Even without the prospect of faster inflation and a declining yen, fundamental conditions in Japan point to higher interest rates. The Japanese government has been able to sell its bonds to domestic buyers because of the high rate of domestic saving. The excess of saving over investment has given Japan a current-account surplus, allowing the country to finance all of the government borrowing domestically, with enough left over to invest in dollar-denominated bonds and other foreign securities. However, that is coming to an end.
The household saving rate has collapsed in recent years, falling to less than 2 percent. The combination of high corporate saving and low business investment has sustained the current-account surplus, allowing Japan to fund its budget deficit domestically. However, the surplus has fallen sharply in the past five years, from about 6 percent of GDP in 2007 to only 1 percent now. With a falling rate of household saving and the prospect of new fiscal deficits, the current account will soon be negative, forcing Japan to sell its debt to foreign buyers.
Abe plans to supplement the easy-money strategy with an increase in government spending of about US$120 billion, or 2 percent of GDP. It is not clear why Abe and his advisers believe that this will deliver sustained real GDP growth of 2 percent a year. Although the US$120 billion is presumably just for the current year (if the spending can be made to happen that quickly), he also spoke during his campaign about a 10-year rise in government spending of ￥200 trillion (US$2.22 trillion), substantially more than the US$120 billion annual rate. The impact of all of this on the national debt and on Japan’s interest rates could be staggering.
Abe is right about one thing: Japan needs to get out of its no-growth and deflationary trap. However, the policies that he favors are not the way to do it.
Martin Feldstein is professor of economics at Harvard University and president emeritus of the National Bureau of Economic Research.
Copyright: Project Syndicate