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Why Not Give Rifure a Chance?

By Noah Smith For two decades, Japan’s intellectual elite has been split. The “rifure-ha” favor a big push by the Bank of Japan to end deflation, while their opponents worry that such a push would either be ineffectual or would lead to a catastrophic burst of hyper-inflation. The Bank of Japan is famously conservative, but with the ascendancy of Shinzo Abe, the “rifure-ha” may have found a champion willing and able to override the BOJ. It is a dramatic moment. In my blog, I have often expressed skepticism regarding the efficacy of monetary policy. Although I am a financial economist rather than a macroeconomist, I studied macro in graduate school, and I have first-hand experience of the rigidity and limitations of the theoretical models used by supporters of monetary easing. I am skeptical of the claims by the more extreme members of the American “rifure-ha” that the central bank is in complete control of the macroeconomy. It definitely seems possible to me that central bank efforts to raise inflation will be unsuccessful, right up until the moment that they are catastrophically successful, causing an abrupt “snap-up” in inflation that does nothing to help the real economy. Nor do I have much confidence in the leadership of Shinzo Abe, whose first tenure as Japanese Prime Minister seems to have been a minor disaster. So it may surprise you to learn that I am a big supporter of “rifure”, both in Japan and in the United States. Let me tell you why. The first reason is that the gains seem disproportionate to the risks. Rifure has the potential to help Japan solve three of its biggest problems at once: 1) the slow economy, 2) deflation, and 3) the huge national debt. Monetary easing will probably lower Japan’s unemployment a bit, and will also cause the yen to weaken, helping exporters. It will also erode the real value of the national debt, which at over 140% is the highest in the developed world. The only risk, on the other hand, is hyperinflation. How much should we fear hyperinflation? In terms of its effect on the economy, it is very similar to a sovereign default, which Japan is headed for anyway if it does not get its deficit spending under control. Hyperinflation destroys savings and causes economic activity to grind to a temporary halt; it usually lasts for about a year, before the government is forced to implement harsh austerity. After the end of hyperinflation, economies often recover strongly as economic activity restarts. In other words, hyperinflation is bad, but it is not the end of the world. Furthermore, it seems like an unlikely event. Hyperinflations are rare in history, and usually seem to coincide with severe disruptions to the real economy, such as wars. So when contemplating rifure, we must balance the likely possibility of three very important gains against the unlikely possibility of one bad but not world-ending loss. To me, the risk seems to be one worth taking.

The second reason I support rifure is that it represents a bet on Japan’s future. Inflation is essentially a tax; people who have borrowed money at fixed nominal interest rates (for example, people who own Japanese government bonds) lose out when inflation erodes their savings. But the only other way to reduce Japan’s national debt is to raise consumption taxes or income taxes. Consumption taxes and income taxes hurt young working people more, while inflation primarily hurts old retirees. Currently, Japan’s young people are under enormous pressure. They are suffering from the end of Japan’s lifetime employment system; it is estimated that almost half of new Japanese workers are part-time or contract workers instead of full-time salaried employees. This means that young people will not see most of the economic advantages enjoyed by the Baby Boom generation under the cushy old lifetime employment system. Furthermore, low Japanese fertility rates mean that young people are now expected to support more and more elderly relatives - a crushing burden even under normal circumstances. Japan’s young generation is crumbling under enormous economic pressure. Fertility rates have fallen as working parents no longer have the time and money to take care of children and elderly relatives at the same time, perpetuating a vicious cycle. Suicide rates are persistently high, especially among working people. Depression is rampant. Meanwhile, much of today’s national debt is the legacy of government spending that benefited members of the Baby Boom generation. If that debt is repaid through higher taxation, it will represent a massive transfer of wealth from the young to the old, in addition to the unfairness inflicted by the temporary, now-defunct lifetime employment system. On the other hand, inflation will act as a tax on the elderly, forcing Baby Boomers to pay for the rich government benefits they enjoyed. Thus, inflation seems to me to be the fairer way to reduce Japan’s debt. Of course, even if it works, rifure will not solve all of Japan’s economic problems. Structural deficiencies have held down Japanese productivity. Poor corporate governance and rigid labor markets will not be solved by higher inflation. But it is difficult to reform these institutions in the current deflationary environment. Of the proposed methods of rifure, two stand out as the most promising. The first is NGDP Level Targeting, in which the Bank of Japan would promise to do whatever it takes to return Japan to a steady, mildly inflationary growth path. Implementing this plan would require a BOJ commitment to buy as many financial assets as necessary to improve the health of the economy; this would be similar to the policy recently adopted by the U.S. Federal Reserve. The second possibility is the idea of “electronic money,” proposed by my advisor Miles Kimball of the University of Michigan. Under this proposal, the government would establish an “exchange rate” between paper cash and electronic money. This would allow the Bank of Japan to

lower nominal interest rates on electronic money below zero, causing people to spend more cash in order to avoid having their savings be eroded. Though this idea is unorthodox, unusual times call for bold experimentation. So to sum up, I am personally skeptical of rifure, but I believe that it is the least bad, least dangerous option for ending Japan’s long spiral of stagnation. It deserves a try.