How will Japan pay for reconstruction?

By R.A. | WASHINGTON

MANY people have linked to Robert Peston's nice piece on the potential obstacle to Japanese recovery posed by its high debt level. Japanese sovereign debt is in a league all its own. Its gross-debt-to-GDP ratio may reach 228% this year—more than twice the ratio in America. There is some concern that reduced expectations for growth associated with the immediate disaster may combine with expectations for increased spending associated with the reconstruction effort may shift debt worries in a definitive fashion. Maybe, it's suggested, markets will finally tire of holding Japanese debt and (another) crisis will strike.

Two factors lean against this argument. One is that Japanese households are voracious savers and hold much of Japan's outstanding debt. This structural feature of the Japanese economy makes a sudden flight from Japanese debt unlikely. OF course, someone has to keep buying the newly issued debt, of which there is plenty. Japan's savers might be willing, but amid crisis it's not clear that they'll be as able.

The Bank of Japan, on the other hand, may be. In addition to a massive release of liquidity to maintain financial market stability, the Bank has promised to double its asset-purchase plan, which will help absorb some of the additional debt. I suspect it is this action that led Japanese bond yields to fall in the immediate wake of the disaster. The question is: to what extent is the Bank of Japan willing to run with this activity? If bond yields were to rise, would the Bank of Japan take additional action?

I ask because deflation in Japan is a well-established fact of life, and Japan's demographics are likely to reinforce expectations of falling prices. Given this dynamic, the Bank of Japan could presumably increase its purchases to extraordinary levels without provoking inflation fears. No central bank on earth has earned more inflation-fighting credibility than the Bank of Japan. Now may well be the time to put that expectations capital to use.

Not least because the money-financed stimulus—the helicopter drop—is the most potent macroeconomic tool available to policymakers. Japan's problem has long been that its households are unwilling to spend. A major reconstruction effort financed by the Bank of Japan would provide the demand Japanese citizens haven't, potentially kicking the economy out of its doldrums once and for all.

In February, The Economistmused on the problem of Japanese saving:

Where Mr Shirakawa and Mr Motani most directly see eye to eye is on the need for companies to boost domestic demand by unleashing the latent spending power of the elderly, who sit on the vast majority of Japanese households' ¥1,500 trillion ($18 trillion) of savings. Mr Shirakawa believes there will be growing demand for health care, nursing, tourism and leisure. He reckons that a 40% rise in the turnover of fitness clubs in Japan in the past decade is due to increasing health consciousness as people live longer. He says deregulation would increase supply in such fields.

Mr Motani takes a more draconian view. He is fed up with the elderly hoarding their money. He says they do this because of a “King Lear” complex: they feel they will be deserted if they give too much away. And he favours tax reform to encourage them to bequeath their money to their grandchildren, rather than their children. One of the flipsides of longevity, he points out, is that the average age of those who inherit is a grand old 67.

Of course, one complication with stimulus spending in a rapidly ageing country is that long-term supply isn't the problem. Japan must obviously see to the rebuilding of critical infrastructure, but should be careful not to overbuild, as that would reinforce deflationary pressures. But there should be the monetary room to finance reconstruction without generating a near-term debt crisis. The debt issue won't go away, but at least Japan may be spared the need to worry about it just now.