A Nobel Prize-winning economist is back in the spotlight. Christopher Sims is challenging a widely accepted claim. It was the speech he made at the Jackson Hole meeting last summer where central bankers from around the world gathered which caught attention. He argued that in times of low or negative interest rates, monetary easing alone may not be enough to spur inflation. And his theory is inspiring policymakers around the world, especially here in Japan.
NHK World's Reiko Sakurai sat down with Sims during his visit to Tokyo to talk about his theory, and the implications for Abenomics.
Sakurai: It's been a year since the Bank of Japan has introduced a negative interest policy, but it's far from hitting the 2% inflation target. What do you think went wrong?
Sims: I was very optimistic about Abenomics at the beginning, but then when consumption tax increase was implemented in the midst of this, I realized there really was no coordination of fiscal and monetary policy.
And the public realized it too that there was going to be contractionary fiscal policy working against the expansionary monetary policy. And I think that’s why it's had little effect until recently. So in order for it to have a truly expansionary effect, the fiscal policy has to also be aimed at getting inflation back up to the target level. It's easy to understand that when interest rates are negative, the government is pulling money out of banks, and out of to the extent they're negative for individuals on deposits, they are pulling away from individuals and banks. Taking money out of the economy, that's contractionary. Low interest rates are expansionary if the money that's pulled out of the economy, by the low interest rates, is put back in the reduced government surpluses, or increased government deficits.
Sakurai: Prime Minster Abe did postpone the second consumption tax hike to 2019. Do you not think that would be enough?
Sims: It would be better if instead of setting a new date, it’d been made clear that the increase in consumption tax was contingent on getting inflation back up to the target level. That could mean earlier or later increase in the consumption tax. If people see the tying of the consumption tax to inflation as a government commitment to generating inflation, and to being willing to postpone tax increases until they see the inflation, the inflation might actually pick up quite quickly, in which case 2019 might even seem too late.
But more likely -I think- is that by the time we get to the end of 2018, that even if inflation is coming back up, that may not really be solidly over the target, and then people will begin to see that contraction is looming on the horizon, and that might undo the whole policy.
Sakurai: Had not Prime Minister Abe hiked consumption tax as he did first, do you think Abenomics had worked better?
Sims: I think it probably would’ve worked better. Yes. Of course he had this sequence of planned consumption tax increases, and that was at least forward thinking about the budget deficit. I think it is important to build people’s confidence, to have them understand that you have thought through how the adjustments are going to occur in the future. So if you’re going to start targeting inflation with your fiscal policy, you still need to provide credible projections of how a combination of inflation and fiscal stringency is going to lead to being able to manage the debt, and at least keep it from growing faster. So, I'm not against planning possible future tax increases, I'm against doing it in a way that suggest that the future tax increases have nothing to do with inflation.
