Japan's conservatives have learned to love deficits
On Monday, 9 May, former prime minister Abe Shinzō was in Oita campaigning for the Liberal Democratic Party ahead of this summer’s upper house elections. In his appearance, the former prime minister offered (jp) candid remarks on Japan’s fiscal policy.
“Half of the government’s quadrillion yen debt is bought by the Bank of Japan,” he said. “Since the BOJ is a government subsidiary, when the bonds mature in sixty years, they can be refinanced without paying them back. There is no need to worry.”
As has now become typical when Abe opines on important policy questions, other political figures felt compelled to respond (jp). Chief Cabinet Secretary Matsuno Hirokazu declined to comment on Abe’s remarks specifically, but reiterated that the Bank of Japan’s autonomy in monetary and financial affairs must be respected. Tamaki Yūichirō, the leader of the Democratic Party for the People and a former Ministry of Finance official, noted that it is not unusual lately to think of the BOJ and the government as functioning on a “consolidated basis,” but did not see Abe’s remarks as problematic, noting that the BOJ does not buy directly from the government and so “its independence is not harmed.” Other opposition parties were more critical. Nishimura Chinami, the Constitutional Democratic Party’s secretary-general, noted, “Mr. Abe’s true intentions have come out.”
But what matters is that these remarks are another sign that Abe, having resumed his role as leader of the LDP’s conservative wing from the party’s backbenches, is now a full-throated proponent of deficit spending. There is now a significant, organized bloc within the LDP in favor of deficit spending for the indefinite future, a bloc that is likely more powerful than the party’s fiscal hawks. Indeed, this transformation of the politics of fiscal policy within the LDP may quietly be one of Abe’s most important legacies. Abe assumed the leadership in 2012 of a party that had campaigned on – and maneuvered the DPJ-led government into accepting – a significant consumption tax increase. The small government, deficit-cutting LDP of the early 2000s is dead.
This became readily apparent during the LDP’s September 2021 leadership campaign and its aftermath. Takaichi Sanae, the conservative firebrand who ran a surprisingly strong campaign thanks to Abe’s unstinting support, campaigned openly on suspending fiscal rules to enable the government to invest in strategic industries.
In the wake of the leadership election, Takaichi, now the LDP’s policy chief, moved against the LDP’s fiscal hawks. She transformed the party’s Fiscal Reconstruction Promotion Headquarters – which, ironically, was originally created by Inada Tomomi, another Abe protégé, when she was policy chief – into the Fiscal Policy Examination Headquarters and appointing conservative Nishida Shōji as its chair, with Takaichi and Abe as senior advisers. Nishida’s presence is notable since he is the LDP’s most vocal supporter of modern monetary theory, even meeting with American MMT theorist Stephanie Kelton when she visited Japan (for which she attracted some criticism).
Takaichi and Abe were given the opportunity to make mainstream their new ideas about deficit spending when MOF administrative vice minister Yano Kōji used an essay in the monthly Bungei Shunjū to criticize politicians for their reckless spending and compared Japan’s fiscal situation to the Titanic. Takaichi criticized the official’s intervention in politics and downplayed (jp) his warnings about default risk, arguing that Japan could not default since it issued its own currency. Abe, meanwhile, made a more elaborate argument about the relationship between the government and the BOJ. In a speech in Tokyo in December, he said:
Japan is absolutely not the Titanic. If Japan were the Titanic, nobody would buy bonds issued by the Titanic. They are selling well.
[The huge supplemental budget for the Corona virus disaster] was financed by deficit bonds, most of which were purchased by the Bank of Japan through the market. It is the Bank of Japan that is bearing the debt, not our grandchildren’s generation. This is a crude way of speaking, but the Bank of Japan is a national subsidiary. It is a splendid central bank, but since the government holds fifty percent of its shares, the idea that [its bond holdings] are not debts on the consolidated balance sheet is also valid. [My translation]
Whether Abe is correct that, with the BOJ’s dominance in the market for Japanese government debt, the Japanese government can continue to roll over its debts in perpetuity, this kind of thinking — call it soft modern monetary theory (MMT) — has become firmly entrenched among the LDP’s conservatives.1
To be sure, Abe was no fiscal hawk as prime minister. He did not adhere to MOF orthodoxy. He was hesitant to implement to first of two consumption tax hikes from five percent to ten percent in 2013, and successfully delayed the second increase twice before finally agreeing to implement it in 2019, battling with both LDP fiscal hawks and the finance ministry to get his way.2 He was reluctant to cut spending, insisting that the deficit could be stabilized through higher tax revenues. But he also insisted that debt consolidation remained a medium- to long-term goal for the Japanese government and he and his key advisers (with one notable exception) were quick to reject suggestions that its fiscal stimulus packages, combined with the BOJ’s large-scale bond buying, amounted to debt monetization or that Japan was a model for MMT. Abe and his advisers were willing to experiment, but they sought to avoid giving investors the impression that the Japanese government was wholly irresponsible.
I can think of three reasons why Abe and its ideological compatriots have openly embraced this soft modern monetary theory. First, the Covid-19 pandemic likely provided some proof that, with the Bank of Japan committed to the theoretically unlimited purchase of government bonds in order to meet its interest rate target via the yield curve control program, the government could significantly increase its deficit spending without worrying that its borrowing costs would spike. In FY2020, once the pandemic stimulus packages were added to the general budget, the government issued more than ¥112 trillion in new bonds, for a bond dependency ratio — the ratio of bonds issued to total spending — of 64.1%.3 Thanks to the BOJ’s interest rate target, the government’s borrowing costs barely moved.
But I would argue that what matters to the conservatives is not just “proof” that Japan can run larger deficits for longer than the textbooks suggest. Ultimately I think it comes back to defense spending, which the right wants to raise to two percent of GDP (at least).4 If the government can continue to run large deficits, then the government does not have to grapple with a guns or butter tradeoff. The LDP-led government can raise defense spending and make the kinds of strategic investments outlined by Takaichi in her campaign book (see my thread on her book here) without having to introduce tax hikes or cut social security spending, both of which could undermine support for defense spending increases. We know from polls that the public is open to more defense spending, but it is harder to say how robust support would be if it meant higher taxes or spending cuts in other areas. To my knowledge Abe has not made this connection explicit, but it is hard to miss the connection that among the issues he is using his bully pulpit for are “deficits are fine, actually” and higher defense spending.
Finally, I suspect another reason why Abe has taken aim at the BOJ in particular is that he is looking ahead to the end of Kuroda Haruhiko’s tenure as governor next year and will want to pressure Kishida to pick a successor who will endorse the BOJ’s role in enabling government deficits. A proper debate over the BOJ succession has not yet begun, but I see Abe’s repeated comments on Japan’s fiscal-monetary compact as staking out a position now to limit Kishida’s freedom of action in his search.
Accordingly, Kishida is now in the unenviable position of having to strike a balance between the fiscal doves on his right flank and a finance ministry that has utterly rejected the right’s arguments about deficits. While Kishida has not generally appeared to have fiscal hawkish tendencies — and clearly has his own spending priorities — as prime minister he undoubtedly feels the same pressure Abe felt to appear responsible. As such, earlier this year, he reiterated (jp) the government’s commitment to achieve a primary fiscal surplus within the end of the decade, even as conservatives have downplayed the importance of such a target. I anticipate that between the FY2023 budgetary process — with the LDP’s push for a defense spending increase — and the BOJ succession process, the second half of 2022 and the first quarter of 2023 are going to see more extensive conflict between fiscal hawks and doves, with Kishida caught in the middle.
President Biden will likely launch the Indo-Pacific Economic Framework during his trip to Asia later this month…CDP leader Izumi Kenta is trying to repair (jp) relations with organized labor ahead of the upper house elections…Here’s a useful explainer (jp) of the economic security legislation that the Diet passed this week…Takaichi Sanae welcomed (jp) Yoon Seok-youl into office by warning him to respect international agreements…Kishida (regrettably) asked (jp) German Chancellor Olaf Scholz about removing a comfort women memorial statute in Berlin when they met on 28 April…LDP and CDP representatives sparred (jp) in a debate about national security and Article 9 in the lower house’s constitution commission on 12 May.
Definitely check out this thread from Bloomberg’s James Mayger on the curious lack of interest in how Japan has managed the Covid-19 pandemic.
Noah Smith points to some arguments about why this argument may be mistaken, pointing to the idea of “fiscal dominance.”
It was not well appreciated at the time, but Abe’s 2014 snap election was the result of a battle with LDP fiscal hawks over the consumption tax hike and corporate tax cuts.
See this Ministry of Finance fact sheet on public finances: https://www.mof.go.jp/english/policy/budget/budget/fy2021/02.pdf.
A post by Takaichi on her blog argues precisely that two percent of GDP will actually be inadequate for Japan’s defense: https://www.sanae.gr.jp/column_detail1400.html.