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Apr 28 2016

The Fiscal Equivalent of War

In the wake of the Bank of Japan (BoJ) decision to stand pat, Japan looks to be in ever more desperate straits, given the growing danger of sliding into its second recession since Abenomics was introduced. Such a recession would be the nail in the coffin of Abenomics, launched with high hopes and much fanfare three years ago. It made sense, therefore, for Prime Minister Shinzo Abe to seek the advice of Paul Krugman, who has been one of the chief cheerleaders for Abenomics, in a private meeting last month meant to lay the groundwork for the G7 Summit at Ise-Shima next month.

Although it was evidently supposed to be confidential, we recently chanced upon a rather revealing transcript of that meeting, which also included BoJ Governor Kuroda and Finance Minister Taro Aso. Mr. Krugman began by declaring that “we are now in the world of pervasive economic weakness. In many ways, we are all Japan.”  Second, he noted “that the linkages among major economies are strong … largely … because of capital flows.” Third, he emphasized “the difficulty in achieving goals through even very bold and unconventional monetary policy.” He concluded “that monetary policy needs help from fiscal and possibly other policies [which] is … very much a global issue at this point.”

Recalling how World War II catapulted the U.S. economy out of the Great Depression, Mr. Aso then emphasized that they were looking for a similar trigger to make entrepreneurs abandon their “deflationary mindset” and “start making capital investments.” Mr. Krugman responded that they were “looking for ways to achieve something like that without war” – what he subsequently characterized as the “fiscal equivalent of war.” Then, regarding G7 countries with policy space for fiscal stimulus, he opined that, while Japan and Canada would go along, Germany, the U.S. and the U.K. were unlikely to “implement significant stimulus measures in coming months.”

In Germany’s case, it was “very difficult to make the argument” as “they simply live in a different intellectual universe.” In the U.S., while President Obama favored major fiscal stimulus, it was not yet politically feasible, but at least, Mr. Krugman said, “we can blunt the push for fiscal consolidation.” Meanwhile, he said, “conventional wisdom [within] the policy community” had been shifting in favor of stimulus, “and it might be possible to move that along.” Finally, he noted the likelihood that by year-end the U.S. would have a “significantly less obstructionist” legislature.

Around the end of the meeting, Mr. Abe concluded that the “international community must coordinate in the fiscal space and the countries which are able would spend fiscally. … After all, this is off the record, Germany has the greatest space … I will have to … persuade them how they will come along with the policy for further fiscal mobilization.”

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