The Debate on Growth Rates and Interest Rates within the Japanese Government
April 19 (Wednesday) 2006
Amidst forecasts for Japan's medium-term economic growth, the debate on the relationship of growth rates to interest rates has recently been gaining attention. The Japanese economy is on a path to recovery, and building off of this positive growth cycle, raising the primary balance of Japan's finances to zero-or perhaps even into surplus-as quickly as possible has become top priority. Many policymakers in the government share this resolve.
The government has set the elimination of debt in the primary balance by 2011 as the basic direction of its medium-term policy management. Every year the Koizumi Cabinet declares its “Large-Boned Policy” for the economy and determines a medium-term economic plan and the direction of policy management strategy. In June of this year as well, the cabinet is scheduled to once again map out its basic policy for economic management in the coming years.
Under the theme of “All-in-one Revenue and Expenditure Reform”, this year's Large-Boned Policy aims at establishing combined fiscal and tax system reforms to achieve a balanced economy as quickly as possible within the medium term. This policy will set the basic course for the next cabinet after Koizumi steps down in September, and thus it carries significant implications.
The two greatest controlling factors in designing financial and tax policies and anticipating expenditure and revenues are economic growth rates and market interest rates. Specifically, if the government can achieve medium-term economic management where growth rates exceed interest rates, swift finance reform will be possible due to increased tax revenue. However, if growth rates fall below interest rates, Japan's interest payments on its enormous long-term debt will grow, tax revenue will be limited, and finance reform will grow even more difficult.
In December of last year, the Minister of Internal Affairs and Communications, Heizou Takenaka, announced at the Council on Economic and Fiscal Policy (CEFP) that “If we pursue proper economic management, I don't believe that the nominal interest rate will rise above the nominal growth rate for any extended period of time *1.” Responding to this, Hiroshi Yoshikawa, member of the CEFP and professor of economics at the University of Tokyo, declared, “Theoretically, long-term interest rates will rise above growth rates *2.” This sparked a debate that would draw in government bureaucrats and connected departments and agencies. The debate quickly moved from policy to politics when Kaoru Yosano, Minister of State for Fiscal and Economic Policy and Financial Services, criticized Mr. Takenaka's assertion, saying, “If it is possible to create a situation in which the nominal growth rate exceeds long-term interest rates, than this would quickly unlock very positive prospects. Whether or not simply carrying on about such optimistic views will bring us closer to the real thing, however, personally I have some doubts.”
From the standpoint held by Mr. Takenaka, and one that has supported the Koizumi Cabinet up until now, early finance reform is an ardent wish, but the tax increases necessary to cover the bulk of these reforms are a dangerous issue. Thus, proponents of Mr. Takenaka's standpoint hold a strong belief that financing these reforms requires creating a positive growth cycle by accelerating growth rates in order to increase tax revenue naturally, and by reducing government debt. To achieve this, they believe that financial policy should be aligned to support this strategy.
On the other hand, the Ministry of Finance argues from the standpoint that raising the tax burden of citizens is unavoidable for achieving finance reform, and thus top priority should be placed on preparing the public early for such a move. As a reference for the “All-in-one Revenue and Expenditure Reform”, the Ministry of Finance drafted various scenarios for the medium-term outlook of Japan's Economy. The ministry has even gone so far as to run a campaign announcing that if the taxes are not raised to a certain degree, the government will have to reduce its services to citizens. From the ministry's perspective, it is not appropriate to assume that medium-term economic growth rates will remain safely above interest rates. Instead, they argue that a scenario in which interest rates rise above growth rates must also be assumed, and that it is necessary to prepare citizens for an increase in their tax burden.
Since the end of last year, the debate raging in the Council on Economic and Fiscal Policy concerning growth rates and interest rates has developed along this political rather than policy sense. It is becoming a theme with repercussions extending to the political sphere of how to build the Koizumi Cabinet only in the sense that it is a problem closely connected with the fundamental stance regarding the future of Japan's medium-term economic policy management. Mr. Koizumi advised the Council on Economic and Fiscal Policy to “stop the difficult academic talk and pursue appropriate policies.” Considering the political implications that this debate carries, it is easy to understand the meaning of his instructions.
Both economic growth rates and interest rates are decided in the market by the results of economic activities. In the end, what is important to the people of Japan is not the theological debate over which will rise higher. Rather, what the Japanese people need is open and understandable information concerning which mix of policies will achieve the economic growth necessary to bring about finance reform as fast as possible, and for the government to pass through a constructive discussion on concrete policies and implement those policies deemed effective.
Rather than a theological debate, the Japanese people desire the strong enforcement of policies that they can trust. I believe that the public is ready to bear whatever tax burdens may be necessary to make this happen. What must be done before this, however, is full disclosure of why the tax burdens are necessary, and whether or not the government is truly doing everything within its power.
- Summary of the Minutes from the 28th Meeting of the Council on Economic and Fiscal Policy, 2005.
PDF http://www.keizai-shimon.go.jp/minutes/2005/1206/shimon-s.pdf - Summary of the Minutes from the 31st Meeting of the Council on Economic and Fiscal Policy, 2005.
PDF http://www.keizai-shimon.go.jp/minutes/2005/1226/shimon-s.pdf