Robin Harding on Abenomics and the ‘Japanification’ of Monetary Policy

With the accomplishments of Abenomics in the rear-view, the route forward for Japan remains uncertain.

Robin Harding is the Tokyo Bureau chief for the Financial Times. Until 2015, he was based in Washington D.C., covering the U.S. Federal Reserve, the Treasury, and the IMF for the Financial Times. Robin Macro Musings to talk about the Japanese economy, Abenomics, and the evolution of monetary policy in advanced economies over the past decade. Specifically, Robin and David discuss what the Bank of Japan’s point inflation target has in common with the Fed’s average inflation target, how the Bank of Japan found itself on the frontlines of innovation in monetary policy, and what the legacy of Abenomics portends for the future of monetary policy.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]

David Beckworth: Robin, welcome to the show.

Robin Harding: Hi there, David. Thank you so much for having me.

Beckworth: It's great to have you on. Now, we've interacted online. This is the first time I think we've actually chatted in person, but we've definitely interacted on Twitter, in the blogosphere back in the good old glory days of blogging. In fact, I remember interacting with you back in 2012 around the time of the Jackson Hole conference. You were still covering the Fed back then and I remember you teased all of us about this great paper that was going to come out the next day by Michael Woodford, but you couldn't give us the details. Remember that?

Harding: Yeah. I remember the paper. The Kansas City Fed was always super sensitive about anybody leaking anything from those papers in advance, because it's a conference, it's an academic conference, and the media are treated as participants in that conference, which was always a very strange privilege. It meant that they gave us the papers in advance, because you're meant to have read them and be able to have erudite comments about them. But for a journalist, you see something interesting, the immediate temptation is to get it out there. So, I always tried to behave myself and they never told me off too badly, but I got some disapproving calls from time to time.

Beckworth: You did not give us any details about the Michael Woodford paper, but you did throw us a clue that this was going to be a great paper, and some great things will come out of it, and I was not disappointed, because he talked about among other things nominal GDP targeting and a lot of other interesting issues that helped shape the conversation really over the next decade. We'll come back to that in a minute, but that was just one great memory from our past, back what I call the glory days of blogging and interacting on Twitter, back when you were covering the Federal Reserve.

Beckworth: But today, I want to talk about Japan with you. And before we get into Japan, and Abenomics, it's been a change there and you've been covering that, some great articles recently. Tell us a little bit about yourself. How did you get into financial journalism? What was your career path?

Harding: My route into journalism was quite unusual. I originally started off working in finance out of university, which I never really got on very well with. But the Financial Times at that era ran an annual fellowship competition, which was basically anyone who wanted to could submit an editorial on any subject you chose, and they chose one person a year who got to do a paid internship on the lead writing team in London, so working with people like Martin Wolf on the paper's editorials. And I was lucky enough to be chosen for that, and I was even more lucky to be kept on after my three months ran out. Basically because they needed someone to do the economics editorials.

Harding: So, my career in journalism was started where most people's finishes, which is as the paper's editorial voice, and then I went from there to doing sort of beat reporting, so it's a complete inversion of the normal career path.

Beckworth: Interesting. Yeah. Yeah, that is fascinating, because you do often have the kind of ladder you work up, right? You start off on the beat and then you become a columnist if you're so fortunate. You did it the other way around. But you've had an interesting journey. You covered the Federal Reserve for many years, the Treasury, the IMF, and now you're in Tokyo, a whole new experience and you've learned a lot about Japan along the way, so I'm really excited to talk to you about it today and you've had some really neat articles we'll link to in the show notes. You had one article titled “Abe's Tenure Marked by Trade Success and Thwarted Ambitions,” and one that just came as of the time of this recording. It was a great article titled “Six Abenomics Lessons for the World Struggling With Japanification,” and we'll provide links to both of those.

Beckworth: But let's begin first by taking a big sweep, kind of painting of the backdrop to the introduction of Abenomics when it first came on scene, when the prime minister first was elected. What was leading up, what's the big sweep of history that kind of led to this moment in Japan's history?

Harding: Let's go all the way back to the second world war, and one thing I think that's not often fully understood about Japan at the time of the second world war is it was still quite a poor country. The militaristic government of that era basically diverted about a third of national product into defense prior to the Second World War, so it was very much a developmental state, a state that was going places fast, but still at the time it very unwisely tried to challenge the United States, quite a poor country.

Harding: In the years after the Second World War, Japan grew spectacularly quickly. It's one of the greatest examples of catch-up growth in history. In a way, it's the first example of catch-up growth in history. Japan was the first Asian country to sort of bridge and fully catch up, and I would now say surpass a lot of Western nations. So, the decades of the '50s, '60s, '70s and '80s were a period of very rapid growth in Japan. But in 1990, you get the bursting of the Japanese stock market bubble, and that coincided with a number of other things. It coincided with the peaking out of Japan's demographics, so famously Japan's population is now declining and sort of the working age population peaked out roughly coincidence with the bursting of the bubble in 1990.

Harding: And the aftermath of the bubble was very badly handled, so Japan became in a way the case study of how not to handle the aftermath of a financial crisis. The banks were encouraged or permitted to roll over bad loans rather than to deal with them and macroeconomic policy in the '90s was also badly judged. So, interest rates were not cut aggressively. The government repeatedly sought to sort of engage in public works type stimuluses, but then immediately to raise taxes to try and cut off its deficit. So, anyway, all these forces kind of came together. The end of catch-up growth, the turn to demographic decline, the badly managed aftermath of the financial crisis, to drive Japan into deflation in the late '90s, early 2000s.

Harding: And so, Japan became the test bed for all the kinds of unconventional monetary policy that then became famous around the world after the 2007-2008 financial crisis. So, Japan was the first country to try zero interest rates. It was the first country to try a form of quantitative easing. And again, partly because those things were so new when they were tried in Japan, they were never really pursued effectively, and Japan never really escaped from this trap of stagnant prices, zero interest rates, and underemployment.

Japan became the test bed for all the kinds of unconventional monetary policy that then became famous around the world after the 2007-2008 financial crisis.

Harding: People sometimes I think look at just the raw unemployment data for Japan and get it a little bit wrong. Japan is always, its labor market institutions mean that unemployment is basically always very low. But through the '90s and 2000s there was significant underemployment in Japan, which scarred a lot of people's careers and life prospects. So, anyway, that's a very long-winded way to set the stage for Abenomics in 2012, which is when Prime Minister Shinzo Abe was elected on a promise to do something new to end this on and off deflation that had been going on for the last 20 years and revive Japan's economy.

Beckworth: So, his arrival followed what's called a lost decade, right? Is that what the term is, lost decade?

Harding: Yeah, so the '90s is often termed the lost decade in the aftermath of the financial crisis. Frankly, it was two lost decades.

Beckworth: Two lost decades. Okay.

Harding: The 2000s were better, but the economic forces in place from 1990 to about 2012 are pretty similar.

Beckworth: Okay, so he comes in and we'll come back to this point, but he comes in from a nationalist perspective, which is interesting because he ends up being much more outward looking by the end. But let's start with the basic economic goals and let's talk about Abenomics. So, this program named after the prime minister, Abenomics, and it had three arrows. So, talk us through those three arrows. What were they intended to do and what were they supposed to change?

Three Arrows of Abenomics

Harding: I think first let's say what they were and then let's talk a little bit about what's behind them, because not everybody's goals were the same in this. It's very easy to look to this and say, "Oh, this was Japan's strategy." But there were different people thinking different things in this. So, the three arrows of Abenomics were stimulative monetary policy, what was called flexible fiscal policy, which was understood to mean stimulus at least initially, and a growth strategy which was designed to boost Japan's structural growth rate. The idea was that all of these three things would reinforce each other, so through the stimulative monetary policy you would drive down interest rates. The government would borrow more, stimulate the economy, so you would have macro stimulus on all fronts, and the growth strategy would sort of boost people's optimism about future growth, encourage businesses to invest more, so the businesses would be more inclined to take advantage of the low interest rates to borrow and invest, and it was meant to be a sort of all-front strategy to get the economy moving and escape the two decades of stagnation previously.

The idea was that all of these three things would reinforce each other, so through the stimulative monetary policy you would drive down interest rates. The government would borrow more, stimulate the economy, so you would have macro stimulus on all fronts.

Beckworth: Okay, so let's break down each of those arrows a little bit more. So, the first arrow, which I think is probably the best known arrow, is the monetary policy one. As you mentioned, Japan was the avant-garde back in the early 2000s of quantitative easing, tried some of this before, but it comes in and it really goes all out, right? It really tries to expand its balance sheet and as I recall, it had a specific target for the growth rate of the monetary base, and it did large scale asset purchases, including non-government bonds. Maybe you could speak to that, as well. And finally kind of ended up with yield curve control, so maybe walk us through some of those contours and how they emerged over that time.

Harding: Yeah. What you've described is basically what happened. Japan had done these experiments in the late '90s and early 2000s with unconventional monetary policy, but always quite reluctantly. And at the time, I would say without a very clear theoretical understanding of how it was meant to work. So, the initial quantitative easing that Japan pursued in the early 2000s was aimed at the monetary base, and that's kind of how people thought it was going to work, which is very different from the later understanding of how quantitative easing works, through reducing term premiums on government bonds and other risk premiums.

Harding: So, anyway, the 2013, which is when the Bank of Japan got going, quantitative easing was informed by the experience of the Fed and other central banks in the crisis, and was very much that later understanding of quantitative easing. So, the idea was massive purchases of government bonds, drive down term premiums. It wasn't just purchases of government bonds. There was also purchases of equities, purchases of real estate by real estate investment trusts. It was framed as a target for the monetary base. That's because there was still a significant group in Japan who felt that quantitative easing worked through the monetary base, but I think the core people in the Bank of Japan, the governor, Haruhiko Kuroda, was thinking a bit in the sort of Fed sense.

Harding: So, the initial monetary stimulus in 2013 aim buying Japanese government bonds at a pace of 50 trillion yen a year, which is about 10% of GDP. That was later expanded to 80 trillion yen a year in 2014. In early 2016, Japan introduced a negative interest rate of minus 0.1%. In the autumn of that year it moved to yield curve control, which is basically you take away the number of purchases and just say, "We're going to cap." Specifically, it was framed as Japan will cap 10-year treasury yields at around 0%. Yeah. Basically everything that was conventionally or even unconventionally thought possible in 2013, the Bank of Japan tried.

Beckworth: That is so fascinating. They've been on the cutting edge for the entire time. 2001 was cutting edge. 2013, they're cutting edge. They're really innovating. I mean, yield curve control. I want to go to their purchase program, though. Their large scale asset purchase program. Because we've had the recent innovations here in the U.S. The Fed is now veering into corporate bond purchases. It's also going down into some mainstream, the municipal purchases, as well. And it's created a lot of controversy here, because the concern is it's creating winners and losers, right? For example, the corporate bond purchases, who can participate is already going to by definition leave out some other businesses.

Beckworth: So, when the Bank of Japan was buying up these ETFs, these corporate securities, was there ever any discussion there about picking winners and losers? Or was everyone just 100% on board? Let's just endorse what the bank's doing? How did it carry over politically?

Harding: No, it's been hugely controversial and highly unpopular in financial markets. The BOJ has never bought corporate debt securities. Well, that's not totally true, but basically true. They purchased equity.

Beckworth: Okay.

Harding: And they were always careful to do it in the form of exchange-traded funds, so index funds, so they bought the whole equity market in an effort to show that they weren't picking winners and losers. But again, it's produced certain distortions, so for example they were initially buying ETFs based on the Nikkei Index, and the Nikkei Index is not a market cap weighted index. It's a price weighted index. So, they ended up buying more of certain stocks than others, which caused a fuss, and there have been questions about whether they should be buying ETFs aimed at promoting better corporate governance. All these things have been a big issue and you will find no shortage of Japanese comments saying central bank's manipulating the market, they're getting inappropriately involved in credit, so all of that stuff has been present in Japan too.

All these things have been a big issue and you will find no shortage of Japanese comments saying central bank's manipulating the market, they're getting inappropriately involved in credit.

Beckworth: Well, that's interesting, so if I could read Japanese and get on Bank of Japan Twitter, I might be able to see some of these conversations.

Harding: Certainly. Yeah. Exactly.

Beckworth: Okay. Let's talk about the target for the Bank of Japan, so they had a 2% inflation target, and you told me in preparing for the show interestingly that it was a form of an average inflation target, which I wasn't aware. Talk to us about that. How was it supposed to evolve over time?

Bank of Japan’s Inflation Target

Harding: Okay, so it's not an average inflation target. I may have miscommunicated a little bit there. Prior to 2012, 2013, I can't remember the exact timing, Japan didn't have a precise point inflation target. I can't remember exactly how it was. It was something more like the ECB, around 2%, or between 1% and 2%, or something like that. Part of the change in 2012-2013 was to catch up with what had been standard practice elsewhere for several decades and adopt a formal 2% inflation target, straight up inflation target, no averaging. And that's what's still in place today. What the BOJ also tried in 2016, influenced by the same line of thinking that has led to an average inflation target at the Fed, was they introduced what they called an inflation overshooting commitment, where they basically promised the interest rates will not rise until they have overshot their inflation target. The details of how that's supposed to work are pretty vague.

What the BOJ also tried in 2016, influenced by the same line of thinking that has led to an average inflation target at the Fed, was they introduced what they called an inflation overshooting commitment.

Beckworth: Okay, so it's in a similar spirit to an average inflation target, though it's not explicitly defined as such. And something else that was fascinating for me to watch and see is that the government also announced a nominal GDP target back in 2015. Now, it wasn't a central bank target, it was just a broader government target, and as I recalled, it was to get the economy, the size of the Japanese economy close to 600 trillion by 2020. So, growing the total nominal size of the economy up, and that of course would rely on fiscal policy and monetary policy and all the structural reforms under Abenomics. But how was

Beckworth: that goal coordinated with the Bank of Japan and its efforts? I mean, was there any cross communication between the government and Bank of Japan saying, "Hey, this is our inflation goal," and the government saying, "This is our nominal GDP goal." How was that supposed to be implemented and worked out?

Harding: Well, simple answer is it wasn't. There was no coordination on that. The 600 trillion nominal GDP goal was a political goal set by Prime Minister Abe, and there was never really any policy put in place to achieve it. The reason why I think that was attractive to Prime Minister Abe at that stage was that because Japan's real growth is so low, to proclaim a nominal growth target makes it much more plausible that you can claim success and achievement, since if you're including price growth in your economic performance, then you're going to get somewhere. But it was also, it did also tie together the themes of Abenomics. So, if the government has a nominal GDP target, then it's saying we do want to revive price growth, because we see a need to increase nominal GDP as well as real GDP. But also, if we revive the real side then we get that growth, too.

Harding: And nominal GDP is also important when you start to worry about Japan's debt, which people in Japan worry about a great deal. It's the biggest public debt in the world, and increasing the nominal size of the economy is crucial for your ability to service and handle that very large nominal debt.

Beckworth: Yeah. It seems almost inevitable that nominal GDP is going to have to really take off and grow over there at some point, whether voluntarily or involuntarily through some changes. Well, let's move from the outlines of Abenomics we've already discussed. We talked about the monetary policy portions, spent most of our time there, but we also mentioned the fiscal policy and the structural reforms. And let's talk about the success. What did they accomplish?

What Abenomics Accomplished

Harding: So, Abenomics, and certainly the monetary part of Abenomics, I think accomplished a great deal. When it comes in in 2012, 2013, you really do see a structural break in Japan's economic performance. So, the yen falls very sharply. That's almost certainly down to the monetary side of Abenomics. Bond yields fall very significantly. They were already very low, but over the next couple of years, from 2012, the 10-year yield in Japan falls another full percentage point.

Harding: Employment starts to increase, so unemployment comes down from the levels of around 5% where it was to basically 2% in the later stages of Abenomics. You see a certain but rather small pick up in wage growth and nominal GDP, if you look at that on a chart, you'll see it also starts to look much better after 2012. What never really happened was prices, which is why it's so hard to judge the legacy of Abenomics. The way I'd sum it up is in the wake of Abenomics, Japan has much better economic performance, but it never actually escaped that trap of inflation being below target and a semi-deflationary environment, and not actually being in control of its macroeconomic destiny, that has plagued Japan since 1990.

The way I'd sum it up is in the wake of Abenomics, Japan has much better economic performance, but it never actually escaped that trap of inflation being below target and a semi-deflationary environment, and not actually being in control of its macroeconomic destiny.

Beckworth: What about some of the other alleged successes? So, I read your work in preparing for the show. I read some other people who've written on Japan, as well, and they point to things such as increased women participation in the Japanese economy, increased immigration. Japanese traditionally have been a very closed society. So, are there any structural landmarks you can point to that say, "Hey, this is where Japan made progress under Abenomics?"

Harding: I would say that all those things are quite disputed. So, first, womenomics. This was another big theme of Prime Minister Abe. He wanted to promote female participation in the labor force and also women at higher levels in sort of positions of power and responsibility. And Japan has for a long time, and still is, been quite a gender unequal country, and he promised to do things about that. The way I'd sum that up is female labor participation increased, but it was much more at the lower end of the labor market. So, the success of Abenomics on female labor participation was mainly getting older women back into part-time work.

Harding: The bit of womenomics which is meant to be encouraging genuine equality and the ability of women to access careers on the same basis as men, I would say much less has been achieved. There's been some steps forward, but nothing like what you might want to see. On immigration, it's true also that the number of foreigners in Japan has risen under Prime Minister Abe, but I think it's also important to note that a lot of those people are what you might call guest workers. So, there's a scheme which is euphemistically called the trainee scheme, which is supposed to allow for young foreign workers to come to Japan and learn skills that they will then be able to take back to their home countries. And in practice, this is quite an exploitative guest worker scheme. So, people are brought in from other countries, they do unpleasant, low-wage jobs that Japanese people don't want to do working in fish canning plants and things like that, and then they're shipped back three years later and more people come in.

Harding: So, the population of foreign workers in Japan has increased under Prime Minister Abe. I personally feel it's not quite right to call that immigration. It's closer to guest workers than immigration. But again, there have been some small steps on immigration, too, and the government has introduced new highly-skilled worker visas, and Japan is actually, of all the countries in the world these days, if you want to come and work in Japan and you have skills to offer, it's a relatively easy place to get a visa.

Beckworth: Interesting. Well, one other area where people will often say there was success during this period is in the number of jobs created, so even as the population continues to shrink in Japan, five and a half million jobs still were created during that time. Some will also throw out on a per capita basis, Japan's done relatively well compared to other advanced economies. They try to resort to on a comparative basis, Prime Minister Abe has done relatively well. Is that a fair comparison, do you think?

Harding: So, taking those two things separately, first, employment is definitely one of the big successes of Abenomics. And I think to me, that's down to better macroeconomic policy. So, you provided much more support, greater demand in the economy, and it basically soaked up all the underemployment of the '90s and 2000s, and by the end of Abenomics, Japan was really getting close to full employment. So, a mixture of structural things which made it easier for some groups, like older women, to come back into the labor force, and greater demand, Abenomics definitely delivered a better labor market performance, and I think deserves credit for that.

A mixture of structural things which made it easier for some groups, like older women, to come back into the labor force, and greater demand, Abenomics definitely delivered a better labor market performance, and I think deserves credit for that.

Harding: On the per capita comparison, you're assessing something slightly different there. You're not really assessing macro performance so much as growth performance and the country's overall wealth, and it's certainly true Japan's a very well functioning, high productivity society. And it has never really underperformed in terms of per capita incomes. The issue in Japan I think has always been on the macro policy side, at least for the last 30 years, and failure to run the economy as hot as it could be. So, I think that the comparison is fair. Japan has done well on per capita incomes. It could probably have done a bit better if demand had consistently been high and it had been able to sustain full employment throughout this period. I guess that's how I'd look at it.

Beckworth: Okay, so to summarize Prime Minster Shinzo Abe's legacy is that he definitely improved the economy, put it in the right direction, but there is still a lot of room for improvement moving forward. Now, something else that you've written about in terms of his success is that he's been a leader in terms of promoting and maintaining the global kind of norms for trade and trade policy, so he's gone from being kind of very inward looking to very outward looking. I mentioned earlier he came from kind of a nationalistic perspective when he came into office, and now he's been very pragmatic and looked abroad and tried to keep trade going across the world, even as the U.S. and China pull back and engage in trade wars. So, is that a fair assessment of his legacy?

Harding: Yes. I think you have to look at Japan in the context of its region, and in particular in the context of China. So, Prime Minister Abe was definitely, he's a conservative, he's a nationalist, he's all of those things, but Japan's also very much a status quo power. It's benefited enormously from the free and open global trading system and it wants things to stay that way, and it feels threatened by the rise of China. And quite honestly, it's right to feel threatened by the rise of China, because China certainly feels no great affection for Japan, given the history between the countries.

Harding: And so, a big part of what Prime Minister Abe has sought to do is to reinforce things like the free and open global trading system, the rule of law in international affairs, democracy around Asia, all of these things, essentially trying to promote the status quo, the liberal international order, as a bulwark against Chinese influence in the region. And in concrete form, that takes things like leading the Trans-Pacific Partnership after President Trump withdrew from TPP in 2016. Japan was really the instigator in persuading the remaining 11 countries to carry on with TPP anyway. Prime Minister Abe also struck a very big free trade deal with the European Union. So, in a way he's taken over the traditional role of Western leaders in promoting this liberal international order, and now Japan is probably the greatest proponent of that international system.

Beckworth: So, what do you think is going to happen after he leaves office in terms of carrying this legacy forward? Will the next prime minister be able to do the same thing as he has done in terms of promoting global trade and his macroeconomic policies?

Harding: So, on the diplomatic side, I think that's very well established now. That's going to be what Japan does in future decades. Japan is the liberal status quo country and they will push that. On the macroeconomic side, in the short term there's going to be no difference. The successor to Prime Minister Abe is almost certainly going to be Yoshihide Suga, who is the chief cabinet secretary and has already said he will carry on with all the Abenomics things. But there's a big question about what Abenomics is now. We didn't really discuss it before, but monetary stimulus in Japan was offset by fiscal tightening. In particular, two increases in consumption tax, which sort of slowed the economy down even as monetary policy was trying to speed it up.

Harding: What Abenomics looks like for the next decade is pretty unclear. The Bank of Japan is kind of stuck with what it's doing. It's not clear how fiscal policy is going to function. It's not clear what the growth strategy is. So, at some point, not straightaway but at some point there's going to have to be a reset, and a decision about what the next decade of economic policy looks like. There's also a big constituency in Japan which sort of feels Abenomics didn't achieve everything people wanted it to. Certainly for example in regional Japan, there are a lot of people in Japan's regions who feel neglected and feel it was a very sort of Tokyo-centric policy. So, I think exactly what it's going to look like in the next decade is still up for debate.

At some point there's going to have to be a reset, and a decision about what the next decade of economic policy looks like. There's also a big constituency in Japan which sort of feels Abenomics didn't achieve everything people wanted it to.

Beckworth: Would you say demographics is the biggest factor driving these decisions going forward? Because I can see two areas in which that's the case. Number one, you have a declining population, so just on the real side of the economy the labor force is going to get smaller over time and they're going to have to deal with that adjustment. But also there's a political economy dimension to this, and I've discussed this with other guests on the show before, but as the population gets older and older, you would think they would probably more risk averse, less willing to tolerate higher inflation, so despite all the promises made under Abenomics in terms of we're going to get inflation up, despite the expansion of the government debt and the central bank's balance sheet, we still didn't hit it. And I wonder if there's a political economy story behind it and the ultimate reason is this powerful constituency, this powerful block of voter doesn't want higher inflation, and ultimately that's the reality shaping what has happened to these programs.

Harding: So, this is a whole fascinating set of issues and we could probably discuss this for a whole hour. So, first to say I'm not sure that demographics directly shape the policy decisions. There's no question that demographics are the biggest underlying force in what's happening to Japan's economy, so I think the reason why interest rates in Japan have to be so low, the reason why there's a chronic problem with generating demand is almost certainly the demographics. Japan's population is outright declining. It loses several hundred thousand people a year. I mean, you're in Nashville. I can't remember the population of Nashville. I think it's about half a million in the urban area or something like that?

Beckworth: Yeah. Yeah.

Harding: Is that right?

Beckworth: Yeah.

Harding: Within the next few years, Japan is going to be losing a Nashville every year in terms of its population, which is quite staggering to think about. And imagine you chop off the GDP of Nashville every year, that's what Japan is wrestling with in its economic management challenge. So, there's no question that shapes the macro environment. The political economy is also really important and really interesting and quite hard to pin down exactly what effect it has. So, there's no question that older Japanese voters, A, don't like inflation, and B, will always vote for more spending on social security, healthcare, and all the good things like that.

Harding: The effects of that are hard to pin down. One thing I've written about is how the rising cost of funding these things tends to soak up all the disposable income of the working age generation of Japanese, which is one reason why I think the wage effects of Abenomics never translated into greater spending, and higher demand, and rising prices in the economy. So, for example, Japan funds old age care through a levy on the wages of all workers over 40. And as the number of older people is rising so quickly, that levy keeps going up. So does the various healthcare levies, social security costs, so what tends to happen if you're a Japanese worker is even if your wages are in theory going up, it's immediately soaked up by various social insurance premiums which are then transferred to older people.

Harding: All the consumption of those older people on healthcare or social care or whatever else is all at regulated prices, and they tend to be regulated to stay low, so it kind of acts as a break on any price effects of increasing wages. So, I've never seen this formally done in an economic model or formally demonstrated, but as a reporter, my way of understanding the economy is to go and talk to people, and this is certainly something that I think you see happening.

Beckworth: It sounds like there's going to be some intergenerational tensions, if not already. The young workers are being frustrated because they can't get ahead. Their earnings are going to support their parents, the elderly generation. At some point, I think that tension gives rise to social change, and maybe again it depends on who's the bigger voting block. I mean, is Japan increasingly an older society, so they'll keep this system in place? Or are there enough young workers who might argue for change? Where are the numbers going?

Harding: Older voters massively outnumber younger voters and they also are more likely to vote. So, older voters completely dominate. I can only talk about this in an impressionistic way and this is not really economics.

Beckworth: Sure.

Harding: This is just journalistic observation. But I feel like a lot of young Japanese have kind of opted out. They feel there's no way the system's ever going to work in their interests, so they don't really expect it to. And you just don't... They respond with disengagement rather than demands for change. So, you don't really, in a way, what's interesting is the absence of that intergenerational conflict, and it's because young Japanese I think just sort of shrug their shoulders and say whatever will be will be. They feel they're stuck with the system and what they would rather do is ignore these huge numbers of older people tut-tutting at them and telling them that they're lazy and that things aren't as good as they were when these people were younger in the '70s or '80s or whatever, and instead they do their thing. They do their music. They do their fashion. And they kind of ignore what the oldies are telling them.

Beckworth: Well, that's very fascinating. I want to segue from Japan back to the United States here, but use Japan as a launching pad by noting that they have this huge amount of debt relative to GDP as you mentioned earlier. The largest for advanced economies in the world. And I want to bring this up because the U.S. during this crisis has seen a huge increase in the growth of its debt, as well. As of today, the CBO released a report showing that debt to GDP will rise about 100% by next year here in the U.S., and of course it's created a lot of commentary, a lot of concern, and Japan is past that number by a long time ago. In fact, what is the number now in Japan, government debt to GDP?

Harding: Gross, it has been 240% of GDP, but it's going to be 270 after all the COVID stimulus works its way through.

Beckworth: So, it's a large number. Still, no inflation and should give us hope here in the U.S. that we're not going to see inflation explode. But you used this as a way to motivate an article that you wrote. You have an article titled “Leave Public Debt Worries for Another Day,” and maybe we can use this to talk about debt, but also talk about the response to this COVID crisis in general. What has Japan done in terms of the COVID crisis? And then let's go from there to the concern about debt.

Debt Concerns and Japan’s COVID-19 Response

Harding: Japan's response to COVID is pretty much in line with other countries. Japan's done a pretty good job on the public health side. Not as good as countries like Taiwan and South Korea, but significantly better than Europe and the U.S. Japan had a voluntary lockdown, which is sort of contradiction in terms, but Japan has no compulsory powers to tell people to stay at home. Instead, they asked people to stay at home and they did, so the effect was quite similar.

Harding: But it wasn't quite as an extensive a lockdown as there's been in other places, so it's kind of middling on the size of the COVID shock. And it's done all the things you'd expect in terms of providing the way of subsidies for furloughs and lots and lots of cheap credit to try and get businesses through it. There's probably not that much that's dramatically different to say about Japan's response to COVID than there is for other countries.

Beckworth: Well, let's speak about the debt then.

Harding: Let's speak about debt. So, I genuinely haven't fully got to the bottom of what I think about public debt, but I think there are several things you can observe about Japan which offer interesting lessons for thinking about debt elsewhere. The first is that with interest rates so low, you can sustain a lot more public debt than people may think, and what you may think based on past experience. So, the yield curve in Japan is negative out to 10 years or beyond, so on most of its public debt now, Japanese government actually gets paid to borrow, so the service cost of this debt is really not a big issue in terms of its sustainability.

With interest rates so low, you can sustain a lot more public debt than people may think, and what you may think based on past experience.

Harding: So, you say 240% debt to GDP. If you're paying less than 1% interest on that, then you're looking at having to find 2% a year of GDP to service the interest bill from taxes, and that really not... So, imagine you have 40% of GDP and you're paying 5%, it's the same thing. So, the low interest really affects the servicing costs and ability to manage the debt.

Harding: The second thing that's becoming very clear is that large scale QE interacts with debt. You get into very complicated and difficult waters quite quickly, but the fact is that the Bank of Japan now owns 100% of GDP in Japanese government bonds. If you consolidate the central bank with the government, a big part of this debt is sort of Japan owes it to itself. And again, in terms of the cost of having that debt, a lot of it's no longer in market hands and so the issue becomes very different. And then the third thing I just observe is that the periods when Japan's debt has risen have been the periods when it's been not stimulating the economy or not stimulating it effectively.

Harding: So, the debt rises very rapidly during the '90s. It also rises rapidly during the more difficult periods of the 2000s. The only times it stabilized are in the window of 2005 to 2007, when Japan's economy was doing better against the backdrop of a strong global economy, and under Abenomics in 2013 to 2020. So, public debt was, I can't remember, about 230% when Prime Minister Abe came in, maybe even a bit higher, and 240% when he left, so one of his big achievements has actually been to stabilize the growth of Japan's debt. And I think that's quite simple to understand. The government can't effectively raise taxes. The government can't save more unless the private sector is willing to consume more and save less.

Harding: The absolute key to tackling public debt is not to rush out and raise taxes or cut spending when the economy's weak. You absolutely first have to reach a stage where you have enough demand so that the private sector can take over from the government in terms of spending. So, I think one of the lessons, and it still... Even in Japan, a lot of people don't really accept this, but I think it's for certain true, is you cannot tackle rising debt and deficits unless you make sure that your macroeconomic policy is working and it's possible to use interest rates to support you, cutting interest rates to support the economy in times of weak demand instead of government spending as stimulus.

You cannot tackle rising debt and deficits unless you make sure that your macroeconomic policy is working and it's possible to use interest rates to support you.

Beckworth: We could spend a lot of time on this and I would love to, but our time is running short and I do want to circle back to the last part of our conversation, and that is the changes in central banking across the advanced world over the past decade. Because again, Japan has been the avant-garde, has kind of set the agenda for the other central banks in the world, and we just saw this past week that the Federal Reserve has moved to an average inflation target. There was talk of yield curve control. Even the ECB is getting more aggressive than it has been in the past.

Beckworth: And you used to cover the Fed. As we mentioned, you were there at Jackson Hole for some speeches and you saw what was happening in the U.S. during the last crisis. So, kind of stepping back, looking at the big picture, what you've seen over the past decade, what you've seen in Japan, where do you see monetary policy in advanced economies going? For example, do you think one path might be closer coordination between monetary policy and fiscal policy, maybe at least at the zero lower bound? Maybe use of like helicopter drops? Do you see some other radical changes happening or just kind of plodding along as we are right now?

Future of Monetary Policy in Advanced Economies

Harding: It's a really good and big question. There've been two sort of directions of travel for monetary policy over the last decade or two. One being sort of communication-type policies in which I'd include things like average inflation targets or nominal GDP targets, all the rest, where you're basically trying to get expectations to do the work for you in terms of stabilization policy, so you convince people that X is going to happen in the future, and since they expect X to happen in the future, they behave now in a way that is stabilizing.

Harding: And the other direction of travel is asset purchases, QE, and attempts to go beyond sort of short-term interest rates as a tool of monetary management. I guess what I observe now in Japan is that both of those things are largely exhausted and we still can't hit the inflation target. So, basically no communications coming from the Bank of Japan have any credibility anymore. So, Japan could adopt an average inflation target, it could adopt a nominal GDP target, it could do all these things tomorrow. The Bank of Japan could do it, but I don't think it would make any difference at all, because there's no longer any belief amongst markets, the public in Japan, that the Bank of Japan is able to do what it says it will do.

Japan could adopt an average inflation target, it could adopt a nominal GDP target, it could do all these things tomorrow... but I don't think it would make any difference at all, because there's no longer any belief amongst markets, the public in Japan, that the Bank of Japan is able to do what it says it will do.

Harding: So, I think that sort of thing is just largely off the table in Japan now. On the QE side, Japan has pushed it further than anybody else. As I said, it's more than 100% of GDP on the central bank balance sheet now. It's bought equities, it's bought property. There is still room to do more there. You could buy more equities. You could expand into corporate debt securities. You could buy more real property. But I don't know. Again, I'm not sure how much you would have to do to get the effects you want and I'm not sure how much appetite there is left to do that.

Harding: So, you're kind of at an impasse in Japan. There doesn't seem to be a route forward. And I'm increasingly inclined to think that some kind of coordination between fiscal and monetary policy, whether you call that helicopter drops or anything else, is the only way that monetary policy, and in fact, once you get to helicopter drops, it's actually fiscal policy.

Beckworth: Right.

Harding: But some kind of coordination between the two may be the only way to actually get any purchase in Japan these days. I'm very hesitant to say anyone should do this, because I don't have a worked out way of making it work, and there are big, big problems with these kind of policies which are well-known, and I've never seen a written down plan that I think you could safely endorse. But if you think it's essential to hit the inflation target in Japan, I think it's very important in terms of stable and effective macroeconomic management. I don't really see what else is left. So, I think this is going to become a bigger and bigger subject of debate in Japan in the 2020s.

Beckworth: I think it's useful to look at Japan because it has been this avant-garde, this leader in terms of these policies, and as you mentioned they're at an impasse, right? They're at a point where the society feels like there's not much more you can do through traditional monetary policy. Now, whether that's right or wrong, it's not the question. The question is what does the body politic believe, and if it's happening in Japan now, it seems like it's only a matter of time before it happens elsewhere in the world as we go down the path of Japanification if it continues in Europe and the U.S. So, I think it'll be interesting to watch and see what happens in Japan and maybe we can learn some lessons from that.

Beckworth: Well, with that our time is up. Our guest today has been Robin Harding. Robin, thank you so much for coming on the show.

Harding: Thank you. It's been lots of fun.

Photo by Pool via Getty Images

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.