It has been more than 20 years since Japan’s public finances were projected to collapse within a decade. Are the advocates of Modern Monetary Theory justified in saying that Japan provides evidence for the validity of their claims? 

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Modern Monetary Theory is a controversial macroeconomic framework that was thrust into the policy limelight when a number of progressive US Democrats cited it as a means of financing new, progressive government programs. The idea has recently received great attention in Japan as well, probably even more so than in the United States.

MMT proponents contend that mainstream economists overstate the risks of government debt, since governments like Japan can borrow in their own currency to finance deficit spending. Public debt is not a problem, they say, as long as the central bank can print money to keep purchasing government bonds. Self-proclaimed “social democrats” like Bernie Sanders and Alexandria Ocasio-Cortez see MMT as a tool for reducing unemployment and mitigating economic disparities.

Stony Brook University professor of economics and public policy Stephanie Kelton, the leading MMT advocate who recently visited Japan, noted that the country’s experience is consistent with what MMT advocates have been arguing for decades. She argues that the government can borrow as much as it wants while inflation is low. Other US economists, however, have been critical of MMT, warning that the failure to pay back government debt will invite hyperinflation and decimate the economy. Should MMT be considered a realistic option?

Ignoring Government Debt

The biggest difference between mainstream and MMT viewpoints is whether ballooning government debt is considered a problem. We have traditionally been taught that when the debt-to-GDP ratio gets too high, bond prices and currency values plummet, leading to hyperinflation. But MMT theorists maintain that countries issuing bonds in their own currency can never default, so piling up debt does not pose a serious risk.

I have long regarded Japan’s mounting public debt to be a real threat and have been warning that its continued expansion would destabilize the economy. MMT proponents blithely retort that countermeasures are available—such as raising interest rates—when additional spending is likely to trigger inflation. When the government is already saddled with huge debts, though, higher interest will erode market confidence and cause market rates to spiral out of control. Even if the Bank of Japan steps up its purchase of government bonds as a stopgap measure, excess cash in the economy would then trigger runaway inflation. The MMT prescription under such circumstances is to raise taxes or cut expenditures. We in Japan know from experience, however, that such measures have inordinately high political costs. Raising taxes in the face of imminent inflation is impractical and unrealistic.

That said, no consensus exists among mainstream theorists on how high the debt-to-GDP ratio can go without breaking an economy. It has indeed been a riddle as to why, despite massive debts, Japan’s bond prices remain so stable with no signs of inflation.

Japan’s Fiscal Resilience

It has been more than 20 years since Japan’s public finances were projected to collapse within a decade. Were the dire warnings of doomsayers unfounded? Are the MMT advocates justified in saying that Japan provides evidence for the validity of their claims? By no means am I about to join the MMT bandwagon, but there is something to be said for Japan’s fiscal resilience. The source of such resilience may be traced to the absence of external debts, the continuing surplus in the current account, and the fact that Japanese companies and individuals hold enough assets to finance the government’s debt, ensuring the creditworthiness of government bonds and the yen. Market confidence cannot be sustained indefinitely, though—even with a surplus in the current account and external assets—if tax revenues are insufficient.

Fiscal expenditures have persistently outpaced revenues in Japan, and this has lulled people into the daydream that the situation is sustainable. It is a bubble of sorts that could easily burst. An unanticipated turn of events could trigger a market reaction and send bond prices plummeting. Increasing taxes and cutting spending may be politically difficult, but the only way to dispel credit anxieties is to put together a policy package designed to effectively keep the debt-to-GDP below a certain threshold over the very long term.

Stephanie Kelton may see Japan as offering proof that MMT works. But with public debt already at 240% of GDP, how much longer can the Bank of Japan continue buying deficit-covering bonds and maintain low interest rates? To assert that all is fine, as MMT theorists seem to be doing, is just denying the simple fact that all bubbles must eventually collapse.