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Japan and the burden of government debt

I don’t write enough about Japan, and now that some of my posts are very kindly being translated into Japanese I should try to remedy that. In fact there is currently a very good reason to write about the Japanese economy, and that is a very strong 2017 Q2 performance. Annualised growth was 4%, compared to 1.2% in the UK. What is particularly heartening about recent Japanese growth is that it is led by domestic demand rather than trade. In the past Japan seemed to have the opposite of the UK’s problem: growth was often led by trade, while domestic demand was weak.

This recent growth is not just making up for poor past performance compared to other countries. Comparisons of GDP growth are misleading for Japan because (unlike the UK and US) it has relatively little inward migration, so it is better to use GDP per head for such comparisons. (As Noah Smith pointsout, even this my bias comparisons against Japan because its population is aging.) Between 2006 and 2016, Japan increased GDP per head by a total of about 5.5%, compared to around 5% in the US and about 3% for the UK. Good compared to other countries, but all these countries should have had stronger recoveries from the recession.

Strong growth is good news because inflation is so low (around 0.5%): way below the 2% inflation target. The government is trying to stimulate growth using a modest fiscal stimulus and large scale quantitative easing (short and long interest rates are exactly zero) as well as implementing various structural reforms. But the striking thing about all this is that their net government debt to GDP ratio is 125% and rising (OECD Economic Outlook measure). This is higher than any other OECD country except Greece and Italy.

Does the conjunction of relatively strong growth and high government debt confound economic theory, as Bill Mitchell suggests? Like high powered money and inflation, any relationship between government debt and growth just does not work when interest rates are stuck at zero. High government debt could crowd out private investment (although some dispute this), but not when real long term rates are zero and inflation is near zero. Servicing high debt could discourage labour supply, but again not when interest rates are zero. Nor is debt a burden on future generations when the real rate of interest is well below the growth rate.

Of course most people think such high debt levels are a real concern because of ‘the markets’. But the markets will only stop buying this debt if they expect default or rampant inflation, and there is no way a government with its own currency can be forced to default. There is also no way it will choose to default with interest rates so low. This is the basic truth that our leaders in the UK choose not to tell us (and pretend otherwise).

But what happens when growth finally raises inflation, and interest rates rise. Will debt not be a problem then? Maybe, but only in the long term, so the government will have plenty of time to fix that roof when the sun shines. [1] Right now Japan does worry about its high levels of government debt, but it rightly worries about the combination of low growth and low inflation much more. In that sense it sets a good example to other countries.

[1] Fixing the roof while the sun shines is one of the Cameron/Osborne little homilies I approve of. The problem when they used it was the UK economy was actually in pretty poor shape, as we could tell because interest rates were so low.    


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