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.
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.
So they often involve something like the government issuing a lot of debt, and the central bank committing to buy all the debt. The commitment has to involve a promise not to sell the debt. Otherwise it doesn’t look like Helicopter Money. So these schemes, all could work, but I actually don’t like them. Because to make them work, you have to make people understand that they actually involve a fiscal commitment. And calling it Helicopter Money makes it sound like it’s not fiscal. I’d rather that the policy was implemented and explained as a certain kind of fiscal expansion, an unbacked fiscal expansion, and without claiming that it’s something the central bank does by itself. So I think Helicopter Money proposals are well-intentioned attempts to make it feasible to get a fiscal expansion of the type I’ve advocated. But I think they don’t really make it more likely that the policy will be successfully implemented. I think it would be better just to say we need a fiscal expansion, and also this helps to keep clear that this is an unusual period in which we require help from the fiscal authorities for the central bank to fulfill its mission.
Sakurai: Some people see that inflation is one kind of tax on households, and that there is not much difference between an inflation and tax on a household perspective it’s the same thing. Would you agree, and is the difference just on the impact on inflation?
Sims: It’s true inflation is a tax, and it’s just not like other taxes, because it falls more heavily on people who have assets and no loans denominated in Yen. So when I make this proposal I’m not suggesting that financing the debt with inflation is painless. It’s painful and it’ll be more For some people, it will be more painful than financing it by taxes. The reason we want to do this, is not to substitute inflation for taxes and paying the debt. It’s rather because we think that the economy does not function very well when inflation is near zero. Shifting from a tax that keeps inflation at zero, a pure consumption tax, to one -an inflation tax- that may be able to raise a similar amount of revenue, it has an advantage to the function of the economy as a whole. It’s not going to make the true burden of the debt any smaller. The true burden of the debt is the amount of debt out there that can be paid for by taxes explicitly, or can be paid implicitly by inflation, and both of those forms of payments are costly to people. But, if you make the inflation rate go up, we think that the economy may start to function better, and they may actually help to pay off the debt. If you can get growth to get back on a more rapid path, it of course raises the tax base, and makes it much easier to avoid expansion of the debt. What’s needed is an understanding on the part of the public, and the commitment by the government not to increase future taxes or cut future expenditures so long as you’re staying below the targeted inflation rate. And that does not require any major increase in the deficit. It might work quicker if there were an increase in the deficit. There’s some reason to think increased spending in ways that increased employment might increase inflationary pressure. But the fundamental issue is to be sure that this is not seen as just another ineffectual expansion of the deficit.
Sakurai: Would a right combination of fiscal and monetary policy be able to solve the problem of secular stagnation?
Sims: I don’t know what I think about secular stagnation. There is a regularity that whenever the economy slows down for any length of the time, some economists start talking about secular stagnation. So this period in history is no different in that respect from many others. That doesn’t mean it’s impossible that we really do have secular stagnation, as I’m sure you know Robert Gordon has argued that there’s something qualitatively different about the recent technical innovations that makes them less productive than what we were seeing in the 30s, 40s and 50s of the twentieth century. I’m not sure I believe that. I think it’s true that a lot of the productive uses of new digital and electronic technology are still being discovered, and it could well be that we could again get growth rates much faster than we have now. I think monetary and fiscal policy has been bad, in most of the rich countries. And that there’s plenty of room for finding out if we’re actually in a technological secular stagnation or not. And the way to find out is get inflation back up to target, and see, does that produce a big growth bonus, or not? I’m not sure that we really do have a permanent secular stagnation problem beyond what’s resulted from inadequate monetary and fiscal policy.
Sakurai: May I ask you about your assessment on Donald Trump’s economic policies?
Sims: I find it very difficult to do that because it’s not at all clear what those policies are yet. Some of the executive orders he’s been signing are temporary or not clearly something that will stand up in court. In his campaign he talked about infrastructure spending, making sure social security and Medicare don’t get changed or reduced. Reducing taxes. This all sounds very expansionary. But he never actually said that it was his policy to run large deficits. And the republicans, who now have the majority in the Congress, have for the last 8 years been extremely reluctant to allow any deficit spending. It’s not clear whether they're really ready to simply turn around and start being happy to make deficit spending because the president has changed. It may well happen, that’s true, but it’s not clear yet. There are people in Congress who have been talking about making deep slashes in other parts of the budget, in order to finance infrastructure spending. And if that turns out to be the dominant policy position, from the point of view of fiscal and monetary contraction, it could be that the Trump initiatives are contractionary rather than expansionary. Wall Street now seems to have the view that Trump’s policies will be expansionary, or are likely to be expansionary. But I think there’s a significant chance that they will turn out to be the opposite.
Sakurai: Well, thank you so much for your time today.
Sims: Thank you. I’ve enjoyed it.