Domestic Bonds

Does Japan Justify Modern Monetary Theory?

Public debt has skyrocketed since the 2008 financial crisis, and especially during the Covid-19 pandemic. According to the International Monetary Fund (IMF), the ratio of public debt to gross domestic product (GDP) in advanced economies rose from around 70% in 2007 to 124% in 2020. But the fear that the increase in Public Debt Fuels Future Financial crises have been moderated, in part because government bond yields have remained so low for so long.

Although yields started falling much earlier, in the 1990s they were kept low by quantitative easing (QE) after the recessions of 2008 and 2020. Few doubt that massive budget spending was warranted for it. alleviate the suffering during these episodes. But supporters of modern monetary theory (MMT) take this logic a step further.

MMT supporters argue that as long as the debt is denominated in a country’s currency, there is no reason to fear a budget crisis, because a default cannot occur. Any withdrawal of fiscal stimulus should therefore be gradual. And in the meantime, new public debt issuance can be used to fund infrastructure investments, income support programs and other items on the progressives’ agendas, provided the inflation rate remains. below the central bank’s target (typically around 2 percent).

MMT boosters cite Japan as a proof of concept. Even though Japan’s debt-to-GDP ratio (including central and local government) is above 250%, compared to 160% in the United States, its 10-year government bond yield has remained around zero throughout. along the Covid-19. pandemic, and its average inflation rate has barely exceeded zero for 20 years. New annual bond issues and skyrocketing debt levels have not had an apparent impact on borrowing costs.


But before other countries rush to emulate Japan, they should keep in mind that Japanese government bonds are issued in yen, and almost all of them are held by Japanese residents, both directly and indirectly. through financial institutions and the central bank. This makes Japan quite different from the United States, whose treasury bills are held by investors all over the world.

Some Japanese politicians believe their country should be praised as an example of MMT. This month, the Diet approved a supplementary budget, which is based on the issuance of 22 trillion yen ($ 192 billion) in new bonds, in addition to the 44 trillion yen of the original budget. The total new issues during the year therefore amounted to 66 trillion yen, or about 12% of GDP. One of the controversial items of expenditure in the supplementary budget is to transfer 100,000 to all resident minors (18 years or less).

One thing that MMT advocates are right about is that the Japanese government doesn’t need and shouldn’t default on its debt. Even if there are no buyers for it, the Bank of Japan (BoJ) can continue to buy new and renewed bonds with cash injections. This can lead to very high inflation. But MMT supporters would say bond issuance can be stopped if and when the inflation rate exceeds 2%.

The problem is, by then it may be too late. With the debt stock having grown so much, it would take sudden massive fiscal consolidation to pay off the repayment of existing maturing bonds. A sudden stop to issuing bonds at an inflation rate of 2% would likely lead to a severe recession. The only other option would be for the BoJ to continue to buy back the debt, which would lead to even higher inflation or even hyperinflation.

Moreover, the fact that a default can be avoided does not mean that continuing to issue bonds after the acute phase of the crisis improves social welfare. Cash transfers, such as the one just approved, and other programs benefit current generations, while the tax burden of eventual bond repayments will be borne by future taxpayers – many of whom may not be. still alive. And even when existing bonds are renewed indefinitely, interest payments for current debt-financed consumption will be borne by future generations.

The validity of the MMT depends in part on the projected real growth (adjusted for inflation) per capita. If the population grows and future generations will be richer than current generations, the “burden” of current bond issuance will indeed be low. In this sense, bond issues intended for consumption function as pay-as-you-go pension systems. As long as the economy grows faster than the interest load, PAYGO makes a sense of the way, because each generation can just pass the load on to the next generation, endlessly.

Like a Ponzi scheme, this only works as long as the base of the pyramid continues to expand. In the United States, the government could continue to go into debt and maintain its PAYGO social security system for several decades. But Japan does not enjoy such luxury. Its population has been declining since 2008 (and its working-age population since 1998) and its per capita income has stagnated for 30 years. The scheme will soon collapse.

Japanese voters and politicians cannot continue to view the liquidity from new and renewed bond issues as a godsend. If the electorate wants income redistribution, they must accept that the transfer will come from the rich today (many of them are elderly), rather than future generations. And if the social security system has become too generous, due to overly optimistic projections, there should be a clawback.

If, on the other hand, fiscal stimulus is needed, spending should be directed more wisely to support future growth, for example by stimulating investment in human capital and innovation. But a blanket endorsement of MMT and its political implications is the last thing Japan needs. Now that the acute phase of the crisis has passed, Japanese leaders would do well to start thinking about the country’s huge stock of debt.

The writer, a former Japanese vice minister of finance, is a professor in the School of International and Public Affairs at Columbia University and a senior professor at the National Institute for Advanced Policy Studies in Tokyo. © Project Syndicate, 2021