Japanese promises (a reply to John Cochrane)

John Cochrane comments on a recent Bloomberg post of mine. In that post I wrote:

[I]nflation reduces the burden of debt. Japan’s enormous government debt represents the government’s promise to transfer resources from young people (who work and pay taxes) to old people (who own government bonds). Since Japan is an aging society, there are more old people than young people. That makes the burden especially difficult to bear. Young people also tend to have mortgages, the repayment of which is another burden. 

Sustained higher inflation would represent a net transfer of resources from the old to the young. That would increase optimism, and hopefully raise the fertility rate, helping with demographic stabilization.

John agrees that (unexpected) inflation is a partial debt default that has (among many other effects) the net effect of transferring real resources from the old to the young. But he believes this to be unfair, and also cruel:

[L]et us remember where debt actually comes from. The Japanese government borrowed a lot of money from people who are now old, when they were young. Those people consumed less -- they lived in small houses, made do with fewer and smaller cars, ate simply, lived frugally -- to give the government this money. The promise they received was that their money would be returned, with interest, to fund their retirements, and to fund their estates which young people will inherit. 

Noah is advocating nothing more or less than a massive government default on this promise, engineered by inflation. The words "default,"  "theft," "seizure of life savings," apply as well as the anodyne "transfer." I guess Stalin just "transferred resources." 

Yes, Japanese Baby Boomers did make real sacrifices in exchange for the promise of future transfers. Yes, inflation (or cutting pensions, or cutting health care spending) does represent a partial default on those promises. It does indeed represent seizure of life's savings. As for "theft", that's a legal term, but if you want, then sure.

Sorry.

Economics involves tradeoffs. I wish it didn't. I wish resources were infinite, but they're not. And sometimes promises can't be kept as easily as you thought they could be when you made the promise. Imagine - as a limiting case - that an entire generation of fifty million produces only one hundred children. The older generation made real sacrifices when they were young, in exchange for government bonds (and suppose the real resources they gave up were spent on useless bridges to nowhere). In order to keep its promise of resource transfer, the government must now pay back those bonds by taxing just one hundred people.

It's not going to happen, no matter how much people want it to happen. One hundred cannot pay back fifty million. Inflation or default will happen.

In Japan's case, the situation is not so extreme, but the principle is similar. The Boomers, who sacrificed real resources (much of which was indeed spent on bridges to nowhere) in exchange for government bonds, had very few children. Japan's population is shrinking by hundreds of thousands per year, and the rate of decrease is set to accelerate. Paying back the older generation will be very, very hard for those less numerous young people. And forcing the young people to make those payments may well cause them to have fewer kids, helping to perpetuate the problem.

Therefore, hard choices must be made. Resources must be allocated - not the way that Stalin did it, thank God, but in a way that will undoubtedly earn the resentment and disappointment of many honest hard-working citizens, and which will undoubtedly cause hardship for many who do not deserve it.

But if you feel the desire to moralize against this "theft", remember that when the promises were made, the younger generation was not yet able to vote. The seizure of the fruits of their labor, in the form of taxes, goes to pay for expenditures that were made without their consent.

In other words, one way or another, some cruel unfairness is going to happen in Japan. And I think our job is to minimize the cruelty and unfairness as best we can - to "spread the pain" as much as possible while minimizing the pain's overall size.

Some more Cochrane points:

Amazingly, to Noah (and the views he ably summarizes here) this "transfer" will "increase optimism." Hmm. Let's look at the evidence for that. We have seen many large inflations, which wiped out middle-class savings along with government debts. Those events have generally been regarded as economically, politically, and psychologically destabilizing tragedies, not FDR-fireside-chat "optimism"-raising sessions. No surprise that few societies have voluntarily signed up for such treatment as Noah recommends. I would be curious to hear of a single happy historical antecedent. (I mean that. Perhaps I am mistaken in my understanding of Noah's proposal. A successful example might correct me.)

The historical example I had in mind was the sustained high inflation between 1945 and 1955, which substantially reduced the debt that the U.S. had incurred during WW2.

How does a government default benefit young people anyway? It does so if a large amount of tax revenue is being used to pay interest or principal on the debt, and the default is accompanied by a large tax cut for young families. Not by the same level of taxes and increased government spending on more railway-to-nowhere stimulus projects.  Without tax cut, there is no transfer. Noah is strangely silent on the essential big tax cut aspect of his plan.

Let me be silent no more! Yes, tax cuts are the plan! Taxes are crushing the youth!!

Of course, given the large tax hikes that will be required to balance the Japanese budget if transfer payments to old people are not cut, even keeping taxes at their current level would constitute a tax cut. But yes, it's about tax cuts.

Quiz: Find in Japanese (or American) government finances the actual "promise to transfer resources from young people (who work and pay taxes) to old people." If you say "government bonds," you (like Noah) got the wrong answer. The right answer is Social Security, Medicare, and public employee pensions. If Noah wishes to reduce the "burden" of intergenerational transfers, no matter that governments have promised to make those transfers and people have planned their lives around them, the silence on these promises is deafening.

I think Japan should absolutely cut transfer payments to the elderly (I said so in this other post, and will say it again, and said it to the Ministry of Finance people when I met them the other day). The problem is that transfer payments are politically hard to cut, while monetary policy is (probably) much more out of the public eye.

But note that government bonds are another promise to transfer resources from young to old. It's not the wrong answer, it's just part of the total answer.

If the purpose is default, why not just advocate default? 

It's one option. But it's an incredibly extreme option, since it would cause lots of business failures, which would cause massive economic disruption. That would put the country in danger of a coup. Sovereign default is a last-ditch option, but I think it would be better than hyperinflation.

So, according to Noah, a self-induced hyperinflation to generate an economy-wide debt default is necessary

No! Hyperinflation is the worst sort of default, since it causes business failures. What I want is sustained moderate inflation of 4-6 percent.

Anyway, that should answer most of John's points. He describes me as having an "insouciant willingness" to upend the lives of millions. I think I'm anything but insouciant. The lives of millions are going to get upended one way or another - Japan's government has made promises that it can't keep. That's not my choice or my doing. I just want to help figure out ways to minimize the overall suffering and spread it around as fairly as possible.

Hopefully that does not make me Stalin.