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Japan has a virulent case of ``secular stagnation’’, i.e. weak private domestic demand. To maintain full employment, it has needed and still needs aggressive monetary and fiscal policies. Monetary policy is doing everything it can. The burden thus falls on fiscal policy.
There are three reasons to want to maintain, or even consider increasing, primary deficits. The first one is to maintain demand. If the fiscal stance is tightened, what will sustain demand? If, for some reason, private demand picks up, then there may be room. But not now.
The second reason is that inflation is below target. It would be desirable to get there. This requires overheating the economy for some time, to get wage and price pressure up. Slightly larger increases in primary deficits would help achieve it.
The third reason is to lift some of the weight falling on monetary policy and giving it more room to act if and when needed. Very low rates also increase financial risks. Slightly larger primary deficits would allow for slightly higher rates.
Even if the main motivation is to sustain demand, primary deficits should be used to help the supply side, to help growth. One should be skeptical of a need for more bridge and tunnels. But there are good projects to be financed, to increase fertility or to fight global warming.
Aren’t larger deficits, and higher debt to GDP ratios costly in the long run? True, debt may crowd out capital, but the risk-adjusted return to capital is low, as reflected in the very low safe rates, so the welfare cost of lower capital accumulation in the long run is small.
Isn’t high debt risky? Yes. The risk of a sudden stop exists today and will exist for a long time. But the risk is roughly the same whether net debt is 160%, 180% or 140%. And the BOJ has shown that it has the tools and the willingness to fight liquidity runs.
