A new life of Keynes

TOKYO — One day, in the fourth century, the Emperor of Japan looked around with a small mountain near his Palace and saw that something was missing — smoke cooking stoves. Although here and there could see some faint traces of smoke, it was clear that people have such a hard economic situation that they can’t even afford to buy food, to prepare it. Shocked by the living conditions of the Japanese people, and it was mostly peasants, the Emperor decided to suspend the collection of taxes.

Three years later the gate of the Palace was falling apart, and through holes in the roof, stars. But the mountains looked out at the thick plumes of smoke billowing from the chimneys of the peasant huts. The moratorium on taxes work. The people were so grateful to the Emperor, named Nintoku (that is, the Emperor is virtuous and generous) that they voluntarily repaired to his Palace.

Almost two thousand years later, the Japanese people once again found itself in a difficult economic situation. The sharp increase in the consumption tax in 2014 (and its new increase, which is expected in the near future) leads to reduced household spending. As in the story of Nintoku, the size of the wealth of the people, not the government, determines the size of consumption.

Of course, the amount of wealth the government has a role in the economy. But excessive concern about the solvency of the government can lead to the fact that the private sector stops spending money. This is what happens now in Japan.

Too high debt may lead to extremely negative consequences. In periods of high inflation, large size of the obligations of the government leads to a deterioration of fiscal policy: to ensure the previous level of real government spending we should raise taxes. But what’s worse, authorities may be tempted to get rid of debt through inflation — this opportunity they abuse since the middle ages, effectively introducing a single inflation tax on asset owners.

However, a large debt is not always bad for the economy, as well as attempts to limit it may not always be effective. For example, in the United States, some members of the Republican party, fixated on balancing the budget, blocked the normal work of the authorities of the States and even the Federal government, and all this supposedly in the name of fiscal discipline. In the Eurozone economic recovery after the financial crisis of 2008 preventing strict fiscal rules that limit the size of the budget deficit in the EU at 3% of GDP.

To understand the relationship between the size of the national debt and the state of the economy, we should refer to the “fiscal theory of the price level” (FTPL abbreviation). It is a macroeconomic doctrine, which lately has begun to attract much attention. In August at the annual conference of representatives of the Central banks in Jackson hole (Wyoming, USA) Christopher Sims of Princeton University very clear, explained this theory.

Sims explained that, contrary to popular opinion, the aggregate demand and the price level (inflation) are determined not only (or even primarily) monetary policy. They are determined by the net size of the country’s wealth and commitment of the Central Bank and the government.

When the budget deficit is low, increasing the attractiveness of investment in national debt. The private sector is stepping up purchases of government obligations, so the demand for goods and services falls, creating deflationary pressure. When the Central Bank tries to boost inflation by increasing their balance sheets through measures of monetary expansion and lower interest rates, there is a further reduction of the budget deficit, which reinforce the cyclical trend. In this context, says Sims, monetary policy alone is not enough to increase inflation; necessary measures of fiscal policy — an increase in the budget deficit.

The theory of the FTPL provides a clear diagnosis of the problems of the Japanese economy — and points to their solution. When 2012 began Abenomics, massive liquidity injection by the Bank of Japan was to eliminate deflation. But, as told to and traditional Keynesians and advocates of the FTPL, quantitative easing, that is actually the exchange of money for their closest substitutes (bonds with zero interest rate), over time becomes a less efficient way of stimulating demand. Add to this the fiscal tightening, in particular, the increase in the consumption tax, and it will be no surprise that the demand in Japan remains depressed.

Recently, the Japanese policy of negative interest rates quite well and helped to reduce market interest rates. But this policy also weakened the status of the balances in the private sector because of financial institutions it is a kind of tax. In the end, she was unable to give the expected boost to the economy.

In periods of recession or stagnation of the increase in interest payments by banks can be a burden for the economy, while the debt helps the economy to reach a state of full employment. (Neoricardian here would be to assure that the national debt in the hands of useless people, because consumers offset future tax payments of their children, owning debt certificates. But, as he himself admitted David Ricardo, people are rarely as intelligent).

The book “the General theory of employment, interest and money” John Maynard Keynes, proving the benefit of active fiscal policy, was published in 1936. Forty years later occurred the counter-revolution, resulting critique budget activity. It took another 40 years, and the key idea of Keynes was back in the form of FTPL theory. Maybe it’s just old wine in a new bottle, but old wine is usually pleasing to those who are willing to try it.