Two to Tango—Inflation Management in Unusual Times
IMF Blog, June 15, 2017
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Bibliographic details
- Authors: Vitor Gaspar, Maurice Obstfeld, Chang Yong Rhee
- Published: June 15, 2017
Overview
- Authors: Vitor Gaspar, Maurice Obstfeld, Chang Yong Rhee
- Publication date: June 15, 2017
- Theme: Interaction and coordination of monetary, fiscal, and structural policies to address persistent low inflation, illustrated by Japan’s experience.
- Key institutional premise: Modern arrangements typically feature a strict separation of responsibilities—central bank targets inflation and smooths business cycle fluctuations; fiscal authority respects its budget constraint and supports financial stability by maintaining the safe asset status of its debt.
Japan’s low inflation
- Inflation is described as "well below target after decades of depressed nominal GDP growth."
- Bank of Japan innovations: "the introduction of yield curve control in September 2016."
- Fiscal policy inconsistency has "undermined the effectiveness of monetary policy."
- Fiscal plans have been caught between:
- "the short-term need to help monetary policy escape the low inflation target," and
- "the very clear medium-term priority of reducing Japan’s large and unsustainable burden of public debt."
- Example of policy reversals: "The planned consumption tax increase has been postponed twice: once from 2015 to 2017, and again until 2019."
Setting objectives (data-dependent, conditional approach)
- Policy framework proposal:
- Introduce a framework wherein policy actions are "data-dependent" to promote achievement of objectives such as "inflation or price level targets."
- If the government tightens sooner than desired, introduce "temporary offsetting measures to continue to support progress toward reflation."
- Expected benefits of higher nominal GDP growth:
- "helping reduce the real burden of the debt."
- Fiscal risks and required safeguards:
- "If the requisite target is not met, then continued fiscal stimulus could imperil debt sustainability."
- Need "a framework to manage public sector balance sheet risks that mitigates the financial stability risks from a potential loss of safe asset status for Japanese government bonds."
- Fiscal stance guidance:
- Deficits must be "offset by real future surpluses."
- Government should "tighten fiscal policy gradually, and consistently with the economic cycle."
- Include "structural reforms that boost future surpluses, for example, measures that close wage gaps."
Credible policies (limits of non-credible fiscal expansions)
- Caution against relying on the Fiscal Theory of the Price Level:
- The approach "assumes that the safe asset status of government debt is guaranteed."
- Risk: a "bond market scare" could cause government bonds to "lose their safe asset status."
- Consequences of lost safe-asset status:
- Monetary policy would be forced into "guaranteeing fiscal solvency (by guaranteeing the promised nominal payments on government bonds)," limiting its ability to stabilize inflation and anchor expectations.
- This outcome would "destroy policy credibility."
- Consumption tax debate as illustration:
- Postponements noted: 2015 → 2017 → 2019; these "policy reversal[s] and the associated lack of a credible anchor has reduced the effectiveness of fiscal policy."
- Recommended approach for consumption tax:
- "A pre-announced, gradual increase of Japan’s consumption tax rate, offset by temporary fiscal measures when necessary, remains a preferred option."
- Continue the gradual increase "until the tax rate reaches a medium-term level that ensures fiscal sustainability."
- Preserve the "single rate," noted as making the system "simple" and an "important structural advantage."
- Rationale: would "help raise inflation expectations and has high revenue potential given the relatively low level of revenue collected from the consumption tax in Japan, compared with VAT collections in other Organization for Economic Cooperation and Development countries."
Policy recommendations — comprehensive and consistent coordination
- Policies should be:
- comprehensive — "exploiting the full range of synergies between monetary, fiscal, and appropriate structural policies"; and
- consistent — "anchoring long-term expectations by demonstrating a clear commitment of monetary, fiscal and structural reform policies toward common objectives."
- Design principles:
- Anchor policy commitments with data-dependent frameworks.
- Use temporary offsetting measures if short-term tightening is unavoidable.
- Manage public sector balance sheet risks to protect safe asset status of sovereign debt.
- Phase fiscal consolidation "gradually, and consistently with the economic cycle."
- Implement structural reforms (e.g., wage-gap closing measures) to boost future surpluses.
- Maintain simple tax-design features (e.g., single consumption tax rate) while raising revenue to support sustainability.
Lessons learned
- Core message: "in such extreme circumstances, macroeconomic policies will only be successful if they take full advantage of the synergies of different policies working together."
- Coordination between monetary and fiscal policy is "key" in particularly difficult circumstances to achieve reflation and preserve debt sustainability.
Source: Two to Tango—Inflation Management in Unusual Times (June 15, 2017).
Content in this bundle
- 孤掌难鸣——特殊时期的通胀管理, 作者：Vitor Gaspar、Maurice Obstfeld和Chang Yong Rhee
- ふたりでタンゴを：極端な経済環境でのインフレ管理, By Vitor Gaspar, Maurice Obstfeld, and Chang Yong Rhee
