Do Japanese interest rates have stability problems?

This is a problem with this large debt. If people start saying the Japanese government will eventually accept that it is money-financed, not debt-financed, it might produce more inflation than the Bank of Japan wants. A downward spiral could start: Inflation would produce a devaluation of the Yen which fuels even more inflation. This could lead to higher government bond yields, the government would have to pay higher interest on their debt which is not money-financed. But there are policies to offset the inflationary effect. When a central bank buys government debt, it creates commercial bank reserves at the central bank balance sheet. The banks currently do not borrow as much as they are allowed to do by reserve rules. To stop banks from creating more private money, you could use the reserve requirement at the central bank. This can be used as a mopping up exercise if the stimulus got too big.

That is from Lord Adair Turner.  He also offers up this bit:

Are there other successful monetizations?

One of the best examples from economic history where it was done successfully and on a large scale is actually Japan. Finance minister Takahashi from 1931 to 1936 used central bank financed fiscal deficits to drive the economy out of recession. It was very successful. Japan pulled out of recession faster than most countries in the 1930s.

Krugman covers Rogoff’s related argument here, I would note that Dornbush overshooting effects hardly show up in the data at all, which are dominated by “news,” in this context unexpected changes in exchange rates.  Exchange rate overshooting is very much an overrated theory.


Comments for this post are closed