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Growing Modern Monetary Theory debate rattles Japan officials

Untested economic model has big implication on country's planned tax hike and debt policy

Modern Monetary Theory argues that deficits can be maintained so long as they do not generate inflation.

TOKYO -- A controversial economic theory has Japanese government officials on alert, even as advocates point to the country as an example of the theory's efficacy.

In broad terms, Modern Monetary Theory proposes that fiscal deficits are tolerable since a government can print money to service its own debt as long as inflation is avoided. If signs of inflation emerge, it can be mitigated by cutting government spending and increasing taxes.

The theory is contested by many mainstream economists, including U.S. Federal Reserve Chair Jerome Powell, who pushed back against it in Congressional testimony earlier this year.

Debate over the idea has picked up in Japan, where the debt-to-gross domestic product ratio is more than 237%, but prices are barely inching up. With inflation still well below the government's 2% target, some lawmakers argue that the country could spend more to stimulate economic growth.

But the government's official line is that it seeks to put Japan's public finances back in order. Officials are also worried that extended discussion of MMT will lead more people to rethink an increase in the consumption tax scheduled for October.

Prices have grown slowly in Japan despite steadily mounting public debt. The Finance Ministry forecasts that government debt will reach 1,122 trillion yen ($10.17 trillion) at the end of the fiscal year ending March 2020. That is up 20% from fiscal 2012, before the Bank of Japan started its unprecedented easing policy. But core inflation, which excludes fresh food, rose a moderate 0.8% in fiscal 2018 from the previous year, still a good distance from the 2% goal.

The interest in MMT has been stimulated, in part, by the fact that the BOJ's easy-money policy is seen by many as having reached its limits. Long-term interest rates are in negative territory and the central bank has been buying massive amounts of government bonds, but prices have not risen as expected.

"MMT has drawn attention in the context of making use of fiscal spending in place of monetary easing," a senior BOJ official said.

Japan's public spending is already on the rise. Persistently low interest rates have kept the government's borrowing costs low, but the country's aging population means social welfare spending keeps growing.

Top officials have sounded the alarm. "Japan's fiscal condition it totally different from what MMT assumes," BOJ Governor Haruhiko Kuroda told a parliamentary committee on May 21.

MMT is "an extreme idea and dangerous as it would weaken fiscal discipline," Finance Minister Taro Aso told lawmakers.

Officials have been particularly flummoxed by the argument put forward by Stephanie Kelton, a professor of economics and public policy at Stony Brook University and leading MMT advocate, that Japan's economic policy has proved that MMT is correct.

To complicate matters, the Japanese economy is entering a period of uncertainty. Japan's exports contracted 2.4% in April from a year earlier amid U.S.-China trade friction. Business conditions are "worsening," according to a government assessment, and an international survey of economists found that Japan is on course for a major economic downturn.

Discussions about economic stimulus measures are likely to come up ahead of the planned consumption tax hike.

"From a cyclical perspective growth is going to slow down. The construction investment ahead of the Olympics is dropping off," said Takashi Shiono, an economist at Credit Suisse. "It wouldn't be strange if there were some countercyclical policies."

But MMT is "too extreme," according to Shiono.

Meanwhile, at a news conference in the city of Nagasaki on May 22, BOJ policy board member Yutaka Harada kept up the attack on MMT.

The approach proposed by MMT will "cause [runaway] inflation for sure," Harada said. Although advocates say the government could raise taxes or cut spending to control inflation, "it's extremely doubtful it can be done in reality."

Nikkei staff writer Mitsuru Obe in Tokyo contributed to this article.

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