Japan’s prime minister, Shinzo Abe, is weighing a tough choice: whether to let an increase in the national sales tax proceed as planned next spring or to postpone it until the economy is stronger. With an announcement expected soon and markets nervously awaiting the decision, Haruhiko Kuroda, governor of the Bank of Japan, last week lent his support to the plan. The economy is strong enough, he said. He’s right.
Admittedly, Japan’s economy still isn’t growing as quickly as either man would wish. With Abe’s enthusiastic support, the central bank radically changed monetary policy earlier this year, adopting a new inflation target of 2 percent a year and an aggressive program of bond-buying to back it up. Growth accelerated immediately. Japan grew faster than any other advanced economy in the first half of the year. Even so, measured against the hopes that the policy shift had aroused, the most recent figures were a bit of a letdown.
Output in the second quarter expanded by 2.6 percent at an annual rate. That’s far better than Japan has been accustomed to in recent years, but hardly stunning. And nobody in Japan needs reminding that it was a controversial sales tax increase in 1997 that helped to push the economy into recession and more than a decade of further stagnation. Caution over tightening fiscal policy too soon is understandable.
Legislation to raise the sales tax from 5 percent to 8 percent next April, then again to 10 percent in October 2015, has long been in place. The goal is to halve Japan’s primary budget deficit (that is, excluding interest payments) by 2015 and bring it into surplus by 2020. At some point, Japan will have to act, because its fiscal position is beyond unsustainable. Its total public debt is pushing 250 percent of gross domestic product; even allowing for public holdings of assets, the net debt stands at about 140 percent of GDP -- almost double the euro-area average.
Japan has been able to get away with this startling fiscal laxity because its banks could be counted on to buy public debt in great quantities, and foreign holdings of Japanese government debt are relatively modest. But as the debts have mounted, so have the economic costs. Even with very low interest rates, debt service is crowding out more productive kinds of public spending. And financial markets know that, one way or another, borrowing on the present scale can’t go on. That puts a heavy burden of financial uncertainty on the economy.
Fiscal stimulus was necessary in the 1990s -- which is why the earlier tax increase was a mistake. But debt has grown to the point where high public borrowing is much less helpful, and far more risky. Equally important, its new monetary policy gives Japan a better way to encourage growth. Inflation is rising a little, as intended, but at less than 1 percent it’s nowhere near breaching the new target. There’s room for even more quantitative easing, and Kuroda has said he’s willing to use it if need be.
That’s the best approach. Killing deflation is the right way to assure adequate growth of demand in Japan. With monetary policy correctly assigned to this task and the economy picking up, gradual fiscal consolidation can start on schedule. Abe should accept Kuroda’s advice and stick with the tax-increase plan.
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