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Tweet Print KOBAYASHI Keiichiro Program Director / Faculty Fellow, RIETI The age of uncertainty When you think comprehensively about Japan's macroeconomic policy, what direction would you recommend? In the current situation where negative interest rates and low inflation continue and public debts continue to increase above 240% of gross domestic product (GDP), the immediate goal of economic management would be to focus funding on redistribution of income to correct disparities and technological innovation to promote growth, based on the prerequisite of avoiding financial crises (unstable high inflation, rise of interest rates, etc.). We have to begin with analyzing the current status, asking why negative interest rates and low inflation continue. It suggests that the natural interest rate at which aggregate demand is equal to aggregate supply might be negative. A possible reason for the negative natural interest rate is growing uncertainty, which urges people to increase savings in preparation for the worst scenario, resulting in the negative natural interest rate. Extreme uncertainty prevailing in the world's politics and economy is roughly classified into two types. One is political instability (such as the rise of populism) increasing in Western developed countries, East Asia, and other areas in the world. Its major cause is thought to be income disparities that have been growing all over the world since the 1980s. Before around the 2000s, the expectation was that the "trickle-down effect" would naturally eliminate income disparities, but the real market mechanism was unable to overcome those disparities, which are being passed down from generation to generation, dividing society, and destabilizing global democracy. The other uncertainty is about the future of key technologies of industry. Currently it is said that the Fourth Industrial Revolution is underway, represented by information technology (IT), artificial intelligence (AI), and fintech, which uses them. When key technologies change significantly, you cannot forecast what will happen and how society will be transformed. You can understand that Facebook's virtual currency Libra may drastically change monetary policies, but who knows what the world will be after that change? Investments in new technologies are full of uncertainty, while existing technologies become obsolete and investment opportunities for them shrink. As a result, investment demand surges for government bonds and currencies, which are safe assets, and negative interest rates occur. It is important for growing disparities, which destabilize politics, to be swiftly corrected through income redistribution policy including social security for all generations. On the other hand, it will take at least two or three decades to eliminate uncertainty associated with changes in key technologies. During that period, investment demand may continue to be diverted by government bonds. With the amount of outstanding government bonds increasing progressively, won't confidence in the bonds collapse on a long term basis? If we can keep the nominal interest rate (r) zero or negative while maintaining the nominal economic growth rate (g) slightly above zero, then we will be able to maintain confidence in government bonds. That is because if r is less than g and the primary balance deficit does not exceed a certain level, the bond increase rate can be kept below the GDP increase rate g. The "good equilibrium" scenario where the interest rate is below the growth rate Although standard economics claims that r is larger than g on a long term basis, Professor Marcus Hagedorn of the University of Oslo showed in his 2018 paper the logical possibility of g being larger than r on a long term basis. And various overlapping generations (OLG) models and incomplete markets models had already shown as well that the steady state of r
