Japan vs. Argentina
Who loves ya (for macroeconomic analysis)?
“….throughout history there have been only four kinds of economies in the world: advanced, developing, Japan, and Argentina.”
The origin of this old saying among macro folks is unknown, but has been repeated for decades. It might be a bit out of date….or not. What is less noted it that macroeconomists can be divided among those who like to talk about Argentina and those who prefer Japan.
Argentina has been the poster child for hyperinflation due to fiscal irresponsibility. So everyone knows governments have to show sufficiently Calvinist characteristics and deny their urges to spend without taxing. But then how does Japan get away with a debt-to-GDP ratio well north of 200% (and anything Argentina experienced) with persistently low interest rates and inflation?
The short answer for Japan is that the causality runs the other direction. The government is responding to low interest rates, not causing them. Since the 90s, Japan has been flirting with the zero lower bound on interest rate with sluggish growth. It is quite possible their equilibrium real rate has been negative. Demographics is a leading candidate explanation. Global population growth rates have been falling, which implies lower real rates in standard models (Solow, OLG), and the population in Japan has been aging faster than most. In such a situation, monetary policy is ineffective on its own, and, with interest rates stuck at zero (the ZLB, see Chapter 6), why not borrow and spend to get the economy moving?
In fact, Japan’s mix of fiscal and monetary policy might be an unintentional example of the type of monetary finance advocated by Modern Monetary Theorists. The Bank of Japan holds a healthy amount of Japan’s debt. The net debt-to-GDP ratio is 156%, which is high, but not nearly as scary as the gross debt number 263%.
Economists with an interest in Liquidity Traps spend a lot of time talking about Japan. Paul Krugman is the most prominent example. His work on the topic include the well-known “It’s baaack…” paper, along with many of his Slate essays collected here. For a combination of wonky and influential, the paper “When Is the Government Spending Multiplier Large?” by Larry Christiano, Martin Eichenbaum and Sergio Rebelo is hard to beat.
Those who want to beat the drum for fiscal responsibility focus on Argentina in particular and South America in general, see the book by Tim Kehoe and Juan Pablo Niccolini (and others). This tradition goes back to the 1970s, when Milton Friedman and the “Chicago Boys” advised Augusto Pinochet. They did break the spell of inflation in Chile, though associating with a murderous dictator left a mark. The recession in the early 1980s was particularly severe in Chile and marked the end of their influence.
The Argentina/Japan camps tend to break down along the freshwater/saltwater divide, with the freshwater folks sneering at government intervention and the Phillips Curve. If you focus on South America, inflation does appear to be wholly dependent on fiscal policy and divorced from unemployment. On the other hand, the liquidity trap in Japan is a situation where fiscal stimulus is particularly effective and may have allowed them to absorb the cost of pensions for an aging population without crisis.
Of course there are a few enlightened souls who can see both perspectives. Ivan Werning has done continuous time modeling of a liquidity trap, while being a native Argentinian with a lot to say about its economy. Juan Pablo Nicolini is mentioned above as an expert on Latin America, but he has also written about the ZLB.
Things may be changing. Interest rates in Japan are starting to rise, so the Japanese may have to get serious about dealing with the cost of their debt. In Argentina, Javier Milei looks to be defeating inflation, though the smoke has not cleared yet.
So the Americas might be rid of high inflation, though one country in the north seems intent on savaging is reputation for responsible policy……