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| Prime minister Shinzo Abe became a late convert to the Yale University professor’s monetary recipe for ending Japan’s deflation and weakening the yen. |
How important are the supply-side reforms in Abe’s ‘third arrow’?
Once the monetary initiative reaches its success point of near-full employment, it can only increase the price level, so we have to have policy for the real economy. That’s why the third arrow is important. It is like potential growth.
Japan’s potential or capacity growth was hit by the 2011 great east Japan earthquake, but the rate is probably between 1% and 2%. Right now the economy is increasing at 4% or so because it is in the process of approaching the full employment level – capacity growth. To increase the capacity growth path there is not much that can be done. You cannot invite technical progress down from heaven.
What I think should be done is not to ask what the government can do, but to ask what the government can undo: its regulations and controls. So there are proposals for deregulation, freer trade and reductions in corporate taxes. In employment and the labour market, in agriculture, in the medical industry, there are many fields where deregulation would work. So the third arrow may work by undoing government controls.
How strong is the bureaucratic resistance to Abe’s policies?
The deregulation drive started under [former prime minister Junichiro] Koizumi and [his cabinet minister Heizo] Takenaka. It requires bureaucrats to shed their armour and to disarm. It is a painful and difficult process, because structural reform in the public sector literally means the public sector should lose some of its authority and power.
Prime minister Abe now has stable majorities in both houses of the Diet, but does he have the will to take on the bureaucracy?
He has the will. Don’t forget the Bank of Japan objected strongly to the easy-money policy, but Abe-san had the courage to adopt it; and, in spite of resistance from many sectors, he managed to join the Trans-Pacific Partnership. The TPP has many aspects and I am not fully happy with some of the demands from the US on the rules of the game, but there are good parts to it, such as making farming more competitive, even turning it into a Japanese export industry, at least the modern part of Japanese agriculture, if not rice production. So Abe-san showed courage. But whether he can stand up to all the pressure from the bureaucracy remains to be seen. He will face a lot of obstacles. But it is difficult to find any other leader who can at least think independently of the ministry of finance, or as it was until recently, the Bank of Japan.
In the first arrow of monetary policy, you appear to have succeeded in changing the expectations of the Japanese about price increases, but what about the money supply?
High-powered money or the monetary base can be manipulated by the central bank, but it is difficult to increase the money supply. One way to break the ice was through expectations, and it is now invigorating the stock market, the labour market and also invigorating the commercial loan market and so forth, through inflationary expectations and the exchange rate change. Because of this long deflationary period of 15 years or more, there was a real liquidity trap; the way to escape from it was through changing people’s expectations. It’s now working, so after inflation returns to a certain percentage, more normal working of monetary policy will be possible.
Also, there are various channels available to us. More investments are profitable because you can sell the new issues of stock more easily. If you have a higher value of financial assets, it will help to raise collateral for lending and borrowing and will unlock the commercial loan market.
Such things are gradually taking place, and I am very happy and optimistic about the future of the first arrow. But how fast it works, or how strong it works, and how soon it hits some kind of grey inflationary zone is unknown. We have to be very careful that this policy does not ignite genuine inflation itself.
Are you beginning to see a rise in land values that would collateralize more lending? Yes. That is very important in this country, more than stock prices.
In the late 1980s, what began as a virtuous cycle to counter the effects of the high yen later turned vicious. Can Japan prevent a recurrence of the asset bubble and its collapse?
Probably the markets were overheated. But it’s also very certain that the ministry of finance policies of direct interventions in the land market plus stringent monetary policy were maintained for so long that the land market collapsed unnecessarily sharply, and that created all the non-performing loan problems. There was too much acceleration, and then the brakes were applied for too long. Some people may say non-performing loans were the result of investment decisions taken in the real economy, but the way I see it, they were also the consequence of monetary policy.
The ministry of finance is dismissive of the notion that increased revenues from a stronger economy lessen the urgency or need for tax increases. Is the MoF right?
The budget bureau of the ministry of finance pays very little heed to revenue effects. They just seem to desire stronger power to tax people. They ignore the fact that the pie will shrink if the consumption tax were to be increased, and they ignore the elasticity of tax revenue to GDP. They just make up projections and scenarios to bolster their argument. Their projections are not based on any historical or empirical result. Sometimes they invent parameters in order to build a particular model.
I understand the high dependence on debt is a quasi-Ponzi game. Relying on future tax revenue for present expenditure is unhealthy, and it restricts the flexibility of budgetary decisions when we ought to be using public expenditures to address genuine needs, such as after the Tohoku earthquake. Of course, I should like to correct the high accumulation of public debt, but it is not by itself the ultimate economic objective. The economic objective is to improve people’s livelihoods.
What do you think of prime minister Abe’s other policies, such as revising the constitution?
In his first cabinet [2006/07], Abe-san tried to realize his ideals, such as in education and diplomacy, but along with his health his manoeuvres taught him hard lessons. He is now very prepared. He doesn’t want to tackle political or diplomatic issues in the near future. He wants the economy to recover first. That is his position right now. Over a long period of time, he believes he will be able to gradually realize his objectives.
Some observers outside Japan fear his overt nationalism. Should they?
When he asked me to become his adviser I told him that I might not share all his beliefs. I said I would probably be more dovish. At the same time, I have to think of Japanese nation’s future seriously. Its strong economy, civilized lifestyle and recently its clean atmosphere may tempt other countries to gain from Japan, if not to invade it. So we have to defend our country for the sake of our nation. In order to achieve this, it is not necessary to resume all the very old values. It would be utterly anachronistic, as an amendment draft for the constitution [of Abe’s Liberal Democratic Party] suggests, to suppress human rights protections in the present constitution.
We don’t need to return to his grandfather’s philosophy right now, but Abe-san is right that Japanese should calmly think about how to defend themselves. Otherwise we will be a very easy target for other countries. My hope for Abe-san – I have told him this already – is that just as Ronald Reagan or Richard Nixon played an important role in making the US a much safer country, he too can take a rather hard posture in not bending easily to other forces, while achieving important peaceful tasks as well.
He is very serious about defending Japanese citizens. He is very honest and sincere in his anger against the aggression of North Korea towards Japanese citizens, or against some Chinese excessive claims. So Japan should be not only a beautiful country, but also a strong country able to defend itself. At the same time, I hope, this normalization shouldn’t entail suppressing personal freedoms for which many advanced nations have fought long and hard. My friends in the US are worried that amendment of the constitution will lead to such extremes. I don’t know. I haven’t had time to talk about politics, even diplomacy, with the Japanese prime minister, but I can tell that he is very cautious recently of the effect of his expressions on diplomatic issues.