There is a heated debate emerging within the government over whether Japan can rely on debt-financed spending at a time of high nominal economic growth. In this sense, Prime Minister Sanae Takaishi is seeking to make the goal of achieving a primary surplus more flexible.
“Nominal growth rates will recover thanks to productivity growth,” Takaishi said at a meeting in Tokyo on Monday. He added, “The debt-to-GDP ratio is declining,” calling for “strategic financial spending to achieve a strong economy.”
In the face of rising long-term interest rates, it noted the need to pay close attention to interest rate trends and continue to improve debt indicators, but did not mention the goal of achieving a primary surplus. In November, it said it was seeking to achieve a primary surplus over several years rather than in one fiscal year.
Fiscally conservative members of the Liberal Democratic Party (PLD), headed by Takaishi, are skeptical. They wonder how the government can achieve a primary surplus over several years if it abandons achieving it in one fiscal year.
Satoshi Honjo, policy chief of the opposition Constitutional Democratic Party, strongly criticized her plan, calling it “extremely problematic.”
The primary balance is an indicator of the government’s ability to finance its expenditures, such as social security and public works, without resorting to debt. When expenditures exceed revenues, a primary balance deficit occurs, leading to an increase in national and local public debt. Japan has been running a primary balance deficit since fiscal year 1992.
Former Prime Minister Junichiro Koizumi set the goal of achieving a primary balance surplus in 2001, within the framework of his government’s economic and fiscal policy guidelines.
The document stressed the importance of “covering the costs of current government services from current tax revenues, without transferring them to future generations.” The warning included: “When interest rates exceed the growth rate, preventing the debt stock from increasing as a share of GDP requires not taking on new debt that will not be used to pay principal and interest.”
This is the central point of the current debate on fiscal consolidation.
If the nominal growth rate is higher than interest rates, economic growth exceeds the debt growth rate, lowering the debt-to-GDP ratio—a theory known in economics as the Domar condition. If interest rates are higher than nominal growth rates, it is better to restrict new bond issuance.
At a press conference in 2005, then-Minister of Economy, Trade and Industry Kaoru Yosano stated that “a nominal growth rate higher than long-term interest rates should be considered a temporary bonus, and it is normal for long-term interest rates to be higher in the long run.”
This view was challenged by then-Interior Minister Heizo Takenaka. “I wonder whether it is appropriate to assume that long-term interest rates are always higher” than nominal growth rates, Takenaka said at a meeting of the Economic and Fiscal Policy Council.
His reasoning was that if growth rates exceeded interest rates, increased tax revenues would allow bond issuance to be reduced. He made the comments in a debate about the need to raise taxes to restore fiscal health.
The deadline for achieving a primary surplus was initially set for early 2010, a target that was postponed to fiscal 2020 during former Prime Minister Shinzo Abe’s second term. The 2008 financial crisis and the 2011 earthquake and tsunami required large-scale stimulus spending.
Low interest rates, resulting from the Bank of Japan’s broad monetary easing, have persisted under the Abenomics economic policy, creating an environment conducive to strong fiscal spending. The consumption tax increase was also postponed, and in 2018, the primary surplus target was postponed again to fiscal year 2025.
The basic economic and financial policy is approved by the Council of Ministers. In June this year, under the government of former Prime Minister Shigeru Ishiba, the goal was to achieve a primary surplus “as soon as possible between fiscal years 2025 and 2026.”
The economic environment has changed radically since the era of deflation. The unprecedented quantitative easing program has ended, bringing interest rates back to Japan. Long-term interest rates are at their highest level in 17 and a half years.
Although nominal growth rates currently exceed nominal interest rates due to inflation, some analysts see this as a temporary phenomenon. “Simulations indicate that interest rates are likely to exceed the growth rate again after 2030,” said Yohei Kobayashi, senior principal investigator at Mitsubishi UFJ Research and Consulting.
“If we do not look at the situation on an annual basis, we must strengthen a framework for the size of the deficit that we can sustain in the medium and long term,” Kobayashi said of the primary balance. “It is important to be careful not to fall into a vicious cycle in which interest payments increase debt, which in turn increases interest.”
Professor Masazumi Wakatabi of Waseda University, former vice president of the Bank of Japan and independent member of the Economic and Fiscal Policy Board, calls for an expansionary fiscal policy. According to him, as long as nominal growth rates exceed interest rates, “there will be no need for a primary surplus target and active fiscal spending is possible.”
Since Takaishi took over the LDP leadership in October, long-term interest rates have risen and the yen has fallen, reflecting the risk of a deteriorating financial situation.
At a House Budget Committee meeting on November 10, Takaishi said he would issue instructions in January on setting a new target for the initial budget. Based on the Prime Minister’s Office’s fiscal estimates, which will be released in January, the government plans to outline its plans during parliamentary budget deliberations and in its core economic and fiscal policy, which will be determined before the summer.