Leonard Schoppa wrote:

>I'm struck that if all of the banks try to do what
Tokyo-Mitsubishi UFJ
>is planning (switch into 1-year bonds), Japan will
lose much of its
>ability to "inflate away the debt"...
>
snip

>once everyone realizes the government has pushed the
inflation button
>
The notion that the BOJ has some magic wand to create inflation is a myth perpetuated by monetarist economist against all evidence. The BOJ has printed money like mad. But once interest rates hit zero, we're in a new ballpark. The biggest factor in inflation/deflation in Japan is the size of the "output gap," i.e. the gap between actual GDP and potential GDP at full employment and full use of capacity. The gap is now about 5% of GDP. By the way, the same is true in the US. The Fed has printed money like mad since the Lehman shock.
While this prevented a complete financial meltdown in
2009 and has pushed interest rates to the floor, it has not created inflation.

>It is possible to inflate away
>debt if much of the government's holdings are in
10-year bonds or
>longer, at low interest rates.
>

According to an article in the Feb. 23 Wall Street Journal, about 44% of Japan Government Bonds are held by banks and another 21% by insurance companies. The WSJ cites Nana Otsuki, an analyst at Merrill Lynch Japan Securities, as saying that the duration of domestic bonds held by major banks at the end of December was two to 3.3 years.

>interest rates that will be much higher once everyone
realizes the
>government has pushed the inflation button
>
One of the big debates is what will go up faster:
inflation or nominal interest rates in anticipation of inflation. The BOJ, in my view, retains the power to push rates to the floor over the next decade as Japan keeps running a current account surplus (i.e. a surplus of domestic savings over domestic borrowing). So, if Japan could stimulate enough demand in the real economy to narrow the output gap, then it could produce inflation. In that situation, Japan could move from positive "real" (i.e. inflation-adjusted) interest rates, to negative ones.

>Perhaps this is why Noda is pushing so hard for the
increase in the
>consumption tax. If he can pull this off and bring in
enough revenue
>to shift the debt trajectory off this path, the banks
will be reassured
>and won't begin shifting into one-year bonds. I can
imagine the MOF
>guys laying this out for Noda. If you were the PM,
wouldn't this
>influence your calculus, even if an election were on
the horizon?
>
>
If I believed the MOF and if I believed that my efforts would bring eventual passage of the tax closer to realization, even at the cost of my job and my party, perhaps. But what my failure makes others even more reluctant to lose their seats by pushing for an unpopular tax?

Richard Katz
The Oriental Economist Report