Economists’ Views on the Global Economy

How Monetary & Fiscal Policy Can
Work Against Coronavirus Shock:Proposal for the Issue of Corona Bonds
By Naoyuki Yoshino, Hiroaki Miyamoto &Muhammad Zubair Mumtaz

AuthorNaoyuki Yoshino

This article discusses how monetary and fiscal policy can work
during the coronavirus shock and how to deal with the structuralproblem of population aging in Japan. The sudden drop in stock
prices in many countries reflects a decline in market sentiment.
Money is shifting from riskier assets to safer assets which causes
stock prices to drop further. Massive fiscal support by issuinggovernment bonds (= Corona bonds) is needed to retain confidence
in the market. At the same time, the structural problem of the aging
population will not go away (“Decreased Effectiveness of Fiscal andMonetary Policies in Japan’s Aging Society” by Naoyuki Yoshino andHiroaki Miyamoto, Japan and the World Economy 42, 2017). The
article will propose how we can mitigate a possibly enormous
increase in government debt due to huge temporary budget
spending.

AuthorHiroaki Miyamoto

AuthorMuhammad Zubair Mumtaz

activities where large gatherings occur has caused a huge decline insales in the services sector; (iii) the disruption of supply chains has
reduced the amount of production by the manufacturing sector; and(iv) the decline in sales in many sectors has led to a fall in income
which has reduced general consumption and had a negative
multiplier effect on the economy.
The coronavirus is different from earthquakes or floods or othernatural disasters. Physical capital is not destroyed and production
processes remain stable. The sudden negative effects on
consumption and production which have led to falls in GDP should
be addressed temporarily by government expenditure. This
temporary drop in various economic activities will recover when thecoronavirus spread ends and normal life resumes. Government is the
only source which can compensate for the decline in private
economic activities.

Introduction
There has been a huge drop in stock prices in many countries
facing the coronavirus infection. In the United States, stock prices
fell 25% in March 2020, while Japanese stock prices fell 21%. In
such circumstances, governments and central banks are the only
institutions which can calm pessimistic market sentiment in orderprotect against a massive slowdown of the economy (Chart 1).

CHART 1

Stock price decline of US & Japan
DOW /29,500/24,100

NK225

28,500/23,409
27,500/22,718
26,500/22,027
25,500/21,336

Effectiveness of Monetary & Fiscal Policy Against
Coronavirus Impact
The decline in stock prices after the virus began to spread from
China can be explained by a number of factors: (i) the uncertainty ofthe timeframe – nobody can predict when the spread will end andthis has created uncertainty in the capital markets; (ii) the sharp
decline in international travel together with postponement of various

54 Japan SPOTLIGHT • May / June 2020

24,500/20,645
23,500/19,955
22,500/19,264
21,500/18,573
20,500/17,882
19,500/17,191
18,500/16,500

11/25

12/10

12/24

1/9

1/24

2/7

2/24

3/9

3/23

Source: Nikkei

https://www.jef.or.jp/journal/

Economists’ Views on the Global Economy

The temporary policy measures recommended are the following.
(1) The government can provide loans to the services sector andmanufacturing sector whose sales have fallen due to thecoronavirus. It could be loans at a zero interest rate until thenegative impact of the coronavirus disappears (say, for two
years). Financing could come in the form of special government
bonds which could be called Corona bonds. It is important todistinguish this special bond from ordinary government bonds.
Japan has already issued two kinds of bonds, one through the
Fiscal Investment and Loan Program (FILP) and the otherthrough the ordinary budget. Both are issued and circulated in
the financial market as a “JGB” (Japanese government bond).
The same could be applied to Corona bonds which would
become the third kind government bond, issued to cope with thevirus spread.
(2) Corona bonds could be purchased extensively by the Bank ofJapan (BOJ). The financial market would receive this new bondissue to compensate for the temporary negative impact onvarious sectors as a positive signal for the future. The drop in
stock prices caused by an unpredictable future could be
mitigated.
(3) Purchases of Corona bonds by the BOJ will be better thanpurchasing stocks through exchange-traded funds (ETFs) since
the recovery of the stock market will come from the economic
activities of Japan and expectations of the future recovery of theeconomy. If the BOJ buys stocks through ETFs, these purchases
would be better terminated when the negative impact of thecoronavirus on the stock market has ended.
(4) Stock prices are affected by many factors in the market.
Purchases of stocks by the BOJ will increase temporary demandand stock prices will recover in the short run. But the mostimportant impact on the stock market should come from the real
economy. The ultimate goal of the BOJ is not the recovery ofstock prices but the recovery of the real economy, inducing
higher sales, higher income and higher consumption etc.
(5) The restructuring of the Japanese economy can be accelerated
by emergency government loans as long as the loan officers inrecipient companies have excellent vision. If a company isexperiencing a temporary downturn caused by the coronavirus, it
should receive zero interest rate loans until the negative shocks
disappear. At the same time, there are many companies facing
structural problems such as lower demand caused by the aging
population and the decline in population in the regions. Thesefirms should change their business strategy and should not be
eligible for zero interest emergency loans. If all companies wereassisted by zero interest rate loans, the Japanese economy
would fall into a long-term recession.
(6) Direct compensation should be made to workers in various
companies who are forced to stay at home due to thecoronavirus. Whether they are permanent employees or parttime employees, the government should support their salaries. It

will be important for the government to keep records of theamount of income provided by support programs. The
employees’ income statements should clearly state how muchcomes from their real work and how much comes fromgovernment support.
(7) Many companies have started letting their staff work from homesince January 2020 due to the coronavirus problem. Commuting
times in large cities are often very long. What kind of jobs are
suitable for work from home? Would a company’s productivity
increase by the introduction of work from home? Would
teleconferencing over the Internet work well? If companies canutilize this opportunity as a milestone and make drastic changes
in the Japanese culture of work at the office, their productivity
could be increased.
(8) Education needs to be changed drastically. Some universities
have started to hold online lectures without the need to attend
classes. Can this be applied to many subjects at university?
Education in primary schools is very different from university
level since children have to be disciplined by teachers face toface. But if many classes in university and in high school can beprovided by video or online lectures, traditional teaching could
be changed. Subjects could be taught online that all students inJapan could access. Teachers at each school could provide
additional comments for students or add their own lectures.
Teachers at school could receive questions from students andprovide answers to them.
Chart 2 illustrates the issue of Corona bonds to cope withemergency government spending. The left-hand balance sheet is theannual government spending and its sources of finance. Ordinary
government expenditures are financed by tax revenues and the issueof government bonds. The proposed Corona bonds would bedirected to special government expenditures to cope with sectors
and businesses affected by the coronavirus. The bonds would bepurchased by the BOJ (right-hand balance sheet).
CHART 2

Issue of Corona bonds to cope withemergency government spending
Government(Expenditure and Revenue)

Bank of Japan(Balance Sheet)

Ordinary
government
expenditure

Tax revenues

Gold

Banknotes

Government bonds

Current
deposits

Specialgovernment
expenditure

Corona bonds

Government
bonds(Ordinary andCorona bonds)

Reserves

Source: Compiled by the authors

Japan SPOTLIGHT • May / June 2020

55

Economists’ Views on the Global Economy

TABLE 1TABLE 2

Two assets
Asset A (riskier asset)(i) Rate of return(ii) Risk (=σ)

0.90670.0290Asset B (safer asset)

1.10740.0621

Source: Compiled by the authors based on Japanese data

Relative allocation of safer asset (B)compared to risker asset (A) wheninvestors change their preference to risks
Asset A (riskier asset)
Asset B (safer asset)

Seeking returns

Medium case

Risk avoidance

44.3%

66.3%

88.2%

55.7%

33.7%

11.8%

Source: Compiled by the authors based on Japanese data

Impact of Uncertainty on the Capital Market
When the economy is faced with big shocks, markets become very
cautious about risks and investors lean toward safe assets.
Traditionally, investors watch two factors: the rate of return, and therisks associated with holding each asset. Government bonds are asafe asset where principal and interest will be returned without any
reduction (as long as the government stays stable). Bank deposits
with a deposit insurance guarantee are another safe asset since theprincipal can be returned. On the other hand, stock prices fluctuate
every day and dividends from stocks fluctuate based on theperformance of the company. The fluctuations in stock prices anddividends are regarded as “risk” factors in investment.
Table 1 shows how risk aversion will affect the portfolio allocationof Japan. There are two financial assets: the oil & gas sector (AssetA) and the electronics sector (Asset B). It summarizes the rate of
return and the risk (which is measured by standard deviation). The
rate of return from Asset A (1.1074) is higher than Asset B (0.9067)
and the risk which is measured by standard deviation of the asset is0.0621 for Asset A and 0.0291 for Asset B, which denotes that A is
risker than B. If investors seek a higher rate of return, they will invest
more in Asset A, but if they prefer to reduce the risk, they will invest
more in Asset B.
Investors compare (i) the rate of return and (ii) the risk of theasset. In a boom period, investors tend to regard the risks of assets
as lower, but in a recession or economic shock they regard them as
higher since the economic downturn is severer. Table 2 measures therelative allocation of the safer asset (B) to the risker asset (A) wheninvestors change their preference to risks. When the economy faces
a severe shock, investors prefer safer assets and reduce their risk
appetite. Three cases of risk appetite are compared.
(i) Investors favor a higher rate of return more than the risk factor(return seeking)(ii) Investors weigh the rate of return and the risk factor equally(neutral investment)(iii) Investors regard the risk factor as higher than the rate of return(risk avoidance).
The simulation results are summarized in Chart 3 as “the case of
seeking returns” in which the rate of returns is regarded as twice asmuch as the risks, “the medium case” where both the rate of returns
and risks are the same, and the “risk avoidance case” in which therisks are twice as much as the rate of returns in the utility function

56 Japan SPOTLIGHT • May / June 2020

shown as US and UR in Chart 3.
This chart denotes the portfolio frontier curve of two assets (A and
B). When investors are placing more emphasis on the rate of return
without so much concern about risks, the utility curve of investors
look like UR (dotted upward red curve). When investors prefer toavoid risk, the utility curve moves to US, as shown in the solid
upward green curve. The optimal asset allocation between safer
asset (B) and riskier asset (A) will move from point “e” to point “f”.
At point “e”, the allocation to the riskier asset rises to 55.7%. At
point “f” where investors are risk averse, the allocation to the risker
asset drops to 11.8% and the share of the safer asset rises to
88.2%.
Point “f” will be the current situation in many countries where
investors prefer safer assets by reducing their risks rather thanseeking higher rates of return. If the coronavirus epidemic continues
for a longer period of time without a specific policy action by thegovernment, the share of riskier assets will drop further than 11.8%
compared to the total asset allocation.

CHART 3

Changes in preference to avoid riskin the market

UR

US

Source: Compiled by the authors

Economists’ Views on the Global Economy

Reducing Budget Deficit Created byCorona Bonds After Coronavirus Ends

TABLE 3

Holders of Japanese & Greek government
bonds

If massive government spending to rescue sectors
Holders of JapaneseHolders of Greek government% of total% of total
government bonds
bonds
and individuals affected by the coronavirus infection
Bank and postal savings
45
Overseas investors
33
were provided, the budget deficit of Japan will riseLife and non-life insurance
20
Domestic investors
21
much further than 220% of GDP. It is quite important
Public pension funds
10
European Central Bank18
to avoid a debt explosion in the budgets of Japan andPrivate pension funds
4
Bilateral loans
14several other countries that may undertake huge
Bank of Japan
8
Social pension funds
6
government spending by issuing Corona bonds.
Overseas investors
5International Monetary Fund
5
Receivers of such government support should alsoHouseholds
5
Greek domestic funds
3
realize that their receipts are financed by Corona
Others3Note: In Greece, 70% of debt is held by overseas investors, compared with 5% for Japan. Data are for 2011.
bonds and that they are temporary issues. Both theSource: “Optimal fiscal policy rule for achieving fiscal sustainability: the Japanese case” by Naoyuki Yoshino,
government and the recipients have to understandTetsuro Mizoguchi and Farhad Taghizadeh-Hesary, Global Business and Economic Review, Vol.21, No.2
(2019)
that they are financed by special issues of Corona
bonds. In other words, those who have provided
temporary loans or subsidies should keep in mind the amount they
controlled by observing three factors: (i) debt/GDP ratio, (ii) deficit/
are receiving both from the central government, local government
GDP ratio, and (iii) GDP recovery. This paper has assumed thatand government financial institutions. These have to be returned bymonetary policy is used to focus on price stability and fiscal policy isfuture tax revenues contributed by business tax, income tax,
assumed to promote economic recovery as its primary objective.
property tax and sales tax revenues when the economy recovers
What kind of weights these three components should be given willfrom the coronavirus shock.
depend on macroeconomic factors such as consumption,
Budget sustainability can be maintained by the simultaneous
investment, deposit behavior, capital market investment, etc. But
determination of both spending and tax revenues. Evsey David
unless these three components of the economy are simultaneously
Domar, a Russian-American economist and co-creator of the Harrodconsidered both through government spending and tax revenues,
Domar economic growth model, came up with a theorem in thebudget stability will not be achieved and the economy will dip into a
1940s about fiscal sustainability. Domar’s theorem proposes
fiscal explosion.
comparing the interest rate and the growth rate of the economy asConclusion
follows:
Interest rate > growth rate of the economy → Budget deficits will
The coronavirus is an unexpected chance for Japan and otherexplodecountries to change their living and business practices to moreInterest rate< growth rate of the economy → Budget deficit will
efficient and productive ones. If the private sector can introduce
converge.
various ways to cope with unprecedented circumstances, theDomar’s theorem shows how a nominal interest rate would
productivity of companies will improve. Society as a whole will move
explode budget deficits, while a high growth rate would result in a
toward a better way of life if this shock can improve various
reduction of budget deficits.
structural issues. Urgent government emergency spending is
The Domar condition does not take into account the demand fornecessary through the issuing of special Corona bonds. Aftergovernment bonds. The Greek budget deficit to GDP ratio wasrecovering from the coronavirus pandemic, simultaneous decisions
smaller than that of Japan in 2019 when the Greek economic crisis
have to be made in the budget process by monitoring spending andhappened. However, Greece went bankrupt and Japan is stillrevenues at the same time, with a special focus on debt/GDP, deficit/
sustained. It relies on the demand structure for government bonds.
GDP and GDP recovery.
In the case of Japan, about 90% of the debt is owned by domestic
investors. On the other hand, 70% of government debt in Greece washeld by overseas investors. Overseas investors quickly sell Greek
bonds and leave. On the other hand, domestic investors tend to hangon to their domestic bonds. Demand for government bonds has tobe taken into account to achieve stability in the government budget
Dr. Naoyuki Yoshino is professor emeritus of Keio University in Tokyo andformer dean of ADB Institute. Dr. Hiroaki Miyamoto is professor of Tokyo(Table 3).
Metropolitan University and a former economist in the International Monetary
When both supply and demand for government bonds are taken
Fund. Dr. Muhammad Zubair Mumtaz is associate professor of finance in the
School of Social Sciences & Humanities, National University of Sciences &into account, the stability of the government budget relies on how
Technology in Islamabad.
well government spending and tax revenues are simultaneously

Japan SPOTLIGHT • May / June 202057