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Government and Economy

The National Debt Is Decreasing
Abenomics Needs No Tax Increase

Tomohiro Inoue
Assistant Professor, School of Political Science and Economics, Waseda University

After the landslide victory of the ruling parties in the last lower house election, Abenomics is to continue. With the rise of the Consumption Tax scheduled in two and half years, success of Abenomics will depend on how much economic stimulus can be implemented, or whether the rise of tax rate can be further postponed. An important point for both is that “There is no trade-off between economic recovery and fiscal consolidation.” I would like to discuss here why that is the case.

Increased Money Brings Economic Recovery

Loosening of monetary policy—that is, policy aimed at increasing money stock (the amount of money circulated in the private sector)—does not alleviate the pain, the problem, like morphine, nor does it create fortune without hard work like alchemy. The more money people have, the more consumption demand increases due to the wealth effect. Then, unemployed people start working, raising the actual volume of production through their work. While quite a few people misunderstand that the increase of GDP due to the increased money is an immoral activity of making a profit without taking pains, the volume of labor does need to increase in order for wealth to actually increase.

Conversely, failing to sufficiently increase money would result in deflationary depression. The rate of the money stock increase, i.e., the “monetary growth rate,” was on average about 9% in and before 1991 when the bubble burst, whereas on average about 2% afterward (Figure 1). The main reason for the “Lost Two Decades” was indeed the constant lack of demand due to such a dramatic decline in the monetary growth rate. Therefore, bold monetary easing is not an extraordinary or stopgap measure, but rather it can be seen for the time being as one trying to normalize the monetary economy.

Figure 1 Changes in Monetary growth rate Data Source: Bank of Japan Website

While this is the case, especially in the zero-interest-rate economy since 1999, private banks did not sufficiently lend to companies (Figure 2) even though the Bank of Japan (BOJ), the central bank, supplied money to private banks through the buying operation (a policy measure to purchase government bonds held by private banks). As a result, money did not go into circulation in the private sector, making the money stock difficult to increase for a long time.

Accordingly, the Abe administration and Kuroda BOJ tried a regime change (a fundamental change in the policy framework), implementing policy measures and announcements to make people have inflationary expectations and expectations for economic recovery. Their effect will not be examined here, as doing so would require a great deal of discussion.

In any case, when companies are not borrowing enough from banks, if the government borrows from banks and increases fiscal expenditures, money will go into circulation in the private sector (Figure 2). In other words, if the government increases borrowing by forcing banks to purchase government bonds and makes fiscal expenditures, the money stock will increase. If government debt is decreased by policy measures reversing this, namely tax increases, reduction of fiscal expenditures, and the like, the money stock will shrink as well, and therefore, recession cannot be avoided, regardless of how much people’s expectations are influenced.

The Debt of “Consolidated Government” Is Decreasing

Nevertheless, as the debt of government is over 1,000 trillion yen, many people are concerned about further increase of the debt. However, as a matter of fact, the “national debt” has been decreasing in recent years.

In economics, the government and the central bank combined are called the “consolidated government” (Figure 2). Since both the government and the central bank must be the public sector and national institutions, “national debt” should mean not the “government debt,” but the “debt of the consolidated government.”

Figure 2 Flow of Money

If the central bank purchases the government bonds held by private banks through the buying operations, the same amount of government bonds in the private sector are collected. In recent years, the amount of government bonds purchased by the BOJ has exceeded that of new issuance. In other words, the amount of government bonds held by the private sector has been decreasing, and so has the “national debt.” Therefore, there is no need to increase taxes at the moment.

In this case, however, the purchase of government bonds by the BOJ is the fiscal resource of government expenditure. This is called the “debt monetization,” which has been repeatedly criticized as damaging fiscal credibility and pushing up interest rates. But in reality, even the interest rates for long-term government bonds have been on a long-term declining trend, currently at less than 0.5%.

In the midst of so many cries for Japan’s fiscal crisis, it is not a mysterious situation where long-term interest rates are low and stable. The market instinctively understands that there is no risk for the debt monetization under deflation or disinflation (low-rate inflation).

While excessive inflation is an associated problem to be concerned with, the inflation target such as 2% can play a role in preventing it. Moreover, if the inflation rate exceeds 2% with the economy sufficiently recovering, tax revenues will naturally increase and the increased taxes can suppress overheating economic activity. Therefore, after the achievement of the inflation rate target, even if government interest payments increase due to the raising of interest rates, increased tax revenues exceeding that amount will enable fiscal consolidation. To say it conversely, until the inflation rate target is achieved and the zero-interest rate policy can be abandoned, there is no need to increase taxes, nor should they be increased.

Distribute Seigniorage to Japanese Citizens

Debt monetization also means making government expenditures using “seigniorage” (profit gained by issuing currency) as fiscal resources. Government has the following three fiscal resources:
(1) Taxes
(2) Government bonds
(3) Seigniorage
However, Japanese policy authorities have misunderstood that only (1) and (2) are fiscal resources. As a result, government has repeatedly made expenditures using government bonds as fiscal resources in order to recover economic activities, and when there is a sign of economic recovery, government has increased taxes to reduce fiscal deficit, and thereby pushed back economic activities. This makes it impossible to overcome deflationary depression forever. Unless such misunderstandings are corrected, the lost two decades will become even three or four decades.

By making government expenditures using seigniorage as fiscal resources, economic recovery can be achieved without increasing the national debt. We have not fallen into the dilemma of incompatible economic recovery and fiscal consolidation.

As for the target of government expenditures, cash benefits are more appropriate than public projects that are facing the restraint on supply (labor shortage). For instance, how about giving 10,000 yen to each Japanese citizen? I call it the “Citizen’s dividend of seigniorage,” which in my opinion should be developed into the “Basic Income,” which is said to be an ideal social security system.

Tomohiro Inoue
Assistant Professor, School of Political Science and Economics, Waseda University

Assistant Professor, School of Political Science and Economics, Waseda University. He graduated from Faculty of Environment and Information Studies, Keio University, and withdrew from the Doctoral Program, Graduate School of Economics, Waseda University after completing the course requirements. He assumed his current position in April 2012. He has a Ph.D. in Economics. His areas of Specialization are macroeconomics, currency economic theory, and growth theory. The books he authored include: New Textbook for Java [Atarashii Java no Kyokasho]; and Readings: Mathematical Approach to Political Science and Economics [Rideingusu: Seijikeizagaku heno Suriteki Apurochi)] (Co-authored).