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Empty Mind after Ten Thousand Reasons

The consequences of the US administration’s fiscal policy

Kazumasa IWATA


The US Biden administration is struggling to approve a bill that promotes investment in social infrastructure and a bill that focuses on human capital investment, such as child-rearing, education, and climate change, in parliament.

The $1 trillion (approximately 110 trillion yen) infrastructure investment bill has been approved by the Republican Party with new spending of about $550 billion. On the other hand, the $3.5 trillion human capital investment bill entails not only strong objection by the Republican Party, but also fierce disagreement between the left (progressive) and the centrists within the Democratic Party. This bill is the core of “growth-distribution strategy” aimed to win the economic competition with China, while reconstructing the United States through the support of the middle class. Thus, the Biden administration cannot easily compromise.

The modern monetary theory (MMT), which recommends expansionary fiscal management, states that countries that issuing government debt only denominated in their own currency have “currency sovereignty,” based on Keynes’s insight; those sovereign debts will never be insolvent like a private-sector company.

Emerging economies often face default risks by issuing foreign-currency-denominated government debt. On the other hand, a state with “currency sovereignty” becomes insolvent only when the debt is canceled by inflation tax. Immediately after the end of the war, Japan’s hyperinflation was also the case in point.

MMT theorists argue that fiscal expansion without inflation is possible, as they observe that inflation is not occurring in Japan today despite the continued budget deficit and massively accumulated government debt. However, we cannot forget the experience of the strong dollar and “twin deficits” caused by the large-scale tax cut policy under the Reagan administration and the subsequent yen appreciation syndrome triggered by Plaza Accord (1985). The US current account deficit in 1985 was 2.7% of GDP. However, Paul Krugman, then a professor at the Massachusetts Institute of Technology (MIT), said the 3% current account deficit was unsustainable and warned against the risk of a sharp fall in the dollar.

According to the Japan Center for Economic Research long-term forecast released before the COVID-19 crisis, the United States will continue to have a current account deficit of 2% to 3% under a budget deficit of about 5% of GDP, and net external debt in 2060 will exceed the size of GDP. The budget deficit for FY21 is projected to be 13.4%, while government debt is likely to be 103% of GDP, with the current account deficit in the second quarter of 2021 reaching the level of 3.3%. Fiscal expansion, even if it induces a stronger dollar in the short term, will eventually raise market suspicion of the sustainability of the “twin deficits” and undermine the stability of the international currency regime.

According to some empirical analysis of Japan’s budget deficit, medium-to long-term sustainability is under suspicion. It should also be noted that the accumulation of government debt will increase the burden of future generations, as is the case of the climate change problem.

On the other hand, the issuance of monetary base and the government debt allows for intergenerational lending that are not well covered by market transactions may have an optimal scale of those stocks. Edward Prescott, a professor at Arizona State University in the United States, once argued that the optimal amount of government debt is about twice the GDP, including the “hidden debt” of social security system in which the working generation supports the retired generation on a pay-as-you-go basis. The United States seems now to exceed this optimal level.

(The english translation of the article was published in the Nikkei morning edition 2021/10/15.)