Nighttime Must-Read: Kenneth Rogoff: Can Japan Reboot?
The very sharp Ken Rogoff muses about Japan:
Can Japan Reboot?: “How can aging advanced economies revive growth after a financial crisis?… The first round of… ‘Abenomics’… failed to generate sustained inflation…. The question is… Abenomics 2.0…. My own view is… Abenomics 1.0 basically had it right: ‘whatever it take’” monetary policy to restore inflation, supportive fiscal policy, and structural reforms…. The central bank… has been delivering… the other two ‘arrows’… have fallen far short. There has been no significant progress on supply-side reforms…. The timing of the April 2014 consumption-tax hike (from 5% to 8%) was also unfortunate….
Mind you, Japan’s outsize government debt and undersize pension assets are a huge problem, and only the most reckless and crude Keynesian would advise the authorities to ignore it. For the moment, the risks are notional, with interest rates on ten-year government debt below 0.5%. But saying that Japan’s debt is irrelevant is like saying that a highly leveraged hedge fund is completely safe; the risks may be remote, but they are not trivial…. What if… a sharp decline in emerging-market growth led to a sharp rise in global real interest rates, or a rise in risk premia on Japanese debt?… It is folly to deny the country’s vulnerability…. Japan’s experience holds important lessons… stimulus policies… necessary… to support demand, cannot address long-term structural deficiencies. If Abenomics 2.0 fails to embrace deep structural reform, it will fare no better than the original.”
Suppose that the global risk premium on Japanese government bonds projected forward for the next twenty years jumps by 1%/year. The Bank of Japan could then hold interest rates constant, allow the exchange value of the yen to fall by 25%, and tighten fiscal policy by 5%-points of GDP. That would roughly hold aggregate demand harmless–downward pressure on consumption and government purchases, but upward pressure on exports. That would put the real yen value of the debt on a trajectory much closer to sustainable.
When a country controls its own monetary policy and possesses exorbitant privilege–can borrow in its own debt on an effectively very large scale–to first-order a loss of confidence in the government is (or can be) not contractionary but expansionary, for the first-order effect is not to raise domestic interest rates but rather to lower the value of the currency. Thus the dynamic that turns a loss of confidence into a crisis and a loss of solvency is simply not present.
So why does Kenneth Rogoff think that it is? He thinks that:
Japan’s outsize government debt and undersize pension assets are a huge problem, and only the most reckless and crude Keynesian would advise the authorities to ignore it. For the moment, the risks are notional, with interest rates on ten-year government debt below 0.5%. But saying that Japan’s debt is irrelevant is like saying that a highly leveraged hedge fund is completely safe; the risks may be remote, but they are not trivial. Think about what would happen if the Bank of Japan actually managed to convince the public that inflation will average 2% on a sustained basis. Would ten-year interest rates still be 0.5%? What if other factors–say, a sharp decline in emerging-market growth–led to a sharp rise in global real interest rates, or a rise in risk premia on Japanese debt? In principle, Japan could weather such shocks without high inflation or other extreme measures, but it is folly to deny the country’s vulnerability. A hedge fund can simply go out of business; that is not an option for a great nation…
Why?
Does he think Japan will lose its reserve-currency status–that it will not be able to roll its debt over into yen but have to roll it over into dollars or renminbi? Does he not understand that a hedge fund’s debt liabilities are ultimately promises to pay creditors in the national currency in which they are denominated, while a great nation’s debt liabilities are ultimately simply promises to print pieces of paper?
Can anyone explain this to me? I mean, we are no longer at Invisible Bond Vigilantes. We are several steps beyond that now…