How Paul Krugman (Almost) Got It Right On Japan

In a recent story on his NY Times blog Paul Krugman mentioned the Japanese downgrade by S&P.  He says:

“Amid all the stories about the S&P downgrade of Japan, I’ve seen hardly any mentions of the fact that Japan was downgraded below Botswana in 2002. And here was the effect on the interest rate:


Nada. In fact, if you bought JGBs just before the downgrade, you ended up doing very well.

I’m not saying that Japan’s long-run budget situation isn’t troubling. But the rating agencies (a) don’t know anything the rest of us don’t (b) are way too quick to downgrade sovereign debt, especially as compared with their what-me-worry attitude toward private securities (c) have very little actual influence on market.”

That’s right.  The S&P downgrade is an absurd non-event.  The fact that a rating agency needs to rate the “credit” of a country that is the monopoly supplier of currency in a floating exchange rate system is absurd.  They might as well put a rating on the odds of the sun rising in 20 years.  What S&P misses is that the ability to pay is never an issue for a country such as Japan or the United States.  Their interest rates are a function of government monetary policy that is based on future inflation expectations.  As we all know, deflation has remained the theme in Japan and despite a continually bloated budget the supposed “bond vigilantes” have remained in a deep slumber.  Of course, this is because bond market investors have never been spooked by the ability of the government to fund itself.  And why should they?  Their bond market funds nothing.  It’s unlikely that investors in Japan actually understand this, however, and there has been an increase in bond investor seppuku as a result.  When Japan wants to spend money they credit bank accounts.  Like the USA they never have trouble funding their spending and they never have trouble with bond auctions because bond auctions are a mere reserve drain as opposed to a fiscal financing tool.

This is what Paul Krugman refuses to admit, however.  He clearly sees the distinction between Greece, Japan and the USA, however, he refuses to admit that the governments of Japan and the USA are never revenue constrained like Greece.  This is the fundamental difference between the two monetary systems and makes one think twice about how actual monetary operations function in such a system.  And it is the primary reason why rates have remained low in Japan and the USA despite supposed debt crises.

Of course, Dr. Krugman came close to trying to understand MMT (and James Galbraith and Scott Fullwiler exposed him in an entertaining comments section), but in the words of the late great John Galbraith “The process… is so simple that the mind is repelled”. MMT is so unorthodox that the mind repels it.  Even a man as brilliant as Paul Krugman rejects it. Not because he understands it, but because he clearly does not.   MMT is not friendly to the conventional mind.  If you cannot remove your political biases and forget your college economics education you will likely never fully grasp the workings of the modern monetary system.


This post previously appeared at PragCap >

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