How to Make Japan's New Fiscal Plan Work
Sizable but unimpressive stimulus.
Japan’s economy sure needs the fiscal stimulus just announced by Prime Minister Shinzo Abe -- but two questions arise. Is it big enough, and will the central bank’s monetary policy help to make the most of it? On both points, the government and the Bank of Japan still have some explaining to do.
Abe unveiled the outlines of a package worth 28.1 trillion yen ($275 billion) in total, but less than half of this is new, and only 4.6 trillion ($45 billion) is planned to fall in the current fiscal year. Roughly half of the immediate stimulus will take the form of higher welfare spending, with outlays on new and repaired infrastructure making up most of the rest. Further announcements will fill out the details.
As fiscal stimulus packages go, the short-term part of the plan, at a little under 1 percent of gross domestic product, is sizable but unimpressive. Analysts expect it to have a modest effect on short-term growth. It’s good, too, that welfare spending is so prominent in the proposal, because that will feed through to aggregate demand more quickly than outlays on infrastructure would. Even so, it’s a shame the government wasn’t more daring.
It doesn’t help that Japan’s governments have made a habit of over-promising and under-delivering when it comes to budget planning. This announcement is no exception -- the actual stimulus is far smaller than the plan’s headline figure. Fiscal stimulus works best when the details suggest conviction. Ideally, as analysts unpack the numbers, they would find the plan bigger than it looks, not smaller. Abe has been a bold innovator in many ways, but he hasn’t been able to break this fiscal habit of seeming to fall short.
The effectiveness of the new plan will now depend on how far the Bank of Japan is willing to back it up. The strongest support would take the form of a promise from the central bank to finance the addition to spending by buying government debt. Outright debt monetization, as this is called, still seems a step too far for the Bank of Japan, and its legality is also in doubt. The likely compromise will be to talk of closer coordination between the bank and the finance ministry, and let investors make of that what they will.
Again, this approach is lacking in conviction. Japan needs a big fiscal stimulus, fully monetized by the Bank of Japan -- no ifs, ands or buts. Concerns that such a policy would impinge on the central bank’s independence can be dealt with. Rather than promise to buy government bonds to the full extent of whatever the budget requires -- which would indeed mean handing over the reins of monetary policy -- the BOJ should say it has chosen to finance the specific plan that the government has just announced. That way, the bank retains the power to decide and preserves the correct division of labor with the government.
Such a combination of fiscal and monetary action would be both new and impressive. And it might actually work.
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