving an economy with actual deflation) versus austerity, at a time when not only Japan but Europe is in recession, and much of the global economy is weak and facing downside risks. Posen writes:
Persistent fiscal policies that fail to adapt to changing cyclical conditions result in long-term damage. This holds true whether a government errs on the side of excessive austerity, as in Europe of late, or on the side of unjustified indiscipline, as in Japan since its recovery a decade ago . . . Italy, the UK and the US should fear the structural damage of following Japan’s example if fiscal expansion is not timed to end with recovery.
But the U.S. recovery is too weak; at the current pace it will take more than a decade to get back to full employment. This is unacceptable. The world economy is projected to grow at 3.6 percent this year, as compared with 5.1 percent in 2010. Japan’s example should be followed anywhere that there is the economic capacity to do so, including in the United States and the eurozone.