Paul Krugman: Shinzo and the Helicopters (Somewhat Wonkish) – NYTimes.com


 

Shinzo Abe’s turn toward expansionary policies has, rather oddly, drawn fire from economists you might have expected to be supportive. Adam Posen — who taught me most of what I know about Japan — is against the fiscal stimulus, and wants a sole focus on monetary expansion to end deflation. Richard Koo likes the stimulus but wants to forget about the whole deflation thing.

And I’m a bit puzzled. I have no stake in Abe’s success politically, and no sense of whether he knows what he’s doing. But the case for a coordinated fiscal-monetary push seems overwhelming given the intellectual framework all of us, I think, more or less share.

Start with whether deflation is a problem. The answer, surely, is yes. Expected deflation keeps short-term interest rates stuck hard against the zero lower bound, and puts a somewhat higher floor under long-term rates (they can’t go all the way to zero, because they price in the possibility that short rates may eventually rise but can’t fall). As a result, real interest rates are higher than they would be if the economy had, say, 2 percent inflation.

And those relatively high real rates do considerable damage. Even if you’re a total Kooian and don’t believe that real rates have any effect on domestic spending — which isn’t plausible — they clearly lead to an overvalued yen, and hence to reduced Japanese competitiveness.

Furthermore, a bit of inflation would help erode debt, both public and private (no, it wouldn’t just be reflected in higher interest rates; remember the zero lower bound). This would both alleviate the balance-sheet issues in the private sector and reduce concerns over the fiscal outlook.

So there is a clear case for breaking out of the deflation trap and moving to modest positive inflation. The question then is how to get there.

As far as I can tell, Posen is going with the notion that unconventional monetary policy, by working both on asset demand and on expectations, can do the job. Maybe, but most of us have taken the limited payoff to quantitative easing as a cautionary tale. There’s a lot to say for the notion of using temporary fiscal stimulus to push the output gap down, ideally even causing some economic overheating, to jump-start the transition to an inflationary regime.

And beyond that, the credibility of a higher inflation target in the face of the deflationary bias of central bankers may well be best established by (a) reducing the central bank’s autonomy and (b) getting the central bank in the business of supporting — indeed, monetizing — government deficits, at least for a while. Gauti Eggertsson made this point long ago (pdf), pointing to Japan’s successful polices in the first half of the 30s as a clear example. Indeed, Gauti argued that having a large government debt can be a real advantage in such circumstances: efforts to raise expected inflation gain extra credibility if the government would clearly benefit in fiscal terms, and the central bank is sufficiently subordinated to elected officials that investors believe that it will take these fiscal benefits into account.

Recently Paul McCulley and Zoltan Pozsar (pdf) have broadened this point, arguing that Minsky-like cycles of leveraging and deleveraging mean that there are times when a central bank that is obliged to support fiscal expansion through “helicopter money” is exactly what the economy doctor ordered. And this is one of those times.

So there seems to me to be a strong case that Abe is on the right track. Yes, the stimulus may not be efficiently spent — but we’re very much in bottles of cash/space aliens territory here, where even useless spending can serve a useful role. My biggest concern is actually that the stimulus plan may not include enough shovel-ready stuff to deliver a significant short-term boost. But here again, the news that the BoJ is bowing to the elected government may be the most important thing.

Way back in the early stages of this crisis I argued that we’d entered a looking-glass realm in which virtue was vice and prudence was folly. We’re still in that realm — and Japan, of all places, seems to be the first major government to figure that out.

Shinzo and the Helicopters (Somewhat Wonkish) – NYTimes.com

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