Krugman: Can Japan pull it off?

Can Japan actually end decades of deflation?

Paul Krugman examines former Bank of England Monetary Policy Committee member Adam Posen's attempts to square the circle between his support for expansionary fiscal stimulus in Britain — where it hasn't happened — and opposition to the same in Japan — where it is apparently about to begin.

Posen wrote, in the Financial Times, that:

Mr Abe’s new fiscal stimulus initiative is therefore questionable. Not because another 2 per cent of GDP will be the proverbial tipping point on Japanese debt sustainability, for the factors protecting Japan from overt fiscal crisis remain. Nor because it will be ineffective; if anything, when combined with monetary expansion and a likely consumption tax rise in the near future, I expect its multiplier and thus short-run impact to be high.

The additional stimulus in Japan is counterproductive because it adds to the long-term costs without addressing Japan’s real problem: a return to deflation and an overvalued exchange rate.

Krugman is "a bit puzzled". He agrees that deflation is Japan's problem, because deflation forces short-term interest rates to bump against the lower bound. Since interest rates can't go below zero, that is, they are forced to remain slightly positive. That means that real interest rates — the nominal interest rate plus inflation — are forced to be significantly higher under deflation than they would be with mildly positive inflation, reducing the effectiveness of monetary policy.

So far, so macroeconomics 101. Where Krugman disagrees with Posen is how to break out of the deflation trap. Posen argues that unconventional monetary policy — quantitative easing and the like — can be enough. It's a monetary problem, so it ought to have monetary solutions. But Krugman argues that there may be a better way:

The credibility of a higher inflation target in the face of the deflationary bias of central bankers may well be best established by (a) reducing the central bank’s autonomy and (b) getting the central bank in the business of supporting — indeed, monetizing — government deficits, at least for a while. Gauti Eggertsson made this point long ago (pdf), pointing to Japan’s successful polices in the first half of the 30s as a clear example. Indeed, Gauti argued that having a large government debt can be a real advantage in such circumstances: efforts to raise expected inflation gain extra credibility if the government would clearly benefit in fiscal terms, and the central bank is sufficiently subordinated to elected officials that investors believe that it will take these fiscal benefits into account.

In other words, it all comes back to the question of central bank independence. If the government destroys that independence (even if it does it for paleo-conservative, nationalistic, reasons), and engineers a situation where inflation would make it better-off, then inflation expectations can be raised far higher than an independent central bank could ever do alone. Especially one which has so consistently failed to reverse the trend as the national bank of Japan.

Visiting Japanese Prime Minister Shinzo Abe speaks during a joint press conference held after official talks with his Vietnamese counterpart. Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

Photo: Getty
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The big problem for the NHS? Local government cuts

Even a U-Turn on planned cuts to the service itself will still leave the NHS under heavy pressure. 

38Degrees has uncovered a series of grisly plans for the NHS over the coming years. Among the highlights: severe cuts to frontline services at the Midland Metropolitan Hospital, including but limited to the closure of its Accident and Emergency department. Elsewhere, one of three hospitals in Leicester, Leicestershire and Rutland are to be shuttered, while there will be cuts to acute services in Suffolk and North East Essex.

These cuts come despite an additional £8bn annual cash injection into the NHS, characterised as the bare minimum needed by Simon Stevens, the head of NHS England.

The cuts are outlined in draft sustainability and transformation plans (STP) that will be approved in October before kicking off a period of wider consultation.

The problem for the NHS is twofold: although its funding remains ringfenced, healthcare inflation means that in reality, the health service requires above-inflation increases to stand still. But the second, bigger problem aren’t cuts to the NHS but to the rest of government spending, particularly local government cuts.

That has seen more pressure on hospital beds as outpatients who require further non-emergency care have nowhere to go, increasing lifestyle problems as cash-strapped councils either close or increase prices at subsidised local authority gyms, build on green space to make the best out of Britain’s booming property market, and cut other corners to manage the growing backlog of devolved cuts.

All of which means even a bigger supply of cash for the NHS than the £8bn promised at the last election – even the bonanza pledged by Vote Leave in the referendum, in fact – will still find itself disappearing down the cracks left by cuts elsewhere. 

Stephen Bush is special correspondent at the New Statesman. He usually writes about politics.