L. Randall Wray

In recent days the international policy-making elite has tried to distance itself from MMT, often going to hysterical extremes to dismiss the approach as crazy. No one does this better than the Japanese.

As MMT began to gather momentum, its developers began to receive a flood of calls from reporters around the world enquiring whether Japan serves as the premier example of a country that follows MMT policy recommendations.

My answer is always the same: No. Japan is the perfect case to demonstrate that all of mainstream theory and policy is wrong. And that it is the best example of a country that always chooses the anti-MMT policy response to every ill that ails the country.

Reporters find that shocking. Biggest government fiscal deficits in the developed country world? Check. Highest government debt ratios in the developed country world? Check.

Isn’t that what MMT advises? No.

Nay, it is the perfect demonstration that all the mainstream bogeymen are false: big deficits cause inflation? No. Japan’s inflation runs just above zero. (See graph https://asia.nikkei.com/Economy/Growing-Modern-Monetary-Theory-debate-rattles-Japan-officials.)

Big debts cause high interest rates? No. Japan’s policy rate is about -0.10 (negative rates).

Big debts cause bond vigilante strikes? No. Japan’s government debt is hoovered up as fast as it can be issued. (All the more true with the BOJ running QE and creating a “scarcity” in spite of the quadrillions of yen debt available.)

Critics of MMT counter that Japan is “proof” that big deficits kill investment and growth.

Well, it is true that Japan has been growing at just 1% per year—certainly nothing to write home about. However, investment grows at about a 2% pace, but is pulled down by lack of consumption growth—which has averaged just about zero over the past few years.

Yet, unemployment clocks in at only 3%–in spite of slow growth—as the labor force shrinks due to an aging population. Per capita GDP has been stuck at about $38,000 for years (not so bad, but not growing). And Japan’s current account surplus has surged from under 1% to 4% of GDP over the past few years (considered to be good by most commentators).

Unfortunately Trump’s trade war seems to have already hurt Japan’s exports and the prognosis for growth this year is rather dismal. The April survey of consumer confidence showed it collapsing to the lowest level in three years. (https://www.focus-economics.com/countries/japan)

From the MMT perspective, what Japan needs is a good fiscal stimulus, albeit one that is targeted.[i] Japan has three “injections” into the economy: the fiscal deficit (which has fallen from 7% of GDP to about 5% over the past few years—still a substantial injection), the current account surplus, and private investment. But what it needs is stronger growth of domestic consumer demand—which would also stimulate investment directed to home consumption. So fiscal policy ought to be targeted to spending that would increase economic security of Japanese households to the point that they’d increase consumer spending.

So what is Prime Minister Abe’s announced plan? To raise the sales tax to squelch consumption and reduce economic growth.

You cannot make this up.

This has been Japan’s policy for a whole generation. Any time it looks like the economy might break out of its long-term stagnation, policy makers impose austerity in an attempt to reduce the fiscal deficit—and thereby throw the economy back into its permanent recession.

Clearly, this is the precise opposite to the MMT recommendation. And yet pundits proclaim Japan has been following MMT policy all these years.

Why? Because Japan has run big fiscal deficits. As if MMT’s policy goal is big government deficits and debt ratios.

No. We see the budget as a tool to pursue the public interest—things like full employment, inclusive and sustainable growth. To be sure, by many reasonable measures Japan does OK in spite of policy mistakes. Certainly in comparison to the USA, Japan looks pretty good: good and accessible healthcare, low infant mortality, long lifespans, low measured unemployment, and much less inequality and poverty. But Japan could do better if it actually did adopt the MMT view that the budgetary outcome by itself is not an important issue.

But, no, the Japanese officials are falling all over themselves to make it clear that they will never adopt MMT. Finance Minister Taro Aso called MMT “an extreme idea and dangerous as it would weaken fiscal discipline”.

One wonders how a reporter could listen to that without bursting out in laughter. Japan’s “fiscal discipline” would be threatened by MMT? The debt ratio is already approaching 250%! By conventional measures, Japan has the worst fiscal discipline the world has ever seen!

But, wait, it gets even funnier. “BOJ policy board member Yutaka Harada kept up the attack on MMT. The approach proposed by MMT will ‘cause [runaway] inflation for sure’. “ https://asia.nikkei.com/Economy/Growing-Modern-Monetary-Theory-debate-rattles-Japan-officials

The BOJ has done everything it could think of for the past quarter century to get the inflation rate up to 2%. Quadrillions of QE. Negative interest rates. And the BOJ thinks MMT could produce runaway inflation? I doubt that even Weimar’s Reichsbank could cause high inflation in Japan.

OK, that’s a cheap shot at Japan’s policymakers.

What they do not understand is that there are two ways to produce a high deficit (and debt) ratio: the ugly way and the good way. MMT has been arguing this for a long time, but with little progress in promoting understanding. I think that the main reason is because we’ve been using plain English. Economists are not good at reading for comprehension. They need pictures and math. Perhaps the following will help.

Yes, I gave it a name. There’s the Laffer Curve, the Phillips Curve, and now the Wray Curve. I didn’t draw it on a cocktail napkin at a bar, but, rather, jotted it down on a note pad before bed last night.

Assume the economy is at Point A—for Japan this would represent a 5% deficit ratio and a 1% rate of growth. Now PM Abe imposes a consumption tax, or the USA plummets into a downturn, reducing Japan’s growth rate. The economy moves up and to the left toward Point B as growth slows and the deficit ratio rises.

Slower growth reduces tax revenue even as it scares households and firms, which reduce spending in an effort to build up savings. The slower growth also reduces imports so the current account “improves” somewhat. From the sectoral balance perspective, the government’s balance moves further into deficit (to, say, a 7% fiscal deficit), the current account surplus rises (say from 4 to 5%) and the private sector’s surplus grows to 12% (the sum of the other two balances).

That’s the ugly way to increase a fiscal deficit. It is the Japanese way. It is like a perpetual bleeding of the patient in the hope that further blood loss will cure her ills.

What is the MMT alternative? Measured and targeted stimulus designed to restore confidence of firms and households. Ramp up the Social Security safety net to assure the Japanese people that they will be taken care of in their old age. Recreate a commitment to secure jobs and decent pay. Either promote births or encourage immigration to replace the declining workforce. Undertake a Green New Deal to transition to a carbon-free future.

In that case we move along the curve from Point A toward Point C. The fiscal deficit increases in the “good” way, while growth improves.

Note, however, that the boost to the deficit will only be temporary. Households and firms will begin to spend and their surplus will fall. The current account surplus will fall, too, as imports rise. Tax revenues will increase—not because rates rise but because income increases. The fiscal deficit will fall as the domestic private surpluses decline. Precisely how much the deficit will fall depends on the movement of the private surplus and current account surplus—with the deficit falling to equality with the sum.

In terms of the graph above, the Wray Curve shifts out to the right. Point A will be consistent with a higher rate of growth for a given deficit ratio. There’s nothing “natural” about the deficit ratio at Point A—as it depends on the other two sectoral balances.

For the USA, Point A is consistent with a higher growth rate but probably a similar deficit ratio to that of Japan. Our current account balance is of course negative—which implies a higher fiscal deficit. However, our private sector’s surplus is smaller than Japan’s for any given growth rate—which implies a lower fiscal deficit. The two essentially offset one another to leave the US deficit ratio at about 5% but with higher growth than Japan.

Note that we are not proposing a sort of Reverse Laffer Curve. Recall that the Laffer Curve says that tax cuts more than “pay for themselves”—trickle-down growth boosts revenue sufficiently to close a fiscal deficit. I am not arguing that the stimulative increase of government spending will increase tax revenue so much that the deficit ratio returns to its original level (or less). Where it actually ends up depends on movements of the two other sectoral balances.

Not that the size of the deficit—by itself—is important. What is important is whether government budget policy helps in the pursuit of the public and private interests. The deficit will always adjust to be “just the right size” to balance the other two sectoral balances. But that equality can be consistent with any growth rate—including a rate that is too low (deflationary) or too high (inflationary).

And the sectoral balance equality holds with any fiscal deficit ratio. So while it is likely that a successful stimulus will shift the Wray Curve out to the right, we cannot predict exactly where the new fiscal deficit ratio will settle as the growth rate rises.

What is most important about this graph is the recognition that there are (at least) two different growth rates consistent with a given deficit ratio. We can achieve a particular growth rate either in the “ugly” way or in the “good” way—while generating the same deficit ratio. Japan continually operates its economy to produce “ugly” deficits—precisely because it fears fiscal expansion.

For further discussion of fiscal deficits along these lines, see the new textbook by Mitchell, Wray and Watts, Macroeconomics (Macmillan International, Red Globe Press), Chapter 8, and especially pp. 124-128.

[1] Note: I am presuming that Japan is unhappy with zero growth, and that the country faces many unmet domestic needs. I am not an advocate of “growth for growth’s sake”—especially in light of the growing recognition that humanity may well have only a decade or so left on planet earth unless we very quickly change our ways. However, “changing our ways” will require major investments in a Japanese Green New Deal—so even with zero growth, there is a role for ramped up fiscal policy.

14 responses to “JAPAN DOES MMT?

  1. Staniels Jeffrey

    Addition? If sectoral balances sum to zero, the sum of -7 (govt deficit) and +5(current account) is -2, not +12, is it not?

  2. Staniels Jeffrey

    My bad on my previous comment about sectoral balances, but if govt sector has -7 deficit, and current account has +5; private sector would have +2, not +12, right

  3. Staniels, what country are you from – learn your MMT. Govt is spending into domestic economy 7%, foreigners are spending 5 % into the domestic economy. So guess what, the private domestic sector takes in 12%.

  4. James Cooley

    Shouldn’t paragraph 36 (my count) read: “Note that the size of the deficit-by itself-is unimportant.”?

  5. Martin Watts

    Randy, Of course, I agree with your basic premise about good deficits and bad deficits (!), but the argument that raising consumption taxes leads to higher fiscal deficits needs some qualification. If injections have remained unchanged, then lower growth ie a lower level of GDP than would have been the case in the absence of the tax increase, means that saving and imports are lower and total taxes are higher, thereby lowering the deficit. (BTW this is somewhat analogous to whether an increase in exports leads to higher net exports, given that equilibrium GDP and hence imports both increase – as described in the textbook.)
    A U (or V given linearity) shaped relationship as shown in the blogpost could be resurrected by drawing on a large cyclically asymmetric investment supermultiplier, which is based on the endogenous component of investment being more sensitive in a downturn than an upturn. A simple but large supermultiplier would generate a higher deficit in a recession, induced by the impact of a higher tax rate being offset by a fall in induced investment (and hence a greater fall in GDP), whereas a cut in the tax rate would actually lead to higher tax receipts from the significant impact on investment. In this case the deficit/ growth relationship, associated with changing the tax rate would be downward sloping. In the simple Keynesian cross model (no supermultiplier) the relationship is upward sloping.

  6. Staniels
    (S-I) = (G-T) + (X-M)
    12 = 7 + 5
    Wray is right

  7. L. Randall Wray

    Staniels: your math is still bad, mixing up injections and leakages. Private Surplus = gov def + current acct surplus. See our textbook Ch6

    All: Another hilarious piece trying to use Japan as an attack on MMT in the WSJ: “Japan disproves the trendy notion that governments can run unlimited deficits in their own currencies”. By John Greenwood and Steve H. Hanke June 4, 2019 6:36 p.m. ET

  8. James Cooley

    Oops, I read “Not” as “Note”. My bad, or did you edit that paragraph already. The previous one starts with “Note”. The power of suggestion?

  9. Newton Finn

    Dr. Wray has offered us an interesting and enlightening analysis of the current Japanese economy, seen through the MMT lens. My only criticism is that the most important statement in the article BY FAR comes in a “note” at the end. Should looming planetary ecocide not be our all-consuming focus…instead of an afterthought?

  10. One way to think of it is to rearrange the identity in Randy’s comment so that the two domestic financial balances add up to the financial balance with the rest of the world:
    current account balance = private sector balance + public sector balance
    If both balances on the right side are negative, you can think of it as adding up two domestic deficits to get the deficit with the rest of the world, which is the current account deficit.
    A different arrangement of the terms in the identity perhaps suggests a different direction of causality in some minds, leading to the use of different versions by different authors.

  11. Staniels, I think you are right but not only for the math you present. Please let me explain.

    If government runs a deficit, the resulting economy is larger than it would be without a deficit. In the example case, we have 7% of GDP larger.

    A current account surplus records sales of product larger than imports. In the case of Japan, this export product represents the fruits of labor. In our example, GDP is larger by 5% due to these exports.

    However, and here is the catch, the exports are paid for in foreign currency. Japan becomes richer because it has earned foreign currency in a fair and square fashion–by working for it.

    This foreign currency is not imported back to Japan to pay workers as they are paid in yen. On the other hand, these workers must have been paid by someone with yen and that someone was not Japanese customers buying exported products. Apparently that unknown someone must be the Japanese government managing to turn deficits into foreign currency. I don’t have a clue on the annual change in private-federal debt ownership ratios within Japan itself, but as a nation, an annual current account surplus will result in increased ownership in foreign assets.

    To me, this all boils down to Japan (as a nation) becoming financially richer by 12% (making Randy’s number right). However, all the extra fruits of labor seem to have been shipped off shore leaving public consumption basically unchanged (making your numbers nearly correct).

    Increased government deficits by themselves seem only to increase the pace of activity. That said, it should be possible to change fundamental distribution patterns by focused governmental tax and spending changes.

  12. I find the Wray Curve to be quite insightful in that it teaches two things: First, when measuring things in terms of numbers, the numbers can quickly become more important than the things being measured. Second—and what I think is the most important point of Prof. Wray’s argument—is that Japan (and the U.S.) are focused on the numbers when they SHOULD be focused, very simply and directly, on what specific, concrete things need to be accomplished for the betterment of collective society. I recently read an article about a major Chinese city that succeeded in creating the first zero-carbon public transit system in the world. From the U.S. perspective, they accomplished this by “cheating”—meaning that instead of waiting around for private commerce to decide this might be a good thing to do, they simply did it with direct sovereign spending. Apparently, the right side of the Wray Curve is the “cheating” side.

  13. Hoje, 08 de junho de 2019, tive meu primeiro contato forte com o MMT e, para minha surpresa, percebi que, mesmo sem conhecer os fundamentos da Modern Monetary Theory, já venho defendendo-a, ao menos pela intuição em alguns textos acadÇemicos de minha “Pesquisa Básica” (https://www.amazon.com/-/e/B00JCMGNDU). Afortunadamente, apesar das barreiras ideológicas, aqui no Brasil, o MMT tem um divulgador de peso, André Lara Resende, um dos mentores do Plano Real no Governo Itamar Franco (1992-1994). Quase fui afetado pela pecha da loucura por propor um Projeto de Incorporação à Renda e ao Crédito Bancário para 40% da população que não acopla à economia de mercado desde 1957 (de lá para cá “sempre tem 40% da população que não acopla à economia de mercado, por mais que refazíamos as contas” (apud Conceição Tavares).

  14. Herb Wiseman

    The big problem with this article is actually the focus on growth being desirable. It would be better to tie MMT to a different measure of progress other than the GDP or a growth model. See Kate Raworth’s Doughnut Economics model.