Oliver Blanchard And The IMF Spout Nonsense About Japan's Debt

by: Ralph Musgrave

Blanchard and other IMF folk have been predicting Armageddon for Japan and its rising debt to GDP ratio for a long time. But Armageddon never comes. Some details of Blanchard's latest and ridiculous ideas on Japan's debt are in this article by Ambrose Evans-Pritchard. (Incidentally, not even Evans-Pritchard seems to get the sheer scale of Blanchard's ignorance)

This passage sums up Blanchard's ideas, and according to Evans-Pritchard, they are Blanchard's own words.

To our surprise, Japanese retirees have been willing to hold government debt at zero rates, but the marginal investor will soon not be a Japanese retiree…If and when US hedge funds become the marginal Japanese debt, they are going to ask for a substantial spread…".

And that, according to Blanchard will lead to Japan facing a horrendous bill for interest on its debt.

Now let's think about that. Unfortunately, we need to start with some very basic economics, as follows.

Governments run deficits and in consequence face rising debts for two reasons. First, there's the ever present temptation for politicians to fund government spending via borrowing rather than tax, as David Hume pointed out over 200 years ago. Raising taxes loses votes at election time.

But it's important to note that in that scenario, demand for loans comes from the debtor or would be debtor. And that's likely to lead to a relatively high rate of interest. Moreover, the higher the debt, the more doubtful lenders become about the relevant government's ability or intention to ever repay the debt, in which case they demand an even higher rate of interest.


The second and quite different reason for running a deficit is so as to provide stimulus. That is, if the private sector is spending too little, demand will be too low and unemployment too high. Thus government or "the state" has to spend more than it collects in tax: e.g. the state can simply print money and spend it, or it can "print debt." Put another way, as Keynes pointed out in the 1930s, in a recession, government can spend more by either printing money and spending it (and/or cutting taxes) or by borrowing money and spending it (and/or cutting taxes).

But note that in that case, demand for the debt comes from the creditor, not the debtor. That is, the explanation for households not spending enough is that they're saving too much, or at least they're saving more than expected. Keynes referred to that phenomenon as the "paradox of thrift." And in that sort of "demand for debt coming from the creditor" scenario, interest will tend to low: exactly what we see in Japan!

In effect, the creditor (i.e. Japanese households) are saying "Please, please, we want you, the government to be in debt to us - that is we want a bigger stock of paper assets in the form of cash or government debt." Clearly, that's what might be called a "debt seller's market."

In that scenario, government can say "OK, here's some government securities, and we're paying an utterly miserable rate of interest: about equal to inflation, which makes the interest bill for us (in real or inflation adjusted terms) around zero."

Japanese households might not like that, but it's the best offer they'll get. At least, they get what they're basically after, namely a stock of government securities.

The allegedly horrendous Blanchard scenario

Now what happens if households cease demanding a bigger stock of government debt/securities? In other words, what happens when households, instead of saving a significant part of their income, decide to spend it all instead? Well in that case, the basic problem, namely inadequate demand disappears. So there's no need for (or at least a reduced need for) a deficit and an ever expanding debt!

Thus (and contrary to Blanchard's claims), there'd be no need for the Japanese government to borrow from the "high interest charging US hedge funds."

So, Blanchard's argument lies in ruins. It's basically a load of nonsense.

But what's worse is that Blanchard has had a senior position at the IMF for years, and "Blanchard-type thinking" has pervaded the IMF for years. That is, at the height of the crisis, the IMF (and indeed to OECD) were advocating debt consolidation, i.e. austerity, rather than advocating what was needed, namely stimulus. For more on that, see various articles by Bill Mitchell on that subject, e.g. this one.