Note to Self: Can Short-Run Stimulative Policy Increase the Chance of a Future Inflationary Breakout?
Paul Krugman says "no"…
Consider Japan and Abenomics. In the long-run, Paul Krugman says, the real interest rate on JGB is determined by supply-side factors: risk tolerance, time preference, and growth. None of these are affected by Abenomics. In the long run the debt-sustainability calculus is what it is, whether favorable or unfavorable.
In the short-run, Paul says, Abenomics raises expected inflation and thus reduces the short-run real interest rate on the debt--that is, after all, the point of the policy. Therefore Abenomics in the short run means that when the long-run arrives the debt-to-GDP ratio is lower, thus reducing the problem of financing the debt that we short-run policymakers hand off to our long-run successors.
Alternatively, consider that today's long real interest rates are a combination of today's short-run short-term rate and the long-run future's short-term rates. Abenomics unambiguously reduces today's short-term real rate. It leaves future supply-determined short-term rates unchanged. Thus it reduces today's long-term real interest rate. Thus it reduces the long-run cost of financing Japan's government debt. Thus it must improve rather than erode Japan's fiscal position.
I think that Paul's conclusion is ambiguously correct--as long as you buy Paul's model: has a Keynesian unemployment short-run and a classical full employment supply-side determined long-run, with today's long-term real interest rates and thus debt sustainability a fixed-weight average of the two.
How could this go wrong?
What if we were to adopt an even more Keynesian model? What if we said that there was a Keynesian short-run, a classical long-run, and a medium-run that could be either?
Could it be that amortizing JGB at its current real values is expected to be sustainable because it is thought that the debt will be paid down to some degree during a long-lasting medium-run, in which unemployment is high, short-term real rates are negative, and yet deficits are low? Could it be that Abenomics eliminates this expected substantial depressed medium-run--if it leads people to expect a rapid transition from today's depressed economy to a future full-employment long-run economy with higher real interest rates--it does not improve but rather erodes debt sustainability?
I find myself unsure…
