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One thing America can learn from Japan's weekend stock market boom

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The Japanese economic and political system recently went through a debate that should be broadly familiar to most Americans, yet different enough to cast some light on issues that still confound us. The issue, broadly speaking, was fiscal stimulus. But since Japanese politics has a different ideological structure from America's, and because Japan's tax system is also different, the stimulus debate took a different form. Specifically, early this year Japan began raising its national sales tax — first from 5 percent to 8 percent, with a scheduled additional increase from 8 percent to 10 percent.

The confidence game

The goal of these tax hikes was to restore market confidence in the Japanese government and economy, confidence that was allegedly spooked by the country's sky high national debt — a debt that as a share of the economy far exceeds the USA's. But so far, at least, confidence-boosting tax hikes have done nothing to improve Japan's fortunes. Instead, the sales tax hike led to a massive second quarter collapse in the Japanese economy, which shrunk 7.1 percent between April and June. Then in an interview with the Financial Times over the weekend, Prime Minister Shinzo Abe hinted he might delay the boost to 10 percent in order to help the economy.

Did investors immediately lose confidence in the system? Nope. On the contrary, the Japanese stock market surged up by 4 percent — its biggest increase in over a year.

Stimulus doesn't mean spending

This is a lesson that, broadly speaking, the world has learned over and over again since the Great Crash of 2008. When a country that issues its own currency is facing an outlook of low interest rates and low inflation, it can boost its economic prospects by expanding its budget deficit. In ordinary times, huge deficits might "crowd out" private sector investment by raising interest rates. But when an economy is depressed, it's easy for the central bank to keep interest rates low without risking inflation. In those circumstances, a bigger deficit just means more opportunity for private businesses to make money. This is what basic macroeconomic models say, it's what the International Monetary Fund says, and it's what the experience of the United States and United Kingdom and now Japan as well suggests.

But it hasn't altered American politics one bit.

One helpful lesson from this regard in Japan is that it should be possible to separate the stimulus question from specific ideological debates about the role of government. If when Americans heard the word "deficit reduction" they thought "two percent national sales tax hike" rather than "cut welfare" then of course Republicans would acknowledge that austerity in a low interest rate environment makes no sense. Consumption tax hikes hurt sales and economic output in a real concrete way — absent strong pressure from inflation or the bond market, it would be silly to set those goals aside in pursuit of the confidence fairy. The reality is that spending programs work the exact same way: if more people had more money in their pockets, they would buy more stuff and people would be employed to make and sell it.

A less political stimulus

Over a generation ago, Americans recognized that fighting recessions is too important to be held hostage to ideological wrangling in congress. Primary authority was turned over to the quasi-technical Federal Reserve, which now fights recessions through monetary measures. This works well enough until interest rates get to zero, but once that happened the Fed started resorting to untested and controversial methods.

What the country needs is a stimulative process that has the bureaucratic properties of monetary policy, but the heft and comprehensibility of fiscal stimulus. If we had a national sales tax like Japan does, letting the Fed set the rate up and down to boost the economy would work. One alternative would be to enact temporary cuts in the payroll tax, and have the Fed fill the resulting gap in the Social Security trust fund with printed money. Another alternative would be to print money and mail it directly to American households. But barring broad Federal Reserve reform, Congress could act on its own. Back in 2008, Nancy Pelosi and George W. Bush teamed up to enact a cash in the mail stimulus program and it was highly effective. And in the winter of 2010, Barack Obama and congressional Republicans agreed on a payroll tax holiday that also boosted the economy.

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