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.
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Sakurai: Do you think the BOJ should change the inflation target?
Sims: Well there’s some discussion about whether a higher inflation target would be better. That argument is that if unexpected developments can more easily push you back to the zero lower bound, or deflation, if you have been targeting 2% than if you’ve been targeting 4%.I think there’s something to that argument. There is 4% inflation starts to get to be a level at which people have to worry about it and think about it. And I think there’s lots of benefits to keeping inflation so low that people just don’t pay any attention to it. So, I think that’s a difficult argument, whether a higher inflation target or the current one is better. Now there’re other people who say “We can’t make the 2% our target, so let’s have our target as 1%”. Move the goalposts. And I think that’s actually a big mistake. Because you’ve shown you couldn’t hit your target, why should people believe that this new target is anymore something that you can attain and maintain than the old target was. I think that once you’ve set a target, you should meet it. And that probably with going to a 4% target, now as people have seen that you can't hit a 2% target, why should they believe that you’d be able to hit a 4% target even if you try?
Sakurai: Many worry about Japan becoming the second Greece with a debt-to-GDP ratio of over 200%.Can Japan afford to postpone a consumption tax hike, and increase fiscal spending?
Sims: One big difference between Greece and Japan, and the reason Japan can still have zero-interest rates, whereas Greece pays high interest rates, is that Japan’s debt is almost entirely Yen-denominated debt. The government can print Yen. So a government that can print the money it promises to deliver in its debt, never needs to default. It can always pay what it’s promised to pay, because it’s only promising to pay paper. Greece has Euro debt and Greece cannot print Euros. So Greece, if it can’t make the promised payments, has no choice but to default in some form or other, and they’ve already defaulted, they’re going to default again, they 're going to revalue the debt. So I think the short answer is Japan is actually very different from Greece, even though the ratio of debt-to-GDP is not so different.
Sakurai: Some have pointed out that your ideas are similar to Helicopter Money. What’s the difference?
Sims: Helicopter Money there’s actually several kinds of proposals for it. The name comes from a proposal of Milton Friedman that if you wanted to stimulate inflation you could have the central bank hire a bunch of helicopters and sprinkle money over the countryside. But modern central banks cannot do this. Modern central banks, they’re ordinarily constrained to do open market operations. They buy government debt and sell it trying to control interest rates. They’re not allowed to give gifts of money to people. That’s a fiscal transfer. And in most rich countries, maybe all of them, the central bank is legally bound not to do that. So the proposals that are called Helicopter Money are all proposals that actually do a fiscal expansion, and try to make it appear as much as possible like a monetary policy action.
