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Japan: Don’t Ruin a Good Thing

Paul Krugman: So far, Abenomics has been going really, really well.

(Image: Paresh/The Khaleej Times - Dubai, UAE / CartoonArts International / The New York Times Syndicate)

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So far, Abenomics has been going really, really well.

By signaling that the Bank of Japan has changed, that it won’t snatch away the sake bottle just as the party gets going, that it’s going to target sustained positive inflation, and also by signaling that some fiscal stimulus is forthcoming despite high levels of debt, Japanese authorities have achieved a remarkable turnaround in short-term economic performance.

But will this short-run success end up being self-defeating? This, from a recent article in the Financial Times, really worries me: “Japan’s economy expanded at a significantly faster rate in the second quarter than initially reported, increasing the chances that Shinzo Abe, prime minister, will press ahead with a contentious sales tax increase — albeit one that would be offset by more government spending.”

Look, maybe Japan can sustain growth in the face of this tax increase. But maybe not. Why not wait until growth is firmly established, and in particular until expected deflation has been solidly replaced with expected inflation? Delaying the sales tax increase would be, I would argue, the prudent thing to do even in purely fiscal terms.

One of the serious consequences of Japanese deflation combined with the interest rate’s inherent zero lower bound has been that Japanese real interest rates have until recently been significantly higher than those in other advanced countries — a matter of considerable concern when you have a very large inherited debt.

Getting those real rates down (and, to a lesser extent, eroding the real value of existing debt) matters a lot to the long-run fiscal picture; it’s just foolish to endanger progress on that front in the name of fiscal responsibility. Yes, Japan is going to need more revenue eventually. But reflation should come first. It’s a really bad sign that this is even being discussed right now. Uncertain at the O.E.C.D.

One of the distinguishing features of economic discourse since 2008 has been the remarkably destructive role played by most, though not all, international technocrats. In the face of high unemployment and low inflation, key institutions — the European Commission, the Bank for International Settlements and the Organization for Economic Cooperation and Development — have consistently called for policies that would depress advanced economies even more.

What’s been interesting about these recommendations is that they do not, as you might expect, come from a rigid application of conventional economic models. Conventional models, after all, say that contractionary fiscal policy is contractionary, and should not be undertaken at a time when those adverse effects can’t be offset with looser monetary policy. And for sure, conventional models don’t say that you should raise interest rates in the face of high unemployment and low inflation. Yet somehow people at these institutions decided that tightening both fiscal and monetary policy was the thing to do, making up stories on the fly — I wouldn’t call them models — to justify their demands.

I guess we should just call these people “crats,” since the “techno” got thrown out the window and replaced by intuition, or something. Anyway, the O.E.C.D. is either the worst or the second-worst offender — the B.I.S. gives it a run for the (tight) money. According to the O.E.C.D.’s own estimates, the “underlying primary balance” of the euro zone as a whole has gone from significant deficit to significant surplus since 2009, a swing of about 4 percent of gross domestic product.

Given what we now know about multipliers, this should have depressed G.D.P. in the euro zone by at least 5 percent, and probably more, relative to what would have happened without austerity. And sure enough, the euro zone has done very badly, with a protracted recession and now weak growth even when it’s growing.

So what could explain this? Why, it must be “uncertainty,” according to the chief economist of the O.E.C.D. What else could it possibly be?

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