The views expressed by contributors are their own and not the view of The Hill

Is Japan’s fiscal stimulus really something other countries should follow?

A dangerous idea seems to be gaining currency as would be amply attested by growing academic support for the recent decision by Japan to engage in yet another round of fiscal stimulus. It is that, if for whatever reason a government can borrow at low interest rates, it has the space to responsibly engage in fiscal stimulus to boost its economy. Never mind that the country in question’s government might be the most indebted among the major industrialized countries.

{mosads}This idea has led many countries before down the road to economic ruin as the wreckage in Europe’s economic periphery should be reminding us. Sadly, in today’s world of very low interest rates, it is all too likely to tempt other countries down this well-trodden path.

Greece’s sorry experience with fiscal expansion following its adoption of the euro in 2001 should be a reminder to all about the dangers of allowing low interest rates to encourage fiscal recklessness. Tempted by the sharp decline in borrowing rates that followed its euro membership, the Greek government went on a massive spending spree.

Yet even as its fiscal space was totally exhausted, on the very eve of the European sovereign debt crisis in late 2009, Greece could still borrow at practically the same very low interest rates as could the German government. Yet as we all know, market sentiment toward Greece changed and the country is still paying the heavy price today of its past fiscal policy recklessness.

Bearing Greece’s experience in mind, the extremely low Japanese and European government borrowing rates should not be taken as an indication that those economies have the space for more fiscal expansion. After all, an important reason for those low rates is that both the Bank of Japan and the European Central Bank are presently engaged in quantitative easing, which involves the aggressive buying of government bonds, on a scale that has practically no precedent. As an indication of the degree to which Japanese government borrowing rates are being artificially reduced, it might be recalled that today the Bank of Japan owns more than 35 percent of all Japanese government bonds issued.

Whether a country has fiscal space depends not simply on the interest rate at which its government can borrow, but rather, it depends on whether or not that country’s public finances are on a sustainable path. That, in turn, depends on the level of its public debt, the size of its primary budget balance, and the difference between its real gross domestic product (GDP) growth rate and the real interest rate.

If the combination of those factors reveal that a country’s debt is on an ever-rising path, it will only be a matter of time before markets figure out that the country is engaged in a Ponzi scheme. When markets do make that realization, financing will dry up and the country will pay a heavy price for its fiscal policy recklessness.

If ever there is a country lacking space for further fiscal expansion, it has to be Japan. After all, the country has a primary budget deficit of around 6 percent of GDP, a gross public debt of over 230 percent of GDP, and practically no economic growth. Even with close to zero interest rates, those factors put Japan’s public debt on a highly unsustainable path. Indeed, a recent study by the International Monetary Fund revealed that on present policies, Japan’s public debt would rise to a staggering 300 percent over the next decade.

Making matters even more precarious is the fact that Japan’s rapidly aging population will result in a continued decline in its household saving rate. In those circumstances, increasing the size of the primary budget deficit by further fiscal expansion would seem to only hasten Japan’s final day of reckoning with its unsustainable public finances.

Hopefully European countries as a whole will not follow Japan’s recent example of throwing fiscal caution to the winds. While a country with fiscal space like Germany might be well advised to engage in fiscal expansion, those European countries without such fiscal space, like Italy and Portugal, would be ill-advised to risk further compromising their public finances.

By following such a course of action, they will only increase their vulnerability to the day when global liquidity conditions are not as favorable as they are today, and when market financing for them dries up.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.


The views expressed by contributors are their own and not the views of The Hill.

 

Tags

Copyright 2024 Nexstar Media Inc. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed..

Main Area Top ↴

Testing Homepage Widget

 

Main Area Middle ↴
Main Area Bottom ↴

Most Popular

Load more

Video

See all Video