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2021 | OriginalPaper | Buchkapitel

Public Bonds as Money Substitutes at Near-Zero Interest Rates: Disequilibrium Analysis of the Current and Future Japanese Economy

verfasst von : Makoto Saito

Erschienen in: Strong Money Demand in Financing War and Peace

Verlag: Springer Singapore

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Abstract

In the past quarter century, Japan’s economy has seen rates of interest, including those on long-term public bonds, remain quite low despite colossal accumulation of public debt, while the price level has been mildly deflationary or almost constant despite rapid monetary expansion. In this chapter, these puzzling phenomena are interpreted using a simple disequilibrium analysis framework. The major reasons for adopting disequilibrium analysis are that (1) Japan’s economy often fell into excess supply in both goods and labor markets after short-term rates of interest were controlled below 0.5% in mid-1995, and (2) public bond markets were clearly in serious excess supply given the expectation that the primary fiscal balance was not going to turn into surpluses in the future relevant to those bonds being issued. In the proposed disequilibrium model, excess supply in goods, labor, and public bond markets is absorbed by excess demand in money markets, induced by strong money demand at near-zero interest rates. In particular, strong money demand absorbs public bonds not as investment instruments, but as money substitutes. This chapter also demonstrates that excess demand in money markets in disequilibrium analysis can be interpreted as public bond price bubbles in equilibrium analysis. Given the analogy between the two approaches, as far as the bubble is sustained, mild deflation and near-zero interest rates continue in spite of massive issues of public bonds and rapid expansion of money stocks. On the other hand, once the bubble bursts, money demand shrinks drastically, a wide range of interest rates rise suddenly, and the price level jumps abruptly. With the government’s credible commitment to future fiscal reforms, a one-off price surge would stop immediately at a level two or three times higher than before, but without the reforms, the price process would be hyperinflationary.

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Vorheriges Kapitel On Large-Scale Monetary Operations in the Japanese Occupied Territories During the Pacific War

Nächstes Kapitel Long-Run Mild Deflation Under Fiscal Unsustainability in Contemporary Japan

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See Wray (2015) and others for detailed descriptions of MMT and its policy recommendations.

Armstrong and Okimoto (2016) survey the literature on fiscal sustainability in Japan. Imrohoroglu et al. (2019) update Imrohoroglu et al. (2016), and present detailed simulations of the sustainability of Japan’s fiscal conditions. The Fiscal System Council, MOF (2018) reports the long-term prospects for Japan’s fiscal policies.

The theoretical framework presented in this section is out of the context of mainstream modern macroeconomics, where all markets are assumed to be in equilibrium simultaneously. Even within modern economics, however, some schools of thought have taken disequilibrium phenomena in money markets seriously. Yeager (1986) surveyed orthodox monetarists, showing that they always considered monetary disequilibrium to be responsible for a systematic relationship between the general price level and monetary aggregates. On the other hand, Zahringer (2012) showed that in Austrian economics, disequilibrium in plural money markets was thought to cause business cycles in a complicated manner. Of course, the orthodox monetarists and the Austrians had sharp disagreements on disequilibrium approaches. In contrast to the orthodox monetarists, Austrian economics took relative prices, not the general price, seriously, and were extremely reluctant to aggregate individual variables to construct macroeconomic variables.

Another drastic departure from equilibrium analysis is disequilibrium dynamics, proposed by Iwai (1981). In the so-called Wicksellian case with flexible prices, the price level continues to fall heavily once aggregate demand runs short of aggregate supply. However, this model may not be applied to the current Japanese economy, in which the present price process is not in a deflationary spiral, but only mildly deflationary.

Ono (2001), Ono et al. (2004), and others adopt a rather different assumption on utility from real money balances to derive a strong liquidity preference. That is, $\mathop {\lim }\nolimits_{{\frac{M}{P} \to \infty }} v^{\prime } \left( \frac{M}{P} \right)/u^{\prime } \left( c \right) > 0$. Such strong demand for money and assets, induced by this unconventional assumption, yields the same predictions as those in this chapter, such as stagnant aggregate demand, high unemployment, and downward pressures on the price level. A major difference between their model and the model presented in this chapter is that in the former any wealth including public bonds are always close substitutes for money in generating liquidity conveniences, but in the latter public bonds and money are close substitutes only at near-zero interest rates. Consequently, the two models make very different predictions once interest rates take off from the zero level; that is, the former is still Keynesian, but the latter returns to a neoclassical model.

As implied by Eq. (2.6), under the assumption that $\sum_{i=1}^{N}{B}_{i}^{d}\left(t-1\right)+\sum_{i=1}^{N}{M}_{i}^{d}\left(t-1\right)={B}^{s}\left(t-1\right)+{M}^{s}\left(t-1\right)$, goods and labor markets are ex post cleared; that is, $\left\{y\left(t-1\right)-\left[inv(t-1)+c\left(t-1\right)+g\left(t-1\right)\right]\right\}+w\left(t-1\right)\left[{l}^{s}\left(t-1\right)-{l}^{d}\left(t-1\right)-{l}_{g}^{d}\left(t-1\right)\right] \left\{y\left(t\right)-\left[inv(t)+c\left(t\right)+g\left(t\right)\right]\right\}=0$.

Equation (2.6) is interpreted to share characteristics of both beginning- and end-of-period formulations in assets markets equilibrium, both of which are proposed by Foley (1975) and others. In end-of-period models, the market-clearing conditions of not only goods markets, but also money and bond markets are defined in terms of flow variables. Here, Walras’s law holds for all of goods, money, and bond markets. In beginning-of-period models, on the other hand, the market-clearing conditions of assets markets are defined in terms of stock variables. In the latter formulation, Walras’s law does not hold. Accordingly, the market clearing conditions of goods markets can be separated from those of assets markets as in the IS–LM model. According to Eq. (2.6), the current setup shares the nature of end-of-period formulations in the sense that Walras’s law holds for all of goods, labor, money, and public bond markets, but it has the property of beginning-of-period formulations in that stock variables appear in the market clearing conditions of assets markets.

As emphasized in chapter “Central Bank Cryptocurrencies in a Competitive Equilibrium Environment: Can Strong Money Demand Survive in the Digital Age?”, when bond interest coincides with currency interest (equal to zero in this case), public bonds are also equivalent to money in that neither generates any additional currency convenience.

Equation (2.3) is rewritten as follows:

$$\begin{aligned} \frac{{B\left( {t - 1} \right) + M\left( {t - 1} \right)}}{{P\left( {t - 1} \right)}} & = \frac{{P\left( t \right)\left[ {tax\left( t \right) - g\left( t \right) - w\left( t \right)l_{g}^{d} \left( t \right)} \right]}}{{P\left( t \right)\frac{{P\left( {t - 1} \right)}}{P\left( t \right)}\left[ {1 + i\left( t \right)} \right]}} \\ & \quad + \frac{{i\left( t \right)M\left( {t - 1} \right)}}{{P\left( {t - 1} \right)\left[ {1 + i\left( t \right)} \right]}} + \frac{B\left( t \right) + M\left( t \right)}{{P\left( t \right)\frac{{P\left( {t - 1} \right)}}{P\left( t \right)}\left[ {1 + i\left( t \right)} \right]}} \\ & = \frac{1}{1 + \rho \left( t \right)}\left[ {tax\left( t \right) - g\left( t \right) - w\left( t \right)l_{g}^{d} \left( t \right)} \right] \\ & \quad + \frac{1}{1 + i\left( t \right)}\frac{{i\left( t \right)M\left( {t - 1} \right)}}{{P\left( {t - 1} \right)}} + \frac{1}{1 + \rho \left( t \right)}\frac{B\left( t \right) + M\left( t \right)}{{P\left( t \right)}} \\ \end{aligned}$$

As the above equation implies, the real seigniorage arises on the previous real money balance $\left(\frac{i\left(t\right)M\left(t-1\right)}{P\left(t-1\right)}\right)$, and is accordingly discounted by the nominal rate of interest. On the other hand, the real fiscal surplus is defined at the current period $\left(tax\left(t\right)-g\left(t\right)-w\left(t\right){l}_{g}^{d}\left(t\right)\right)$, and is consequently discounted by the real rate of interest.

According to chapter “Long-Run Mild Deflation Under Fiscal Unsustainability in Contemporary Japan”, if the transversality condition fails to hold in the equilibrium analysis of Eq. (2.11), then the bubble term, which is finitely positive at asymptotically zero rates of interest, contributes to appreciation of the real balance of public bonds $\frac{{B}^{s}\left(t\right)}{P\left(t\right)}$ and yields deflationary pressure on the current price level. Kobayashi (2019), Sakuragawa (2019), Murase (2020), and Brunnermeier et al. (2020) also demonstrate that deflationary pressure is generated by the unsatisfied transversality condition in the consolidated government’s budget constraint. Hagedorn (2018) regards government bonds as net wealth in the sense that the bond valuation exceeds the present value of future fiscal surpluses, and presents a similar monetary model.

If both the nominal rate of interest and the price level converge to zero in the limit, $B\left(t\right)-B\left(t-1\right)$ also converges to zero in Eq. (2.3).

Estimates for the output gap are from Kawamoto et al. (2017), and their updates.

According to Nakayama et al. (2004), rapid rises in long- and ultra-long-term yield spreads in mid-2004 were triggered by an increase in US long-term yields, and the market participants’ expectation that QE would be terminated quite soon (though it actually ended in March 2006).

Chapter “Long-Run Mild Deflation Under Fiscal Unsustainability in Contemporary Japan” explores in a theoretically rigorous manner how longer-term yields decline toward zero slowly given the expectation that the public bond price bubbles will burst in the (far) future.

However, the Public Finance Act allows the BOJ to underwrite and refund T-bills for the government directly.

Note that the BOJ’s taxes and payments on the government accounts [(5) in Fig. 18] are excluded from net changes in the TFs.

Titel: Public Bonds as Money Substitutes at Near-Zero Interest Rates: Disequilibrium Analysis of the Current and Future Japanese Economy
verfasst von: Makoto Saito
Verlag: Springer Singapore
Buch: Strong Money Demand in Financing War and Peace
Print ISBN: 978-981-16-2445-2

Electronic ISBN: 978-981-16-2446-9

Copyright-Jahr: 2021
DOI: https://doi.org/10.1007/978-981-16-2446-9_4