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Japan fiscal policy should be linked to inflation target: Nobel laureate

By Stanley White and Yoshifumi Takemoto

By Stanley White and Yoshifumi Takemoto

TOKYO (Reuters) - Japan should delay raising the sales tax and commit to an expansionary fiscal policy until inflation meets the Bank of Japan's 2 percent inflation target, Nobel laureate Christopher Sims said on Monday.

Linking fiscal policy to inflation, combined with continued BOJ debt purchases to keep yields low, would help overcome the limits posed by the zero lower bound on nominal interest rates, said Sims, a Princeton University economist.

Japan's government should also delay returning to a primary budget surplus until after the inflation target is met, said Sims, who is in contact with Koichi Hamada, one of Prime Minister Shinzo Abe's influential aides on economic policy.

"Fiscal expansion needs to not simply run deficits or increase spending, it needs to make people realize that at least part of the debt is going to be paid off by increased inflation," Sims told Reuters in an interview.

"One way to do that is to make fiscal policy explicitly contingent on meeting inflation targets."

The views of Sims, visiting Japan to speak about his fiscal theory of the price level, could be influential because they fit with the policies Abe is trying to pursue.

Last year, Abe said he wanted to shift priority to infrastructure spending from fiscal discipline. This makes it less likely Japan will achieve its self-stated goal of returning to a primary budget surplus in fiscal 2020.

Abe has already twice delayed a nationwide sales tax hike.

Sims stressed that monetary policy needs to coordinate with fiscal policy, meaning the BOJ needs to continue its debt purchases to keep yields low until 2 percent inflation is achieved.

Once sustained inflation is in sight, the BOJ could revert to conventional policy to manage it, Sims said.

Sims, who won the Nobel Prize in economics in 2011, argues that as nominal policy rates approach the zero lower bound, governments need to increase deficit spending in tandem with central bank stimulus to generate demand.

Governments also need to convince the public that future debt will be paid off with inflation and not with higher taxes for this policy mix to work.

If people think taxes will rise in the future to pay off the deficit, they have more incentive to buy government debt, which reduces the amount of money flowing trough the economy, according to Sims.

(Reporting by Stanley White; Editing by Richard Borsuk)

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