The IMF’s Recommended Fiscal Path For Japan

With a bit of technical assistance, I was able to do a better job of quantifying the IMF’s recommended fiscal path for Japan.

The IMF wants a 50 to 100 basis point rise in Japan’s consumption tax every year for the foreseeable future, starting in 2017. A 50 basis point rise would result in between 20 and 25 basis points of GDP in structural fiscal consolidation a year (the call for the tax increase is in paragraph 23 of the staff report, and is echoed in the IMF’s working paper).

The IMF doesn’t want Japan to continue relying on fiscal stimulus packages, which typically have funds for public investment and the like (paragraph 23). As a result, there is a 60 basis points of GDP consolidation from the roll-off of past stimulus packages (the change in the structural primary balance is in both table 1 on p.38 table 4 on p.41 of the staff report).

That implies 80 to 85 basis points of GDP in structural fiscal consolidation.

But, in the staff working paper (not formal advice, but it clearly reflects the IMF’s overall recommendations), the preferred policy scenario shows an 80 basis point of GDP increase in temporary transfers and public wages to support the proposed incomes policy (this is in the working paper appendix, in table I.1 on p. 33).

Net it all out; the result is basically a neutral stance, not the consolidation I initially suspected. The 0.5 percent of GDP fall in general government net lending/borrowing in table 2 on p. 25 of the working paper stems from a fall in interest payments and an increase in nominal GDP that is projected from the new incomes policy.*

Actually if you look at table 4 in the staff report, Japan’s is expected to receive more in interest income than in pays out in interest in 2017. Japan’s government is projected receive 1.6 percent of GDP in interest on its assets (including its foreign reserves, which are largely held by the ministry of finance) and pay 1.3 percent of GDP in interest on its debt. The total fiscal deficit is thus smaller than the primary fiscal deficit in 2017. Welcome to the world of negative interest rates.

The same methodology can be applied to deduce the IMF’s proposed fiscal stance for 2018. It generates a small proposed fiscal expansion in 2018, as the contraction from the roll-off of past stimulus is smaller (table 3 of the staff report shows a smaller change in the primary balance in 2018 than in 2017) and there is an ongoing increase in temporary transfers.

Alas, these calculations are not totally straight-forward: getting the right answer requires two documents, and an appendix table! Using the change in the structural balance rather than the change in the structural primary balance also generates a slightly different result (a modest consolidation in 2017). A box that pulled together and quantified the Fund’s proposed offsets to the consolidation measures proposed for 2017 would have been helpful.

I trust numbers in tables more than words. There have been too many stimulus packages in Japan that haven’t actually stimulated the economy, as one package just offset the roll-off of an earlier package.*

A flat 2017, slightly expansionary 2018, and then a period of steady consolidation doesn’t actually detract from the core of my initial argument. I was focused on the impact of the IMF’s policy recommendations on global current account adjustment. The Fund is still recommending a medium-term fiscal consolidation in Japan, one that on its own would be expected to raise Japan’s current account surplus over time.

And the proposed medium-term fiscal consolidations in the eurozone, Japan, and China still dwarf the (very modest) medium-term fiscal expansions proposed for Sweden and Korea. As a result external rebalancing—a reduction in the size of both external surpluses and external deficits—necessarily would have to be achieved through a larger fiscal consolidation in countries around the world that now run external deficits than in the countries that now have external surpluses. For a fiscal expansion in the surplus countries to contribute meaningfully to external rebalancing, the Fund will either need to recommend sustained fiscal deficits in countries like Japan, or encourage countries with both trade and fiscal surpluses (Korea and Germany) to move into fiscal deficit, not stop at fiscal balance. Such is the math.

Paul Krugman though was more irked by the near-term impact of the IMF’s recommendations on demand. I suspect Dr. Krugman would prefer that the Fund embrace a bolder fiscal relaunch, especially with Japan stuck at the zero ten year bound (see Cecchetti and Schoenholtz, among others). A government that makes more on its lending than in pays on its borrowing probably has a bit of fiscal space.** But directionally, in Japan, the IMF is pushing (softly) in the right direction (at least in 2018).

And, well, if the IMF can propose a few basis points of fiscal expansion in Japan over the next couple of years, I would hope it could do the same for the eurozone. ***

* The paragraph in the staff report that I thought outlined the IMF’s recommended pace of consolidation (paragraph 28) only applies if Japan doesn’t adopt the IMF’s proposed incomes policy. I confess I missed the text in italics that limited the advice in paragraphs 27 and 28 to the "no reforms, no incomes policy" case; mea culpa.

** On net, Japan’s government is forecast by the IMF to receive more interest income than it pays (remember Japan has substantial financial assets, net debt is much smaller than gross debt) from 2017 to 2020 (see Table 3 on p. 40 of the staff report). Perhaps that will change with the BoJ’s new policy, as the Bank of Japan now doesn’t want the ten year JGB rate to be substantially negative—but probably it will not change by much.

*** And do so without relying on the creation of new fiscal capacity at the euro-level. Common fiscal institutions are a good idea for the medium-term but the reality right now is that the eurozone’s aggregate fiscal policy is the sum of the national fiscal policies of its member states.