Modern money theory and lessons from Japan

Just about a year ago, with its rising ‘rock-star’ appeal in the United States media, Modern Money Theory (MMT) faced a brutal attack from the neoliberal orthodox mainstream fraternity with barbs like “smoke and mirrors nonsense” (Kenneth Rogoff), “voodoo economics” (Lawrence Summers) and even “garbage” (Larry Fink). Fear ran alongside slander; and that MMT would turn the US into a Venezuela, Greece or Zimbabwe.

Then came the pandemic and the headlines changed. Some examples are: ‘Pandemic moves Modern Monetary Theory from the fringes to actual US policy’, ‘Can Coronavirus Response Open the Door to Modern Money Theory?’, ‘Could Modern Monetary Theory rescue us from the Covid-19 economic crisis?’, etc.

Even before the pandemic, if there was any country turning out to be a nemesis for mainstream economics, it was Japan. In spite of persistently large fiscal deficits, Japan struggled to ward off deflation rather than fight inflation. Its debt-to-GDP ratio of 250 percent had not ‘crowded out’ private investment with high interest rates. Way back in 2011, a confused Paul Krugman wondered: “A question (to which I don’t have the full answer): why are the interest rates on Italian and Japanese debt so different? As of right now, 10-year Japanese bonds are yielding 1.09%; 10-year Italian bonds 5.76%.”

There were also no bond market vigilantes who brought the Japanese government on to its knees. To the contrary, Japanese bonds were being bought by foreign investors, banks, pension funds and insurance companies. The Yen even accounted for some 4.5 percent of global foreign exchange reserves.

Although these facts lent credence to MMT, Japanese commentators and policy-makers such as Koichi Hamada, Finance Minister Taro Aso and Bank of Japan Governor Haruhiko Kuroda vehemently resisted the idea of Japan as an exemplar of MMT. Fear over deficits and debt had prompted Japan to switch intermittently to fiscal consolidation, killing any possible momentum in consumption expenditures, and thereby investment demand, stalling economic growth and buoyant prices.

Between 2013 and 2014 Japan experienced a spike in consumer confidence with employment income increasing by ¥8 trillion and consumer spending increasing by ¥10.4 trillion. However, bitten by the fiscal consolidation bug, former Prime Minister Shinzo Abe increased the consumption tax in 2014 from 5 to 8 percent so that from 2015 to June 2018 employment income rose by ¥24.3 trillion, but consumer spending rose by just ¥3.6 trillion. In October 2019, Abe once again announced another hike in the consumption tax (to 10 percent) to pay for social security costs of an aging population.

These attempts clearly delineate the wedge between MMT’s focus on revival of growth and Japan’s present policy preoccupation with fiscal consolidation, summarised by MMT economist, Randall Wray: “This has been Japan’s policy for a whole generation. Any time it looks like the economy might break out of its long-term stagnation, policy makers impose austerity in an attempt to reduce the fiscal deficit — and thereby throw the economy back into its permanent recession.”

Now Japan continues to grapple with the same dilemma, when earlier this month Taro Aso “brushed aside some ruling party lawmakers’ calls for a big extra stimulus budget.”

A critique of mainstream macroeconomics through the Japanese case should not be taken to imply that MMT advocates the same policy prescription for all situations; such naïve logic is a common weapon that macroeconomists often use against MMT. In general, MMT argues for expansionary fiscal policy until the economy reaches full employment. However, in addition to real resource constraints there is another critical constraint that must be underscored when it comes to ‘applying’ MMT, particularly to developing countries: the current account. Many developing countries run current account deficits (CAD). Increased government spending can quickly worsen the CAD and trigger a balance of payments crisis. With inelastic exports and rising import demand, the country’s currency could go into free fall with major economic and political ramifications.

On the other hand, Japan, in spite of its economic crisis since the 1990s, continued to maintain its position in the top 10 of the Global Competitive Index of the World Bank and World Economic Forum as well as first position on the Global Economic Complexity Index. While imports as a percentage of the GDP increased significantly from 10 percent in 1990 to 17 percent in 2017, Japan’s global competitiveness has ensured that exports kept up at the same rate. Current account surpluses and autonomous capital inflows have prompted Japan to build up foreign currency reserves to partially offset appreciation of the Yen. With the probable exception of China, most developing countries do not enjoy this ‘degree of freedom’ that Japan does, which has allowed it to ‘do MMT’.

Developing countries such as India should decentre the debate away from fiscal deficit target numbers, sustainable national debt and questions like where does money for government spending come from, and, instead focus on unemployment, real resource constraints and the external account. This caveat neither contradicts the basic tenets of MMT nor does it give mainstream economists anything to cheer about with their institutionally decontextualised models.

Sashi Sivramkrishna is an author, economic historian and documentary filmmaker. Twitter: @sashi31363. Views are personal.