Does Japan Vindicate Modern Monetary Theory?

Takatoshi Ito, former deputy minister of finance for Japan in this proj synd article asks whether Japan is poster child of MMT:

Public debt has soared since the 2008 financial crisis, and especially during the COVID-19 pandemic. According to the International Monetary Fund, the ratio of public debt to GDP in advanced economies increased from around 70% in 2007 to 124% in 2020. But the fear that rising public debt will fuel future financial crises has been subdued, partly because government bond yields have been so low for so long.

Although yields started falling much earlier, in the 1990s, they were kept low by quantitative easing (QE) after the 2008 and 2020 recessions. Few doubt that massive fiscal expenditures were warranted to alleviate suffering during those episodes. But advocates of Modern Monetary Theory take this logic a few steps further.

Advocates of MMT contend that as long as debt is denominated in a country’s own currency, there is no reason to fear a fiscal crisis, because a default cannot happen. Any withdrawal of fiscal stimulus therefore should be gradual. And in the meantime, new issues of public debt can be used to fund infrastructure investments, income-support programs, and other items on progressives’ agenda, provided that the inflation rate remains below the central bank’s target (generally around 2%).

MMT’s boosters cite Japan as proof of concept. Even though Japan’s debt-to-GDP ratio (including both central and local government) is above 250%, compared to 160% in the United States, its ten-year government bond yield has remained at around zero throughout the COVID-19 pandemic, and its average inflation rate has barely exceeded zero for 20 years. Annual new bond issues and soaring debt levels have not had any apparent impact on borrowing costs.

The Japanese story cannot go too far. It is like a ponzi scheme:

MMT’s validity partly depends on projected real (inflation-adjusted) growth per capita. If the population is growing and future generations will be richer than current ones, the “burden” of current bond issues will indeed be small. In this sense, bond issues for consumption function like pay-as-you-go pension systems. As long as the economy is growing faster than the interest burden, PAYGO is a sensible approach, because each generation can simply shift the burden to the next generation, ad infinitum.

Like a Ponzi scheme, this works only as long as the base of the pyramid keeps expanding. In the US, the government may be able to keep increasing its debt and maintaining its PAYGO social-security system for several decades to come. But Japan enjoys no such luxury. Its population has been declining since 2008 (and its working-age population since 1998), and its per capita income has been stagnant for 30 years. The scheme will soon collapse.

Japanese voters and politicians cannot keep treating cash raised from new and rolled-over bond issues as manna from heaven. If the electorate wants income redistribution, it must accept that the transfer should come from today’s rich (many of them elderly), rather than from future generations. And if the social-security system has become too generous, owing to overly optimistic projections, there should be a claw-back.

If, on the other hand, fiscal stimulus is needed, the spending should be directed more wisely to support future growth, such as by boosting investment in human capital and innovation. But a blanket endorsement of MMT and its policy implications is the last thing Japan needs. Now that the acute phase of the crisis is over, Japanese leaders would do well to start thinking about the country’s huge stock of debts.


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