Paul Krugman: Meeting with Japanese officials, 22/3/16(Moderator)
Now we would like to start the third analysis meeting on international finance andeconomy, inviting Professor Paul Krugman of the City University of New York. Prime
Minister, please the floor is yours.
(PM Abe)This is the third meeting of the analysis meeting on international finance and economy.
Allow me to provide my greeting. Now, a Nobel Laureate and the former member of the
Presidential Council on economic advisers, we have invited Professor Paul Krugman of
the City University of New York. Thank you very much for coming to this meeting.
Professor Krugman hitherto on the subject of the economics, you have provided various
suggestions and proposals. In this meeting, we would like to hear your view on theanalysis of the world’s economy, at the same time, since the start of the administration
we have introduced the policy on three arrows. And also, we have come up with new
three arrows in the face of the aging society with low fertility.
In May of this year, we are going to be the host of the G7 Summit at Ise-Shima looking
toward the forceful growth of the world economy. We would like to transmit andcommunicate a strong message. This meeting would be a forum which will prepare
grounds for the Ise-Shima summit in May of this year. Thank you very much.
(Moderator)
Thank you very much, Prime Minister.
Professor Krugman, the floor is yours. Your initial remarks, please.
(Prof. Krugman)
I believe I should just say a few words before we close the meeting, just to basically bethankful of the honor of being asked to address this group and to speak about theseissues. It is a difficult world economy, unfortunately for now almost 8 years there havebeen no easy times for any of us. We are all very much wishing, I am a great admirer ofthe policy moves that have been made by Japan, but they are not good enough, partly
because all of the rest of us are in trouble as well. So, again I am very honored andpleased to be asked to speak about the things that could be done looking forward.
(Moderator)
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Thank you very much, Professor Krugman. I would like to ask the members of the press
to leave the room.
So, without further due, Professor Krugman, can you make a presentation?
(Prof. Krugman)I really want to make four points. The first is that we are now in the world of pervasive
economic weakness. In many ways, we are all Japan now. This complicates policy foreveryone including Japan. The second is that the linkages among major economies arestrong. They are stronger than much conventional economic discussion suggests, largely
I would argue because of capital flows. This is very important to speak about. The third,
which may be of particular concern here is, we are seeing the difficulty in achieving
goals through even very bold and unconventional monetary policy. Kuroda-san here, wewill clearly need to speak about that. The fourth then is that monetary policy needs help
from fiscal and possibly other policies but certainly on the fiscal side, and certainly does
not need to be struggling against fiscal policy moving in the opposite direction. That is
not just a Japanese issue but very much a global issue at this point.
So, let me enlarge on those points and say a few things about what follows from them.
The weakness, if you like the Japanification of other major economies, is...that is
unfortunate we are using that phrase but I think it is useful here...is, quite significant.
The Euro area looks a great deal now like Japan circa 1998, 1999. The fundamentals
are similar. Working age population is shrinking. Technological drivers of investment
do not seem strong, there appears to be just persistent weakness. Although theEuropean Central Bank is run by a very smart person and very effective one, they havebeen unable to achieve their inflation targets. Despite the occasional periods when theEuropean economy looks better, it does appear to be a situation of...that growth, to anincreasing extent, looks like the notion of the secular stagnation, persistent weakness
despite very easy money. The US looks better, has done much better, but we need to putthat into perspective. Employment growth has been good but output growth not somuch and there are signs that we are importing the weakness. Inflation is still below
target and wages are not going much of anywhere, which suggest that we are not doing
too well and for reasons I will explain in a moment. There is a reason to think that wewill be dragged back by the problems elsewhere. And emerging markets are in big
trouble, most particularly, the biggest emerging market which is right next door to you.
China has been simmering with known for several years that there was going to be a big
problem of adjustment, as it was no longer able to sustain that very high investment2

economy. They have not yet found a way to deal with it. The policy in China seems quite
erratic, which is not a good sign, given what is happening.
The interdependence of the major economies is, I will argue, very large. Ordinarily, theview that I and others have is that the interdependency is limited because even now
international trade flows are not that big. Even now, each of the major economies
exports only a few percent of its GDP to the others, but the effects are much larger if theperception of investors is that weakness is sustained. If the Euro area’s problems areseen not as a problem just for now but as a problem for a very long period of time, thenEuro area interest rates become very low even for long maturities. Right now, the 10
year German bond is about two tenths of a percent. That means that any economy thatappears stronger is a likely recipient of large inflows of capital which drive up its
currency, make it uncompetitive and cause them to share in the problem. You can seethat the dollar has risen drastically. Even economies that are not too happy with theirposition, may find themselves recipients of capital inflows from other countries, or findthat their own efforts to expand or somewhat undermined. So, we see, despite
everything, despite everything that Mr. Kuroda is doing, the rise in the yen, which is avery unfortunate development from Japan’s point of view, is driven by the weakness ofother major economies.
There is a special issue involving China. China is in big trouble. China which seemed to
be a source of strength but also not very long ago we were accusing China I thinkcorrectly of manipulating its currency to keep it down. China is now in fact intervening
to support its currency in the face of huge capital outflows. We believe that the capitalflight in 2015 was about one trillion dollars. China has immense reserves but not
infinite reserves, which mean that depreciation of the renminbi becomes a real prospect
and that will make life very difficult for the rest of us. So, all of this interdependence isthere.
Monetary policy has been, in most places, the only game in town. It’s their line because
fiscal policy has been politically paralyzed. Here, less so, but still in fact, of the three
arrows by far the largest, so far has been monetary. Mr. Kuroda has done most of thelifting here. We are seeing the limits of monetary policy. We are seeing that it becomesdifficult when you try the unconventional methods, we can argue this but it seems to be
having diminishing effect. Negative interest rates, it is remarkable that that turns out
to be possible. I do think it was the right move to make but it is very hard to push it
further. The effects are proving to be limited. If we look elsewhere, if we look in Europe,
despite another very able essential banker, the ECB seems to be losing traction. Here,as you know better than I, inflation expectation seems to be fading. Wage growth is not3what it should be. We are seeing that the policy that has been the principle lever fortrying to deal with this global weakness is not as effective as we had hoped and not as
effective perhaps as it seems to be recently.
Fiscal policy. Everything we have seen for the past seven years suggests that fiscal
policy remains effective, especially effective in these circumstances. It has been very
difficult to apply it, a few years of bad debt, political conflict, the Europe is divided
among counties, the United States is divided between parties, but fiscal policy iseffective and the global environment right now is one where economies really, reallyneed fiscal support. The idea that one should be prioritizing long-run budget issue overfiscal support now seems to me to be extremely misguided. Obviously I am talking about
the consumption tax here.
Two points are following on all of that. You notice that I did not say anything about
structural reform. That is not because I am against it but because structural reform
seems largely beside the point on this crucial issue of boosting demand. Some kind of
structural reform might spur private investment, which is good but that is rarely whatis emphasized. Some other kinds of reform, the Abenomics, by expanding the futurelabor force helps to offset the demographic headwinds that the economies face. So all ofthat is good but I do worry that sometimes the talk of structural reform becomes anexcuse not to deal with the primary immediate issue of sufficient demand, of fighting
deflation or low-flation, inadequate inflation, which has got to rely on monetary policy.
But as I said, that has limits and on fiscal policy which needs to be more focused on that
immediate need than it has been.
A last point, it is very important, I would argue, in this circumstance to understand thatthe risks are asymmetric. It could be that I am being too pessimistic and that things aregoing to be all right and demand would be stronger and there would be spontaneousrecovery. It could be that things are even worse than I am portraying, that China isgoing to experience an explosive collapse, or simply that demand is going to be weaker
than even my rather downbeat projections. The consequences in those twocircumstances are very different. If the world economy starts growing and inflation
picks up, we know what to do. Mr. Kuroda, Mrs. Yellen, Mr. Draghi have had the tools
to deal with that, no problem. If the world turns out to be weaker, then we are in deep
trouble because we do not have effective tools, which mean that it is very important to
err on the side of being more expansionary. This is an argument that my old colleague
Larry Summers has made many times and I make it also. It is not simply what you
expect to happen but what happens if you are wrong in either direction. It is very, very
important to leave room in case you should be wrong on the downside.
4So, this is the time for expansion. It should be coordinated as much as possible. I know
the G7 Summit is coming up. Ideally we would have everyone agreeing on a coordinatedfiscal expansion, in practice, that might mean Japan and Canada. I am not sure anyone
else is prepared to deliver at this point but we can certainly try to have the language
push in that direction. Japan itself needs to remain focused. The original goals of
Abenomics are still the primal. Breaking out of that deflationary cycle is “Goal Number
1”. Everything else should wait upon that. Now I will throw it open. Thank you.
(Moderator)
Thank you very much, Professor Krugman. So you saved a lot of time for us so let’s havea good discussion from now on.
(PM Abe)About two years ago, I had a pleasure meeting with you, Professor Krugman. At thattime, Japan was able to be going out of the deflation then we have set for ourselves the
2% inflation goal. We were talking during that time that a rocket has to go out of theatmospheric region, which means that an escape velocity has to be earned in order to lift
the Japanese economy out of deflation and we were looking for a good speed to do that.
That was a priority that we have been talking about. Hence, the rest of the world has
been thinking about the fiscal spending and Japan should also come up with the fiscal
spending in a coordinated fashion. We have been talking about that. But we worry
about the accumulated debt. That is a source of another concern. What to do about it?
But Governor Kuroda took a policy to introduce negative interest rates so that the 10
year JGBs yield turns negative at the moment.
So, we would like to take advantage of this situation and Japan should come up with afiscal spending. That is what some of the people are saying right now within Japan. Do
you have any view on this? Any observation on this point?
(Prof. Krugman)
Very much so. The case for spending now is quite strong despite the debt. It is true formultiple reasons. First, fiscal stimulus is very important as an aid to monetary policy inbreaking out of deflation. We have seen that it is difficult to do it with money alone.
Second, interest rates are very low. In fact, real interest rates in Japan are negative out
to very long maturities. There are needs, there are spending that needs to beundertaken. A business faced with very low borrowing cost and with real investment
opportunities would find this a good time to spend. That is true even for Japan. Third5

point I would make is that the concerns about the debt, I don’t want to wave away
entirely but one thing we have learned from Japan but also from other advanced
countries is that stable advanced nations that borrow in their own currencies have avery long road for them to have a fiscal crisis. People have been betting against JGBs
since about 2000. All of them have suffered financial disaster. The robustness of themarket is very strong. It is even hard to tell a story. If someone says Japan would be
like Greece, tell me how that happens. You have your own currency. The worst that
could happen would be that the yen would depreciate which would be a good thing fromyour point of view. I do not think that is a thing to be worried about. Finally, to theextent we are concerned about the long-run fiscal position. One of the problems ofdeflation or inadequate inflation is that at least Japanese real interest rates being too
high. And the way to break out of that is to get a sustained positive inflation rate. As allof you know, I would like it to be above 2. But whatever the number is, you need toachieve that. Compare with that goal what the budget balance is over the next two or
three years is of much less importance. In fact, the low interest rates right now meanthat the weight of the future position which depends upon breaking out of deflation ismuch higher compared to the current budget. I would say, this is not a time to be
worried about the fiscal balance.
(Moderator)
Thank you very much. Minister of Finance, please?
(Minister of Finance Aso)
During the 1930’s, I remember that in the United States likewise there was a situationof deflation. And the New Deal policies have been introduced by then President
Roosevelt. As a result, it worked out very nicely, but the largest issue associated with itis that for a long period of time entrepreneurs and managers of companies did not go to
make a capital investment by receiving the loan. It had continued up until the late1930’s and that is the situation occurring in Japan too. The record high earnings havebeen generated by the Japanese companies but they would not spend in the capital
investment. There are lots of earnings at hand on the part of the corporate in Japan. Itshould be used for wage hike or dividend payment or the capital investment, but they
are not doing that. They are just holding onto their cash and deposits. Reserved
earnings have kept going up. A similar situation had occurred in the US in the 1930’s.
What solved the question? War! Because World War II had occurred during the 1940’s
and that became the solution for the United States. So, let’s look at the entrepreneurs in
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Japan. They are stuck with the deflationary mindset. They have to switch their mindset
and should start making capital investments. We are looking for the trigger. That is theutmost concern.
(Prof. Krugman)
The important point about the war from the macroeconomic point of view is that it wasa very large fiscal stimulus. That fact that it was a war is very unfortunate. It was
simply something that led to a fiscal stimulus that would not otherwise have happened.
In fact, the story in the 1930’s was that the New Deal, Roosevelt backed off the fiscal
stimulus in 1937, because then, as now, there were many calls for balancing the budget.
That was a terrible mistake. It caused the major second recession.
Yes, obviously we are looking for ways to achieve something like that without war.
There has been a good deal of talk about using not just moral suasion which has alreadybeen done perhaps as an incentive to induce the private sector in Japan to raise wages. I
have no knowledge of the institutional details about what might work but I am certainly
in favor of trying such measures. That is one thing that can happen. Other than that,the linkage between corporate earnings and corporate investment has always been
weak. There has never been much reason to expect companies that have high profits toalso invest, unless they see reason to expand capacity. And what is happening is thatthey have the deflationary mindset. They believe that Japanese growth will be weak.
Clearly if we look at the behavior of wages, they expect, or at least fear, that Japan willslide back down towards very lower negative inflation. What is still needed is a shock to
break that. That is escape velocity. This is part of what I mean by escape velocity byachieving enough. Escape velocity: the rocket that goes fast enough to not come down
again.
(PM Abe)Well, talking about Japan, in 2014, the consumption tax rate was raised from 5% to 8%.
There was a last minute demand which came in. So right after that, we had seen adampening effect on consumptions. We are still having a lingering effect. We arethinking about the further rise in the consumption tax rate which was deferred by one
year and a half but in case of Europe, as for the VAT raise, maybe in the European
situation, the impact was not as large as that in Japan. Why such a big impact inJapan? Because deflation continued for a 20 year period. Moreover, it is not a deflation
situation anymore but we have not completely gotten out of the deflation. Do you thinkthat is the reason that we are stuck with this kind of situation?
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(Prof. Krugman)
I am not certain why the VAT hike did so much to arrest recovery in Japan. It may bethat it was the public viewed it as a signal that the policy would not be expansionary,that it was a break in what had seemed to be a run of all expansionary measures, but I
do not know that. I would say that Japan does have some fundamental reasons for why
it is hard to raise demand. The demography in Japan is uniquely unfavorable and theworking age population is now shrinking at more than 1% a year. Now, Europe has
moved in the same direction and even in the United States we have seen a sharp
deterioration of working age population growth. But there are reasons why Japan has
special difficulties. Essentially, there is a reason why Japan entered this situation in
the 1990’s when the rest of us did not enter it until 2008. But that does not mean that it
cannot be dealt with. It just means that there are needs of extremely vigorous sustained
aggressive policies to break out.
(Male 1)
Regarding fiscal stimulus measures, I think there are some G7 countries which haveenough policy space for fiscal stimulus, like Germany, the United States and the United
Kingdom. But as you alluded, none of them are likely to implement significant stimulus
measures in coming months. How do you think we should argue for further stimulus
measures in those countries with enough fiscal space?
(Prof. Krugman)
It is very difficult to make the argument. In the case of Germany, they simply live in adifferent intellectual universe, very difficult to talk about this. In the case of the UnitedStates, I assure you that President Obama favors increased infrastructure spending. In
fact I can actually say that there was one meeting of economists which he opened bysaying, “I want to hear your ideas. Don’t tell me we should spend a trillion dollars on
infrastructure. I know that, I can’t get it through congress”. So, the US has that problem.
Still, believe that it is the case that at the very least, we can blunt the push for fiscal
consolidation. There is some role of persuasion between the countries. My sense is thatconventional wisdom, sentiment among, if you like, the policy community, has beenshifting in the direction of seeing again the case for stimulus and it might be possible tomove that along. About my own country, we have an election coming and something
really terrible could happen in the election. But it is also significantly possible that wewill, at the end of this year, have a legislature that is significantly less obstructionist
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than the legislature that we now have. So, the United States may be a more helpful
partner on macroeconomic policy. I certainly hope so.
(Chief Cabinet Secretary, Suga)
There has been the declining of the commodity prices which had hit big blow on thedeveloping countries in particular. Do you have any outlook on the impact coming fromthe declining commodity prices? What would be the impact expected upon the economy?
Can I ask you?
(Prof. Krugman)
The impact is very severe on some emerging markets. It is interesting to know that themost important, biggest emerging market, which is China, is a commodity importer. So,on the whole, it is actually favorable for them but very severe consequences for Brazil
and for Africa. Those are important stories because there are a lot of people involved,
not clear how much the backwash to advanced countries is from that economically. We
would think we can worry about geopolitics. One unfavorable surprise has been that thefall in oil prices are not the positive thing that we had once thought, at least not as
positive. The reason has a lot to do with the fact that, the very thing that has brought oil
prices so low, which is the rise of “fracking”, means that the energy is an importantinvestment sector in the United States especially, and the drop in oil prices, although it
encourages consumption hits investment and so it is much less of a positive than it oncewas.
My story, however, would be that the commodity price decline, although a huge thingfrom the point of view of understanding geopolitical developments, very important for alarge number of people in the world, is not that big a part of the problem that we arefacing in the advanced world, that the problem is instead these demand issues. I mean,
it is shocking what has happened to commodity prices but that is not where thedowndraft on our economies is coming from.
(PM Abe)Now, on the subject of EU, European community, there are people with the pessimistic
views. Within the European Union, they have the single currency and because of that
there was the Greek problem. Other countries had the only limited options in terms ofpolicy in those countries. Fundamentally, the Greek problem will persist within theEuropean community according to some people. How do you see the situation?

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(Prof. Krugman)This is a very severe problem and not being resolved. The Euro is a major constraint,
not just on Greece but on much larger economies as well. France would have fiscal spacefor expansion. It really is not a serious trouble at all except that because of the Euro, itfeels that it does not have that strength, that ability to move. I would argue actuallythat it could but it is certainly much more difficult. If France had its own currency,
there would be no question. France is able to borrow at interest rates only 30 or so basis
points above Germany. They are not a country which has difficulty raising funds but
because of the constraint of the Euro, they are not able to move. That, just right there,
you would have a much stronger position.
The trouble, I think, with Europe reaches beyond the Euro. In fact in Europe right now,the economic issues have almost been pushed into the background by the refugee crisis,
which is bringing about a crisis also in Schengen, in the open borders. This is in a way
similar to the Euro. It is the incompleteness of the European project. They created avery open integrated system without the institutions necessary to make it work, whichleaves Europe rather paralyzed and contributes to the problems we all have. In effect,
the only effective player on European policy is Mario Draghi at the European Central
Bank who was a very good player but has limited reach without any government reallybehind him. I should mention, just as one more thing to worry about, there is a quite
significant possibility that Britain will vote to leave the European Union in a couple ofmonths. This will add to uncertainty and is a further drag on the world economy. If weare going to say which members of the G7 are really able to move effectively and seem to
be clear-headed, at the moment it would be basically, I think, Japan and Canada.
We have excellent leadership at the top of the United States but then we have a crazycongress, so it makes life difficult.
(Moderator)
Other questions from other members of the meeting? Prime Minister? Would that be
alright?
(PM Abe)Well, this time around, at the G7, how we analyze this situation, of course, we have tohave a thorough discussion going forward. Professor Krugman, international
community must coordinate in the fiscal space and the countries which are able would
spend fiscally. This message is very important. I presume that this is going to be
essentially your message and I agree with your message.
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So, we will coordinate and collaborate with other countries. Of course, countries havevariety of their issues and their situations. After all, this is off the record, Germany has
the greatest space for a fiscal mobility. Going forward, I plan to visit Germany. So, I will
have to talk to them and I will have to persuade them how they will come along with thepolicy for further fiscal mobilization. Is there any idea from you?
(Prof. Krugman)
It is difficult and let me say also that Chancellor Merkel is preoccupied with othermatters as well, which she has been very good but it is an impossible situation. There is
one thing that I think I should have raised, one area where there might be a possibilityof getting, at least raising something that might be an accessible form of stimulus,
which is that in fact climate policy, in addition to being, of course, crucial, in some ways
nothing else matters compared with that, is also a possible incentive for private
investment as a shift to green technology across the advanced world. Perhaps at least
some statement about the desirability of moving forward, we have the Paris ACCORD
that may be one route on which things can happen. I wish I had better suggestions. A
brilliant diplomacy is not something I am an expert in.
(PM Abe)Certainly, climate policy would be one area, which will stimulate further private
investment. So, we would like to discuss along those lines as well. For example,
Germany, because of the refugee question, investment, for example, housing investment
for refugees or educational investment for refugees, do you think that would be effective
in terms of fiscal policy?
(Prof. Krugman)
Yes, it is a stimulus. I think if you actually cost it out, it is not very large. The refugee
issue creates enormous tension because of social fears but if we can say, though strange
way to put it, taking care of the refugees does not actually cost enough to be a major
fiscal stimulus. It is not trivial but it is not that big. When we were looking at it, I knowthat President Hollande was speaking about we should lift the fiscal restraints in orderto deal with this crisis. For a moment we are all kind of excited saying this is the end of
austerity but the numbers just did not seem to be big enough to actually be a reallymajor departure. If you are looking for the fiscal equivalent of war, it is not that. It istremendous social political strain but not in fact that much money.

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(Moderator)
Professor Krugman, thank you very much. Thank you very much for the valuableadvices today. Secretariat, we are holding a press briefing right after this. I hope you
agree with us. Of course, what was mentioned by Prime Minister will remain
confidential. Thank you. I thank everyone for coming.

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