Monday, November 23, 2015

Japanese promises (a reply to John Cochrane)

John Cochrane comments on a recent Bloomberg post of mine. In that post I wrote:
[I]nflation reduces the burden of debt. Japan’s enormous government debt represents the government’s promise to transfer resources from young people (who work and pay taxes) to old people (who own government bonds). Since Japan is an aging society, there are more old people than young people. That makes the burden especially difficult to bear. Young people also tend to have mortgages, the repayment of which is another burden. 
Sustained higher inflation would represent a net transfer of resources from the old to the young. That would increase optimism, and hopefully raise the fertility rate, helping with demographic stabilization.
John agrees that (unexpected) inflation is a partial debt default that has (among many other effects) the net effect of transferring real resources from the old to the young. But he believes this to be unfair, and also cruel:
[L]et us remember where debt actually comes from. The Japanese government borrowed a lot of money from people who are now old, when they were young. Those people consumed less -- they lived in small houses, made do with fewer and smaller cars, ate simply, lived frugally -- to give the government this money. The promise they received was that their money would be returned, with interest, to fund their retirements, and to fund their estates which young people will inherit. 
Noah is advocating nothing more or less than a massive government default on this promise, engineered by inflation. The words "default,"  "theft," "seizure of life savings," apply as well as the anodyne "transfer." I guess Stalin just "transferred resources." 
Yes, Japanese Baby Boomers did make real sacrifices in exchange for the promise of future transfers. Yes, inflation (or cutting pensions, or cutting health care spending) does represent a partial default on those promises. It does indeed represent seizure of life's savings. As for "theft", that's a legal term, but if you want, then sure.


Economics involves tradeoffs. I wish it didn't. I wish resources were infinite, but they're not. And sometimes promises can't be kept as easily as you thought they could be when you made the promise. Imagine - as a limiting case - that an entire generation of fifty million produces only one hundred children. The older generation made real sacrifices when they were young, in exchange for government bonds (and suppose the real resources they gave up were spent on useless bridges to nowhere). In order to keep its promise of resource transfer, the government must now pay back those bonds by taxing just one hundred people.

It's not going to happen, no matter how much people want it to happen. One hundred cannot pay back fifty million. Inflation or default will happen.

In Japan's case, the situation is not so extreme, but the principle is similar. The Boomers, who sacrificed real resources (much of which was indeed spent on bridges to nowhere) in exchange for government bonds, had very few children. Japan's population is shrinking by hundreds of thousands per year, and the rate of decrease is set to accelerate. Paying back the older generation will be very, very hard for those less numerous young people. And forcing the young people to make those payments may well cause them to have fewer kids, helping to perpetuate the problem.

Therefore, hard choices must be made. Resources must be allocated - not the way that Stalin did it, thank God, but in a way that will undoubtedly earn the resentment and disappointment of many honest hard-working citizens, and which will undoubtedly cause hardship for many who do not deserve it.

But if you feel the desire to moralize against this "theft", remember that when the promises were made, the younger generation was not yet able to vote. The seizure of the fruits of their labor, in the form of taxes, goes to pay for expenditures that were made without their consent.

In other words, one way or another, some cruel unfairness is going to happen in Japan. And I think our job is to minimize the cruelty and unfairness as best we can - to "spread the pain" as much as possible while minimizing the pain's overall size.

Some more Cochrane points:
Amazingly, to Noah (and the views he ably summarizes here) this "transfer" will "increase optimism." Hmm. Let's look at the evidence for that. We have seen many large inflations, which wiped out middle-class savings along with government debts. Those events have generally been regarded as economically, politically, and psychologically destabilizing tragedies, not FDR-fireside-chat "optimism"-raising sessions. No surprise that few societies have voluntarily signed up for such treatment as Noah recommends. I would be curious to hear of a single happy historical antecedent. (I mean that. Perhaps I am mistaken in my understanding of Noah's proposal. A successful example might correct me.)
The historical example I had in mind was the sustained high inflation between 1945 and 1955, which substantially reduced the debt that the U.S. had incurred during WW2.
How does a government default benefit young people anyway? It does so if a large amount of tax revenue is being used to pay interest or principal on the debt, and the default is accompanied by a large tax cut for young families. Not by the same level of taxes and increased government spending on more railway-to-nowhere stimulus projects.  Without tax cut, there is no transfer. Noah is strangely silent on the essential big tax cut aspect of his plan.
Let me be silent no more! Yes, tax cuts are the plan! Taxes are crushing the youth!!

Of course, given the large tax hikes that will be required to balance the Japanese budget if transfer payments to old people are not cut, even keeping taxes at their current level would constitute a tax cut. But yes, it's about tax cuts.
Quiz: Find in Japanese (or American) government finances the actual "promise to transfer resources from young people (who work and pay taxes) to old people." If you say "government bonds," you (like Noah) got the wrong answer. The right answer is Social Security, Medicare, and public employee pensions. If Noah wishes to reduce the "burden" of intergenerational transfers, no matter that governments have promised to make those transfers and people have planned their lives around them, the silence on these promises is deafening.
I think Japan should absolutely cut transfer payments to the elderly (I said so in this other post, and will say it again, and said it to the Ministry of Finance people when I met them the other day). The problem is that transfer payments are politically hard to cut, while monetary policy is (probably) much more out of the public eye.

But note that government bonds are another promise to transfer resources from young to old. It's not the wrong answer, it's just part of the total answer.
If the purpose is default, why not just advocate default? 
It's one option. But it's an incredibly extreme option, since it would cause lots of business failures, which would cause massive economic disruption. That would put the country in danger of a coup. Sovereign default is a last-ditch option, but I think it would be better than hyperinflation.
So, according to Noah, a self-induced hyperinflation to generate an economy-wide debt default is necessary
No! Hyperinflation is the worst sort of default, since it causes business failures. What I want is sustained moderate inflation of 4-6 percent.

Anyway, that should answer most of John's points. He describes me as having an "insouciant willingness" to upend the lives of millions. I think I'm anything but insouciant. The lives of millions are going to get upended one way or another - Japan's government has made promises that it can't keep. That's not my choice or my doing. I just want to help figure out ways to minimize the overall suffering and spread it around as fairly as possible.

Hopefully that does not make me Stalin.


  1. There is another argument. Japan being at the zero lower bound, its banks holding large amounts of excess reserves and the difficulty it has reaching its inflation target are signs that holding yen grants you a subsidy.

    If Japanese cash holders (or the banks on their behalf) were to subject more of their savings to free market stores of value, they would get lower risk adjusted returns.

    If the central bank was not keeping money's returns above market, savers would be forced to invest at lower returns which would push worker's salaries up.

    These subsidies is what happens when an economy hits the zero lower bound, builds up excess reserves and money starts acting as a backstop for returns on savings. On top of being an unfair distortion, it is a subsidy that destroys value by impeding investment and employment (although this is less true in a climate of low unemployment).

  2. "The historical example I had in mind was the sustained high inflation between 1945 and 1955"

    -1952. But there was deflation in 1949 and most of the inflation was pent-up inflation accumulated during the war. Doesn't smell very sustained.

  3. "No surprise that few societies have voluntarily signed up for such treatment as Noah recommends. I would be curious to hear of a single happy historical antecedent. (I mean that. Perhaps I am mistaken in my understanding of Noah's proposal. A successful example might correct me.)"

    -Russia and Belarus, 1998-2008. But that wasn't unanticipated inflation, though.

    Canada in the 1970s? That had very high real wage growth.

    East Timor, 2000s?

  4. Anonymous6:45 PM

    This graph explains the thinking of Roger "Raise My Assets , Not Your Wages" Farmer :


  5. Sustained inflation of 4-6 percent is very likely just not enough, given the age and size of the Baby Boom generation. Twenty years ago, sure. Now an inflation rate closer to 10% is probably necessary. Of course, many mixes of inflation and benefit cuts could work.

  6. Anonymous2:34 AM

    As part of a social contract between state and it's population, and because a state's investments can give benefits to a nations population for a real long time, I do believe that a state wants (/expects(/incentivizes)) the population too keep growing or at least stand still. If we are going to blame sides (Cochrane) I want to argue that a population that stopped having babies are somewhat to blame for the demographic shift that takes place some generations later. If inflation therefore is needed (partly) because of that demographic shift and that inflation is a theft (come on...) from a generation that stopped having babies, well, so be it then.

  7. Nice to see a debate where Noah is the hard-nosed econ rationalist and John is standing up for the old.

  8. Here's two pro-Noah, anti JC points.
    1, When today's elderly bought their bonds, I doubt they did so in the expectation there would be prolonged deflation. So they've probably done better than they expected for several years. A bit of inflation might just get them back to what they reasonably expected.

    2. JC mentions social security, Medicare, public sector pensions. I don't see why it is any "fairer" to default on elderly people's reasonable expectations of these (for which they paid taxes) than their expectations iro the real value of bond payments.

    1. Tim Young11:59 AM

      Even with deflation, the real interest rate on Japan's government debt has been relatively low - less than nominal GDP growth, for example. The real reason for Japan's growing debt has been not deflation, but the fact that Japan's mostly LDP governments (Japan is almost a one-party state) have chose to blow the associated interest windfall pampering their traditional supporters in farming and construction instead of reducing fiscal deficits, cheerled by fools like Paul Krugman.

  9. Autolycus6:14 AM

    I think we should be wary of accepting the idea that inflation equals default (even partial default). A bond contract is struck in nominal terms - the issuer promises to make the regular interest payments and pay back the principal on maturity. The buyer has to decide what these transfers will be worth in real times. It has been official government policy in japan for years to end deflation. Anyone who has bought JGBs at the prices available has implicitly bet on the failure of this policy. So far the bet has worked - the investor cannot complain if the bet does not work in the future

    1. Agreed. Buying nominal bonds is an investment like any other

    2. True. Any investment carries a risk. To conflate inflation risk and default risk just seems silly.

  10. Noah: "...transfer resources..." "I wish resources were infinite, but they're not."

    Cochrane: "...where debt actually comes from..." "...a default on this promise..."

    BOTH of you are making TWO mistakes:

    You both are using the word "resources" to mean their valuation in money.

    You both are presuming that we don't have enough real resources.

    Don't you guys realize that the two underlying premises, that wants are infinite that money is real, are both false beliefs?

  11. That's a very important point. Bond buyers accept risk. A shift in monetary policy regime may be unexpected, but there was no promise attached to the bonds that inflation risk was nil. Otherwise they'd be inflation protected bonds. And nobody talks about the "Stalin" like transfer that occurs when inflation surprises on the downside.

    1. Meant as a reply to Autolycus above

  12. .
    When you control the policy levers, you have the ability to change the constraining facts.

    If you are constrained by birth rates, flip the policy lever to increase them.

    For example, promise a sum, X, to each married citizen that produces a micro human.

    Periodically increase X until adequate birth rates are established.

    Is there any doubt that for a sufficient X that birth rates would not dramatically improve?

    Never accept the facts on the ground when you control the ground.

    1. .
      Additionally, this gets you an allocation of resources to a valuable part of the economy, demand improvements and possibly, although not necessarily, inflation - which under the above regime may no longer be desirable.

    2. .
      And The Stalin picture is offensive.

    3. Not as offensive as your ignorance.

    4. This comment has been removed by the author.

  13. Japanese debt is sustainable so long as the real interest rate on their debt is less than real growth. Has little to do with past sacrifices, only future ability to produce or import the needed goods/resources/labor.

  14. Griff Wodtke9:59 AM

    This is amazingly restrained, given the patronizing and OTT tone of Cocoran's comments. Well done, Noah.

  15. Anonymous10:03 AM

    I find it odd that Prof. Cochrane asks for a "single happy historical antecedent" where attempted inflation has produced desirable outcomes AND in the same paragraph says that inflation is NOT the optimism-boosting actions of FDR. FDR attempted deliberate inflation through abrogation of the gold standard and a ban on gold hoarding. This "wiped out middle-class savings and government debt". It was analogous to a 40% haircut and the economy rebounded at about 10%/year from 1933-37.

  16. These guys like Cochrane who redefine "redistribute" as "thieve" (and "healthcare policy" as "death panels", and etc.) just don't understand the modern civilized world at a basic level. Truly the beginning of another "dark ages" if their type of characterization of everything carries the day.

  17. Want to make Medicare affordable? It can be done by paying (developed) world prices for medical care instead of rent-inflated American prices. But that would come at the expense of the wealthy and politically powerful...

    IIRC France after WWI benefited substantially from inflation that reduced the real burden of Government debt.

    Insert snide remark about Cochran here.

  18. I simply do not understand Cochrane's apparent belief that there are simply no numbers between "approximately but in no case to exceed 2% per year" (the current typical inflation target) and "more than 50% per month" (one of the few attempts at a numeric definition of "hyperinflation" I could find). As our host points out, isn't "3% per year" between those two numbers? Maybe even 10% per year? Hauling out the term "hyperinflation" as the apparently definition of any inflation target above the one currently in use seems thoroughly disingenuous. Granted, Noah didn't set a bound on the inflation target he thought might be beneficial, but I think "less than Weimar" was pretty well understood.

  19. Looks to me like Cochrane is engaging in doubletalk for the benefit of his blog readership's prejudices at the expense of Noah's credibility for them.

    He's not accidentally misunderstanding a persistent negative real rate of 2-5% for a decade as a call for hyperinflation or total debt default, he's deliberately pretending that there is no difference, or that the one must always lead to the other, to discredit "financial repression" in the eyes of his (inflation paranoiac) followers.

  20. A decreasing or stable population is a real challenge, but the alternative is an increasing population which cannot be sustained indefinitely. Japan cannot support a population of twenty or fifty billion despite what the techno-futurists might say, at least not without some serious changes in societal structure.

    I think there are two real problems.

    One is that old people in Japan were expected to provide for their own futures rather than relying on social insurance which would let them pool risks. This means that there is a lot more money saved up than is actually needed to ensure every old person a satisfactory retirement. This is simple actuarial stuff. Having to save for a maximum possible life span rather than an average life span removes money from the working economy. It is available for investment, but that investment only happens when demand is growing. It's a Catch-22.

    The other is that Japan, like most countries, has a power curve wealth distribution even among old people. This means that only relatively few old people have assets well beyond actuarial necessity. Old people just aren't able to spend enough. If they were spending appropriately for their wealth levels, we'd see the rising demand for goods and services which would feed a dynamic economy with rising wages for young people who would be in scarce supply, i.e. inflation.

    Raising inflation and improving social insurance would provide old people with more goods and services. It would also provide young people with more goods and services. Inflation, like high taxation, is just a way to force people to spend. Given that spending is the lifeblood of every modern economy it is sad the Cochrane finds spending repugnant while he considers general deprivation laudable.

    1. By a real challenge I mean something some economist should be working on for real. Where is our modern Wassily Leontief with an input output model searching for eigenvectors in a stable or shrinking population economy? Leontief had to invert 100x100 matrices by hand, and he did, with help. Surely some promising graduate student can be interested in this.

  21. I think you and Cochrane have left a few options off the table. Like helicopter drops. You both characterize the current public investments as bridges-to-nowhere. Then a better approach is to print money, give it to people, and let them signal via there spending where investments would be useful. This also increases demand and lets the old put their savings to productive use by creating investment opportunities. Additionally, this does not efficiently produce inflation (unless, of course, you are an Austrian and define inflation based on the amount of money as opposed to the level of prices). The labor force participation rate can rise in Japan. Until a bottleneck is reached, inflation won't occur. For awhile, the production of goods will increase within the bounds of existing production capacity. Capacity is thus used more efficiently, helping to keep inflation low.

    You can also look at encouraging business to pay higher wages. This also increases demand and allows excess savings to be productively invested. It also reduces the returns on investments to the old. Certainly Cochrane will claim that re-negotiating the balance of income that is paid to labor vs capital is Theft. But the rest of us will realize that the excessive payments to capital were also Theft.

  22. Cochran's comments are moral crap.

    Older people made their investments in government bonds knowing that they were creating unasked for duty to repay with interest by the next generation. Is that any more moral than paying back at a lower rate? And as has been pointed out above, it is normal to expect inflation to take a cut of your investments.

    As for the idea of redistribution through inflation, that normally occurs in all investments. You also get redistribution in investments that fail for whatever reason. Generally, middle class investments involve substantial redistribution to Wall Street by a variety of means. We all should remember when our 401K's became 201K's for example. But you don't hear Cochrane bemoaning the redistribution due to the financial industry or the "creative destruction of the market that results in lots of people losing their shirts.

  23. Just a comment on "hyperinflation"...

    Inflation, even bad inflation in the double digits, does not lead to hyperinflation. Hyperinflation is always caused by a massive reduction in the real productivity entering into the national monetized marketplace. The reduction is caused by a war, or other catastrophe, destroying the means of production - or a loss of confidence by producers who no longer accept money as a payment for their output.

  24. All of the arguments on both sides seem to be in the context of a stagnant economy. if the economy is growing at a reasonable rate, don't these problems just slowly evaporate?

    So all the bonds are owned by old people? Except for some decades-past-maturity Series E savings bonds, my mom sure didn't have any. Are all the mutual fund managers octogenarians?

    Does anyone seriously believe that governments actually pay off their debts, rather than issuing new bonds, etc, etc?

    I second what has been said in comments about hyperinflation.

    Noah - 1945-55 is a pretty bad example of sustained inflation. There were two recessions in that period, with almost 3% DEFLATION in 1949. After Feb. '52, except for a blip up to 3.2% that summer, inflation never reached 2.5% again until Dec. '56.

    None of this takes into account wealth disparity. If I have a haircut choice between the Walton heirs and and an old couple living on SS, I will have no difficulty in making it.

    Maybe other old people are more savvy than i am, but I actually do pay taxes on my pension and social security. Now think about what most old people do with their money. They spend it. Sure most of that spending is wasted on health care [they're going to die anyway] but it ends up in the real economy diong something.

    I'm OK, but there re a lot of old folks in poverty who depend on SS to eke out an existence. {Pro tip - they don't own bonds!] I love the way the solution is always to target the pain on those who have the least.

    Wasn't there a time when Cochrane was a real economist?


  25. It is nice to know that both Republicans and Democrats want to push Grandma off the cliff.

  26. Cochrane is being inconsistent. If higher than expected inflation is “theft” from the old or bondholders, then Japan’s lower than target inflation and actual deflation have been a massive theft from the young and from future taxpayers and you now need higher inflation to redress that “theft.”

  27. It doesn't make you Stalin but it does make you undemocratic and illiberal. Advocating wealth transfer through monetary policy because it's politically easier being out of the public eye.

    I'm skeptical though that a surprise bout of inflation would be politically easy. To generate inflation some public body would need to spend in the real economy, a lot. The central bank isn't equipped. You need a democratic mandate to get it done like that or not.

    Another thing your economic analysis misses is the very large foreign assets especially corporate.

  28. Tim Young12:07 PM

    Noah, your remark on your Bloomberg article: "In the long run, any deficit that stays higher than the rate of nominal GDP growth is unsustainable" is strictly incorrect. If for example, the fiscal deficit is 6% of GDP and GDP growth is 3% per year, the debt to GDP ratio will converge on 200% of GDP. Still not good though!

  29. Inflation is too blunt an instrument which would also penalise those who, concerned about government indebtedness, lent their money to, say corporates, instead, or stayed in cash.

    My suggestion would be a halfway house between you and Cochrane of levying a special withholdings tax on JGBs in lieu of default. In addition to putting up taxes - Japan's sales tax is low by at least European standards, and raising it progressively, say by 1% per year for a decade could generate the kind of "buy now" incentive that is supposed to be created by engineering inflation.