Tsutomu Watanabe University of Tokyo & Nowcast Inc.

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1 Tsutomu Watanabe University of Tokyo & Nowcast Inc. February 10, 2017

2 My comments 1. More on US-Japan comparison Abenomics, which started in late 2012, was successful at least in its early stage in raising the inflation rate. Did unbacked fiscal expansion (UBFE) play any role during this process? 2. Fiscal policy commitment to end deflation A second lesson from the Roosevelt policies is that fiscal stimulus and fiscal sustainability need not be in conflict (p.42) Temporary UBFE Is it possible for the fiscal authority to be active in the short run but passive in the long run? 2

3 Number of tweets with シムズ (Sims) Lecture by Prof Sims at Nikkei Hall on Feb 1 3

4 Comment #1: More on US-Japan comparison 4

5 25 20 CPI Inflation Overnight Call Rate

6 1. Aggressive monetary easing 2. Flexible fiscal policy 3. Growth strategy that promotes private investment 6

7 Main nominal variables during the Great Depression Dollar/Pound right scale Nominal wage left scale CPI left scale Jan-29 Jul-29 Jan-30 Jul-30 Jan-31 Jul-31 Jan-32 Jul-32 Jan-33 Jul-33 Jan-34 Jul-34 Jan-35 Jul-35 Jan-36 Jul-36 Jan-37 Jul-37 7

8 0.02 Main nominal variables during the Abenomics period CPI left scale Yen/Dollar right scale Main nominal variables during the Great Depression Nominal wage left scale Dollar/Pound right scale Nominal wage left scale CPI left scale Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul Jan-29 Jul-29 Jan-30 Jul-30 Jan-31 Jul-31 Jan-32 Jul-32 Jan-33 Jul-33 Jan-34 Jul-34 Jan-35 Jul-35 Jan-36 Jul-36 Jan-37 Jul

Source: M. M. Jacobson, E. M. Leeper, B. Preston, Recovery of 1933, October 2016.

9 Source: M. M. Jacobson, E. M. Leeper, B. Preston, Recovery of 1933, October Unbacked fiscal expansion => lowers nominal bond price and raises the price level => lowers real bond price 9

0.6 Nominal and Real Prices of Bond Portfolio: US 0.4 0.2 0.0-0.2-0.4-0.

10 0.6 Nominal and Real Prices of Bond Portfolio: US Mar-20 Mar-21 Mar-22 Mar-23 Mar-24 Mar-25 Mar-26 Mar-27 Mar-28 Mar-29 Mar-30 Mar-31 Mar-32 Mar-33 Mar-34 Mar-35 Mar-36 Mar-37 Mar-38 Mar-39 Mar-40 Mar-41 Nominal bond price Real bond price CPI Source: M. M. Jacobson, E. M. Leeper, B. Preston, Recovery of 1933, October This cheapening of bonds is consistent with bondholders substituting out of debt and into buying goods and services an increase in aggregate demand triggered by unbacked fiscal expansion. (p.18) 10

0.11 0.09 Nominal and Real Prices of Bond Portfolio: Japan 0.6 Nominal and Real Prices of Bond Portfolio: US 0.07 0.4 0.05 0.2 0.0 0.03-0.2 0.01-0.

11 Nominal and Real Prices of Bond Portfolio: Japan 0.6 Nominal and Real Prices of Bond Portfolio: US Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Nominal bond price Real bond price CPI -0.6 Mar-20 Mar-21 Mar-22 Mar-23 Mar-24 Mar-25 Mar-26 Mar-27 Mar-28 Mar-29 Mar-30 Mar-31 Mar-32 Mar-33 Mar-34 Mar-35 Mar-36 Mar-37 Mar-38 Mar-39 Mar-40 Mar-41 Nominal bond price Real bond price CPI Source: M. M. Jacobson, E. M. Leeper, B. Preston, Recovery of 1933, October This cheapening of bonds is consistent with bondholders substituting out of debt and into buying goods and services an increase in aggregate demand triggered by unbacked fiscal expansion. (p.18) Such substitution did not occur in Japan. 11

12 Fiscal dominance in Japan? Some argue that Japan is already in fiscal dominance (active FP & passive MP) because ❶ Monetary policy is passive due to ZLB ❷ The government conducts fiscal expansion as second arrow of Abenomics. Given this, they argue that the consumption tax hike in April 2014 was a mistake as it made the expectation of primary balance higher, thereby creating downward pressure on the inflation rate. However, the rise in nominal and real bond prices in the early phase of Abenomics does not seem to be consistent with fiscal dominance. A more natural interpretation of this result is that Japan was still in monetary dominance (passive FP & active MP). Monetary easing by BOJ brought about a substantial rise in nominal bond price, but only a slight rise in goods prices, and consequently a rise in real bond price. Implications: ❶ There was still room for BOJ to conduct active monetary policy despite ZLB ❷ Given that Japan was in monetary dominance, it is not easy to make a case against the consumption tax hike in April

13 Comment #2: Fiscal policy commitment to end deflation 13

14 Temporary UBFE by FDR Yes, it depends entirely on how you define the term, balance the budget. What we are trying to do is to have the expenditures of the Government reduced, or, in other words, to have the normal regular Government operations balanced and not only balanced, but to have some left over to start paying the debt. On the other hand, is it fair to put into that part of the budget expenditures that relate to keeping human beings from starving in this emergency. I should say probably not...you cannot let people starve, but this starvation crisis is not an annually recurring charge. I think that is the easiest way of illustrating what we are trying to do in regard to balancing the budget. I think we will balance the budget as far as the ordinary running expenses of the Government go. Roosevelt (1933a, pp ) 14

15 Temporary UBFE by Abe? On January 11 of this year, the government decided the Emergency Economic Measures for the Revitalization of the Japanese Economy, intended to avoid a recession and paving the way to the growth strategy. The government also decided the supplementary budget for fiscal 2012 giving concrete form to the Measures. Efforts toward fiscal consolidation are extremely important for the three-arrows strategy to demonstrate its effects in a sustained way. Source: Basic Policies for Economic and Fiscal Management, Decided on by the Cabinet on June 14,

16 Fiscal policy commitment to support a temporary UBFE In t=1, tax cut of 100m and the new issue of JGB by 100m. The fiscal authority announces a state contingent plan in t=1: ❶ It will adopt active fiscal policy in t=2, and increase tax by 80m (in real terms) in t=2 ❷ In t=3 and after that, it will continue to adopt active fiscal policy until the price level goes up sufficiently so as to raise inflation tax revenue by 20m. ❸ Once the price level goes up sufficiently, the fiscal authority will switch from active to passive policy. Unique equilibrium: The price level goes up and inflation tax by 20m is raised in t=1 Switch from active to passive fiscal policy occurs in t=3 The fiscal commitment is equivalent to saying that the fiscal authority will continue active FP as long as the prices level does not go up sufficiently. Such a permanent active policy occurs only off the equilibrium path, but the commitment to it is crucial in changing people s expectations. 16

17 The Japanese data in indicates that Japan is still in monetary dominance (active MP & passive FP) rather than in fiscal dominance (passive MP & active FP). It may be a good time to think about switching to fiscal dominance and conduct temporary UBFE to end deflation. However, it may not be so easy for the fiscal authority to make credible commitment to temporary UBFE. The fiscal authority needs to announce that it will not stop active FP unless the price level rises sufficiently, which is a big departure from the current fiscal policy rule. 17

Delinquent ratio for the National Pension 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.

6% 2006 2008 2010 2012 2014 90 80 70 60 50 40 30 20 10 0 78.6 43.7 68.3 Delinquent Ratio by Age 61.8 50.1 48.9 57.9 57 57.1 42.

18 Delinquent ratio for the National Pension Delinquent Ratio in FY % FY % FY % FY % FY % FY % Delinquent Ratio by Age Delinquent / Total Age group Delinquent / (Total - Exempted) The delinquent ratio for the national pension started to decline in 2013, when Abenomics started, suggesting that people became more optimistic about fiscal sustainability

Japan's Growth Potential and Quantitative and Qualitative Monetary Easing

June 3, 2 0 14 B ank of Japan Japan's Growth Potential and Quantitative and Qualitative Monetary Easing Remarks at a Panel Discussion at The Bank of Korea International Conference 2014 Kikuo Iwata Deputy