Recent Problems in Macroeconomic Policy

Miyohei SHINOHARA (Professor Emeritus, Hitotsubashi University)

I. Blind Spot in Macroeconomic Management

Japan's nominal GDP growth rate was 6.6 % on the average during the bubble period of 1985-1990, but dropped drastically to 0.7% during the period of 1996-2002. As a result, the tax revenue/GDP ratio declined from 13.4% in 1990 to 8.8% in 2002. Due to the progressive rate of income taxes and the high elasticity of corporate profits to GDP, it was inevitable that the tax revenue/GDP ratio decreased during the recessionary period. While the growth rate of expenditures in the government's general budget slowed down from an average of 1.9% during 1991-1995 to 1.5% during 1996-2002, the total amount of government bonds increased progressively from 7.3 trillion yen in 1990 to 21.2 trillion yen in 1995, 33.0 trillion yen in 2000, and 35.0 trillion yen in 2002, thereby offsetting the decrease in the tax revenue/GDP ratio.

There used to be a common idea that government bonds would increase only when public investments are actively undertaken. But during the past prolonged recession, low growth and deflation reduced general tax revenues and corporate tax revenues, and increased the amount of government bonds issued to offset the tax reduction, contrary to the common idea.

These days, Japan's national debt/GDP ratio has risen to an abnormally high level and has attracted much attention internationally. However, the problem is more serious than meets the eye, if this ratio is raised by low nominal growth rates with deflation trends.

There seems to be an empirical law of numerical relations built in for any economy in the post-war world such that more or less the same inflation rate as the real GDP growth rate is required to maintain real economic growth rates around 3-4% over time, although logical proofs of such numerical relations are omitted here, due to space limitations. If that is the case, Japan needs to have a policy of a mild inflation rate of approximately 3% of consumer price increases to lighten the burden of excessive national debt.

So far the Bank of Japan appears to have been averting the adoption of an inflation target. Mild inflation must be realized, however, for the Japanese economy to have increasing tax revenues and thereby escape from the burden of its huge national debt. This fact seems to be a complete blind spot in macroeconomic management for today's Japanese economy.

II. Massive Amount of Government Bonds

Japan's central government debt was 556 trillion yen at the end of fiscal year 2003. Actually, the GDP being 501 trillion yen, the national debt/GDP ratio amounted to 111%. Given this fact, no one would suggest that Japan's government bonds should be increased. Just for the last few years, the national debt/GDP ratio has been rapidly increasing, as this ratio was 74.3% in fiscal year 2000. It certainly appears to be an emergency situation.

However, government bond prices have not collapsed, and interest rates have not risen sharply. The reason may be that much of the government bonds are being held by the Bank of Japan and financial institutions under some government influence. In fact, at the end of fiscal year 2003, 15.4% of government bonds were held by the Bank of Japan, 7.8% by the general governments (the central government, local governments and the social insurance fund), 15.2% by postal savings, 8.2% by postal life insurance, and 10.0% by public financial institutions (the fiscal loan fund and government-affiliated financial institutions), totaling 56.6%. If, furthermore, we add government bond holdings by public financial corporations for agriculture/forestry/fishery (4.2%) and for small & medium size businesses (3.3%), the ratio becomes 64.1%. In other words, well over half of the national debt is "non-marketable." In contrast, private banks' holdings of government bonds is 75.3 trillion yen, a mere 13.5% of the total. Due to this fact, the collapse of the government bond market seems to be avoided. This point is yet to be fully recognized even by specialists.

Consider the U.S. case for the purpose of comparison. At the end of fiscal year 2003, 9.7% of U.S. government bonds were held by the Federal Reserve Board, a percentage that is lower than 15.4% for the Bank of Japan. If, however, not only the Federal Reserve Board but also other governments and government-affiliated institutions are included, up to 51.8% of U.S. government bonds was held by such public institutions.

This is consistent with the fact that 49% of U.S. government bonds are "non-marketable." It may be that the government and the central bank have taken a step in the direction of maintaining a high proportion of "non-marketable" bond holding to avoid a possible collapse of government bond prices when the national debt/GDP ratio becomes quite high. This is a very important point.

Moreover, in the case of Japan, the overseas holding rate of government bonds was only 3.4% in fiscal year 2003. This rate is much lower than 33.9% for the U.S. and 40.4% for Germany at the end of fiscal year 2003, and 12.2% for the U.K. at the end of fiscal year 2002. This is in addition to the fact that the ratio of government bonds held by the central bank and government-affiliated institutions is very high in Japan. This condition might be regarded as abnormal from the international point of view. However, this "abnormal" condition may well play an important role in preventing government bond prices from collapsing in Japan, at least in the next five year or so. In a sense, "normalizing" this condition hastily could have an adverse effect in the government bond market. This fact should be emphasized.

III. Privatization of Postal Services

In Japan today, postal privatization seems to be widely accepted and is being implemented. While this may be the right policy in the long term, privatization could cause a serious problem if it has a negative effect on government bond holdings in the medium term. We should avoid a sharp reduction in the purchase of government bonds through postal savings and postal life insurance. Currently the amount of government bond purchases by postal savings is 84.5 trillion yen, and an additional 45.8 trillion yen by postal life insurance, totaling 130.3 trillion yen, which is a huge amount. Therefore, postal privatization may well have a negative impact on government bond holdings, even if it is in the right direction in the long run. This point seems to be largely forgotten in the debate on postal privatization in Japan.

If government bond holdings by postal savings and other government-related institutions become too low, then the issuance of "perpetuity bonds" such as consol bonds by the government could play the same role as public bond holdings. These days the importance of perpetuity bonds is sometimes emphasized in the context of social insurance in the economy with a declining population. It should be recalled, however, that a proposal for issuance of perpetuity bonds was already made several decades ago by Mr. Sohei Nakayama, a charismatic leader in Japan's post-war business world. In my opinion, what we should envisage now is the issuance of perpetuity bonds, where interests are payable but principals are non-redeemable to replace outstanding government bonds in Japan.