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March 24, 2012

[SSJ: 7308] Re: Why Noda is pushing for a tax increase

From: Richard Katz
Date: 2012/03/24

Ron Dore wrote:

> I beg to differ from 'Rick Katz on
2 points. He says there is no

> difference between

>

>

>

>> (a)the government running a fiscal
deficit....auctioning an

>> eqaivalent

> amount of JGBs.... BoJ takes a similar quantity of

>> them out of circulation in the name of quntliitative
easing...
(b)

>> MoF simply paying its bills with yen it orders

> BoJ to print...

>

> The difference is that the BoJ adds more JGBs to its
balance sheet
in

> the one case, and reduces the percentage of
outstanding BoJs held

> privately.

>

I'm not sure I understand your point, but let me suggest three different scenarios. I think you are suggesting the difference between scenario 1 and 3. As background, keep in mind the important distinction between the GROSS debt of the govenment versus the NET debt owed by the government to the private sector. It is the latter that raises the possibilty of fiscal crisis. Recall that any profits made by the BOJ (including when the MOF pays it interest) go back to the MOF. So, for the MOF to owe the BOJ is the government owing money to itself.

SCENARIO 1: The MOF adds Y1 trillion to the deficit; it sells Y1 trillion JGBs to the private sector; the BOJ buys those Y1 trillion yen worth of JGBs by creating new money.

RESULT: a Y1 trillion increase in the GROSS debt of the MOF but ZERO increase in the NET debt owed by the government to the private sector. The increase in the monetary base is Y1 trillion. The operation prevents the increase in the fiscal deficit from pushing interest rates upward.


SCENARIO 2: The MOF adds Y1 trillion to the deficit; it sells Y1 trillion JGBs directly to the BOJ which the BOJ pays for by creating new money.

RESULT: Same as in Scenario 1: a Y1 trillion increase in the GROSS debt of the MOF but ZERO increase in the NET debt owed by the government to the private sector.
The increase in the monetary base is Y1 trillion. The operation prevents the increase in the fiscal deficit from pushing interest rates upward.


SCENARIO 3: The MOF adds Y1 trillion to the deficit; the BOJ creates new money which it simply hands over to the MOF so it can pay its bills. It gets no JGBs in exchange.

RESULT: A zero increase in the gross debt of the MOF and a zero increase in the NET debt owed. The increase in the monetary base is Y1 trillion. The operation prevents the increase in the fiscal deficit from pushing interest rates upward.

In all three scenarios, the increase in the net debt is zero; the increase in the monetary base is the same Y1 trillion; the fiscal stimulus is the same, and in all three operations the BOJ action prevents an upward spike in interest rates. And, because the fiscal action should add to both real and nominal GDP, the ratio of net debt to GDP will DECLINE.

Since net debt is the pivotal issue for fiscal stability and because the fiscal and monetary stimulus are exactly the same in all three scenarios, I maintain that there is no difference in the impact on either real growth or inflation. Since deflation began in the mid-1990s, the key to the ups and downs of inflation/deflation has not been the money supply, but the "output gap," i.e. the gap between what GDP could be at full employment and full use of physical capacity and what actual GDP is. So, in all three cases, the anti-deflationary impact from fiscal stimulus and keeping down interest rates is the same.

A useful paper on this theme is Bernanke's 2003 speech in Tokyo at
http://www.federalreserve.gov/boarddocs/speeches/2003/2
0030531/default.htm. I don't agree with everything he said, but I do agree with his proposal of a compact between the MOF and BOJ and what it would do.


> What effect that has on the
propensity to unload JGBs and raise

> interest rates I am not clever enough to work out.

>
In the first round, I don't see why it would cause anyone to unload JGBs or raise interest rates. Since the BOJ is buying JGBs, that increases their price, making them more attractive to private investors. The same action pushes interest rates downward, not upward.
When the BOJ announced its recent monetary ease, including increased purchases of JGBs, that pushed rates down.

Eventually, if the action helps to improve real growth and lower the output gap, that whould reduce deflation and bring about inflation. The question is what comes
first: does inflation rise first and then nominal interest rates rise later? If so, that would LOWER"real" (i.e. inflation-adjusted) rates. Or would bond investors demand an inflaton premium in anticipation of eventual inflation down the road? In that case, nominal rates would rise first and inflation later; that would RAISE real rates. The history over the past decade shows that, despite the explosion in government debt and in the money supply, 10-year bond rates have been lower than at almost any time in the past dozen years. So, I think combined MOF-BOJ stimulus would raise inflation first and nominal interest rates later.


> Secondly, I find it hard to
believe that if the government declared

> that it was going to expand the monetised deficit
until inflation

> reached 5%, and shortened the revision period for the
minimum wage
to

> ensure wage cost push, it would fail to lead to a
sell-off of JGBs


> and a rise in interest rates to the zone where
monetary policy
starts

> to be effective and isn't just pushing on a piece of
string.

>

>

If I understand you correctly, you seem to be saying that a rise in interest rates is a good thing because it would return Japan to the zone where monetary policy can be effective. I think that is confusing the cart and the horse. The key thing is to end the "output gap"
and restore normal (1-2%) inflation, and that will lead to a rise in nominal interest rates. The horse is the closing of the output gap and the return to inflation.
The cart is the rise in nominal interest rates.

As far as announcement effects go, there is absolutely no evidence that they have had any impact on behavior in Japan during the period of deflation. Announcement effects can add to the potency of monetary policy when a country has normal inflation. Monetary policy works very differently in a normal situation from one in which there is deflation and rate are at, or virtually at, zero.

By the way, on Friday, the Wall Street Journal ran an oped by me under the title "How Japan Blew Its Lead in Electronics." For subscribers, it's at
http://online.wsj.com/article/SB10001424052702304636404
577297621752245682.html?mod=ITP_opinion_0. In the Asia edition, it's at
http://online.wsj.com/article/SB10001424052702304724404
577297102672086074.html?mod=WSJ_Opinion_LEFTTopBucket


Richard Katz
The Oriental Economist Report

Approved by ssjmod at 11:17 AM