August 3, 2010
Ken Rogoff has written a book about the perils of increased sovereign debt levels. What is your take on his work, and particularly for Japan in terms of how it's going to deal with its debt level currently?
People have the right to worry about debt levels, but if a balance sheet recession is the reason why the economy is so weak, then the government has to take the extra savings generated in the private sector and put it back into the income stream. If government decided to stop playing that role by saying, “Our budget deficit is too lousy, but we can’t charge it to our grandson's credit card,” then the economy will collapse and debt levels will actually increase.
On two occasions the Japanese government listened to the IMF, which didn't know much about what was happening in Japan, and told us to cut our budget deficit. In 1997, the IMF argued that all the fiscal spending was not bringing much growth. Prime Minister Hashimoto listened to those guys and we raised taxes, cut spending, and guess what? The economy collapsed.
First, our budget deficit skyrocketed. It took us years to bring the deficit back down to where it was before 1997. When the private sector is deleveraging, which is the case in the US, UK, and Spain at this very moment, the option of cutting a budget deficit might not exist at all. Unless the private sector is willing to take the extra savings that government is not borrowing through increasing taxes or whatever, and unless the private sector comes in and snaps up whatever money the government is not borrowing and puts it back into the income stream, the economy will collapse.
Are there options other than the government spending (and raising deficits), for example tax incentives for companies to invest?
A tax cut is a fiscal stimulus, right? A fiscal stimulus is needed. Of course, some tax cuts may be useful, but if a general income tax cut comes when the private sector is deleveraging, the private sector will take that and use it to pay down debt. It is still better than nothing, but for the same budget deficit you are incurring, a tax cut will give you much less fiscal stimulus to the economy, because so much of that will leak out in repayment [as companies use those tax savings to improve balance sheets].
What about a targeted tax cut, perhaps based on incentives to invest and spend in the private sector, instead of a broad tax cut?
Even targeted ones might not be as effective. If corporate executives realize that the private sector is also deleveraging, they will question the point of adding additional capacity when the economy will be shrinking going forward. In a circumstance like that, fiscal stimulus, government borrowing, and actually spending money is far more effective in terms of keeping the economy going than tax cuts.
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