When contraction is called expansion – Japanese government style

Well my holiday is over. Not that I had one! This morning we submitted the manuscript to the publisher for the Second Edition of our Macroeconomics text, which will come out later this year. Finishing a massive project like that always is non-linear – the last few months have been hideous – checking everything and filling gaps. Anyway, that was the Xmas break. And as the New Year starts, one always hopes that humanity learns from the mistakes of the previous year. In economics, though, that is the hope of the forlorn. I read this morning’s Japan Times newspaper and lo and behold there are predictions of dire consequences as a result of the current Cabinet decision to shift focus away from pursuing a primary fiscal surplus to massaging the public debt ratio. The mainstream economists are arguing about the relative virtues of each and forecasting gloom. The reality is that neither target is worth attention. Meanwhile, the privatised rail companies are negotiating with communities for the closure of certain rail segments because they are loss making. All that discussion is about costs per passenger km, rather than satisfaction gained from bringing people together. The priorities are all wrong.

Privatised rail in Japan

In this article – JR companies and local governments to continue talks on loss-making railway lines – we learn that the – Japan Railways Group – otherwise known as JR, is negotiating closures of loss-making train lines throughout Japan.

JR was previously JNR, the state-owned railway company (Japanese National Railways) until it was privatised by the neoliberals on April 1, 1987.

The privatisation was partial, as three of the regional parts of the company (it was divided into 7 regional operators) were still held by the state, given their loss-making performance.

The liability of JNR were also significantly diverted into a holding company owned by the state, given the new private owners are largely clean slate.

In other words, all the assets and some of the liabilities.

In addition, a significant number of workers (particularly those belonging to the two main railway unions) were not re-employed by the three privatised companies (JR East, JR Central, JR Kyushu, and JR West).

There was a 23-year legal struggle (finalised in June 2010) for unfair dismissal and finally the Supreme Court ruled that the state-owned holding company overseeing the split of assets and liabilities would be liable to compensate the workers (cash not their jobs).

So the public purse, once again, picked up the damage, while the private owners escaped liability.

That is the same theme for many privatisations around the world since the 1980s.

Anyway, I digress into that little bit of Japanese railway history.

The problem facing the JR Group is that the population in Japan is shrinking and many of the rural trains – those little single cars that scoot around the countryside – are now making losses.

JR wants to shed 21 segments.

Of course, the impacted local communities believe having transport available to them is a right and they want JR to continue cross-subsidising the services.

JR is negotiating with local government agencies to make up the losses – there you go – public money again.

In Victoria (Australia), the state government privatised the railway system and also closed a number of regional lines.

I live some of the time in one of the regions impacted and the closures have had a devastating, long-term impact on the communities, particularly young people who have to rely on slow and infrequent bus services.

The problem starts with the decision to privatise because then the calculus on what is worthwhile or not comes down to whether the activity generates a private profit, not whether it delivers a service that advances the well-being of the community.

And the decision to privatise starts from the erroneous claim that the currency-issuing government no longer has the cash to run an efficient and well-maintained public transport system.

That false claim then justifies a sequence of poor decisions that end up with the sort of discussions that JR is having with local communities.

All unnecessary and very costly (when costs are measured in well-being terms).

The fiscal debate goes on …

The problem is that the erroneous starting point is still rehearsed on a daily basis as mainstream economists waste their time debating nuances of what is essentially an elaborate fiction – not that they see it that way.

The Japan Times published this article yesterday (January 4, 2026) – Japan policy wonks consumed by debate over how to measure fiscal woes.

The journalist has a degree in political science.

I guess that qualifies him to discuss the intricacies of currencies and equips him with the capacity to ask the right questions rather than just being a mouthpiece for the mainstream.

My guess was probably wrong.

When Ms Takaichi was elevated to the Prime Ministership in Japan in October 2025, her differentiating spiel was that the Cabinet would no longer target an annual primary fiscal surplus.

The primary fiscal balance is the difference between government spending net of interest servicing costs on outstanding government debt minus tax revenue.

Given the interest payment component of government spending each year really reflects decisions made in the past, the mainstream argue that the primary balance is the best indication of the current government’s discretionary fiscal decisions.

That, of course, is not exactly true because as we know, the fiscal balance recorded each year is not under the control of the government anyway.

Why not?

The spending and saving decisions of the non-government sector play an important role in determining what the government’s fiscal balance will be each year.

If the non-government decides to spend less, through pessimism etc, then economic activity will decline in lieu of a government fiscal expansion to fill the spending gap.

The declining economic activity causes lost tax revenue (less people employed) and increases income support payments to those who lose their jobs, in addition to other payments that might accompany rising unemployment.

The result? The fiscal balance moves into deficit from surplus, or, more usually, into a higher fiscal deficit without any discretionary shift in government policy settings.

So the primary balance isn’t a clean indicator of the government’s fiscal plans at all.

That reality aside, the mainstream claim governments should pursue a primary surplus because it means the government can pay down the outstanding principle on its debt and reduce the overall debt ratio.

Of course, in the example I gave above, imagine if in pursuing a primary surplus, the government cuts back discretionary net public spending and that the causes a recession or stagnating GDP growth.

The non-government sector then respond by reducing their own spending as unemployment rises.

The result? The debt ratio would rise because the governments fiscal balance would move further into deficit (usually) and the denominator, nominal GDP would be lower.

So that doesn’t seem like a good strategy.

The mainstream also claim that running primary surpluses sends a powerful message to the bond markets that the government is credible and this lowers the yields that the bond markets demand for purchasing the debt.

Again think about the logical sequence:

1. The currency-issuing government pretends it has to borrow its own currency from the users of the government’s currency.

2. It then proposes an auction where the non-government sector (bond dealers) place bids to buy the public debt.

3. The wherewithal held by the non-government sector to use the government’s currency to purchase bonds from the government comes from previous fiscal deficits – the government injecting more of its currency into the economy than it is taking out in tax revenue.

4. Those deficits provide the non-government sector with the capacity to net save in the government’s currency, which then can be used as a wealth portfolio choice to hold a range of financial assets including government bonds.

5. So effectively the bond markets just send some of the past government deficits back to the government in return for a bit of paper!

6. At any point along the way, the central bank, which the treasury side of government voluntarily constrains from bidding in the auctions, can go into the secondary bond markets (after bonds initially sold in the auction process – the primary market – are then traded among speculators), and buy as much government debt as it likes, given its currency capacity is unlimited (minus a penny!).

7. In doing so, the central bank can drive the yield on government debt to zero and even into negative territory as was the case on the 10-year Japanese government bond in recent years.

8. The non-government bond investors can do nothing about that – the central bank can always outbid them and so the yield aspirations of the bond investors can only be realised if the government itself gives them the freedom to express those aspirations in the primary auctions.

Conclusion: credibility is just one of those terms used by the mainstream economists to give a perceived legitimacy to a process that is totally unnecessary in the first place.

It would not matter a skerrick if all the bond investors thought the government was wasteful and would default on its liabilities – if the government used its central bank’s capacity to thwart the intentions of the bond markets.

The bond markets only have the capacity to move if the government allows them too.

So it is an elaborate sort of hoax – an example of massive corporate welfare – that the government even sells debt to the bond markets at all.

The mainstream also talk about primary surpluses being saved up (for example, in sovereign wealth funds) to pay for future needs (such as, the ageing society, natural disasters, etc).

Another hoax.

Whether the government runs a surplus or a deficit now, provides it with no more or no less spending capacity tomorrow nor the next day.

The currency-issuing government can spend what it likes when it likes – that is after all what a currency-issuing monopoly means.

So starving the society of government spending and desirable services and infrastructure to ‘save up’ for the future, when the latter aim makes no sense is the height of fiscal irresponsibility.

Think about those train services in Japan.

The situation becomes a little more complex in the current Japanese debate.

Up until recently, Japan has been stuck in a deflationary dead end.

Since the COVID-induced inflation, the difference between real and nominal GDP has been getting larger – with nominal GDP being inflated by the rise in prices faster than real GDP is growing because of increased production.

As a result, the overall public debt to GDP ratio has been falling a little because of the inflationary impacts on nominal GDP.

Ms Takaichi and her advisers claim that the falling ratio is a good sign (it is actually irrelevant and tells us little about the robustness of the country) and that there is no longer any need to run primary surpluses in order to reduce the debt ratio.

She recognises that trying to run a primary surplus each year is likely to undermine economic growth because “fiscal resources” will be artificially constrained.

The mainstream economists are going into conniptions because they think this is the thin edge of the wedge of fiscal profligacy.

They point to the “government’s massive economic stimulus package, along with the supplementary budget for fiscal 2024 and initial budget of 2025” as evidence.

In fact, the recent fiscal stimulus announced (21.3 trillion yen) is relatively modest in terms of the size of the economy.

I recommended to the Japanese government in November during my talk at the Diet that the expansion should be more like 50 trillion yen.

On December 26, 2025, the Cabinet approved the latest 令和８年度予算政府案が閣議決定されました新しいウィンドウで開きます – (Fiscal plan for FY2026).

The fiscal year starts in April each year in Japan.

This document – 令和８年度予算フレーム (FY2026 Budget Framework) – projects a primary fiscal surplus of 1.34 trillion yen in FY 2026.

This is rather historic because it would be the first primary surplus in 28 years.

This Japan Times article (December 27, 2025) – Japan set to see first primary balance surplus in 28 years in 2026 – which is characterised as:

… an apparent attempt to ease market concerns over her proactive stance on spending.

The government estimates the shift in the primary balance between fiscal year 2025 and 2026 will be 2.12 trillion yen, a rather massive contraction.

The reason for the higher surplus than planned is because tax revenue has been considerably upgraded.

Whatever, you read from the Takaichi administration about pursuing an expansionist and responsible fiscal strategy, the reality is that the projection for fiscal year 2026 indicates on-going fiscal austerity.

Ms Takaichi told the media on announcing the FY2026 fiscal projections that:

The national government’s initial budget is set to see a primary balance surplus for the first time since 1998 … I believe we have put together a budget that strikes a balance between achieving a strong economy and ensuring fiscal sustainability.

In Japanese, there is no nuance in the meaning – it is the same as the English version reported by the Japan Times.

The Japan Times article doesn’t get it – that is for sure:

While Takaichi has said she wants to focus on other yardsticks for measuring progress in improving fiscal health, a primary surplus offers support for her characterization of the government’s expansive fiscal policy as “responsible.”

Primary balance – government spending minus taxation revenue, ignoring spending on debt interest.

Positive – government spending net of debt interest LESS THAN revenue

Negative – opposite

Positive – contractionary

Negative – expansionary.

The fiscal document cited above noted this:

財政収支赤字（利払費相当分と基礎的財政収支の差額）は、11.7兆円。

Which basically says that the overall fiscal deficit will be 11.7 trillion yen and it is the difference between interest payments and the primary balance.

So yes, the on-going fiscal deficit of 11.7 trillion yen projected for FY 2026 is expansionary, but it is being driven entirely by interest payments.

The actual expenditure on recurrent services and capital formation net of taxation is contractionary.

So even though Ms Takaichi gained a lot of public attention in building up anticipation that she was going to break with the austerity of her predecessors, no such reality is apparent.

Conclusion

And if that was gloomy – then I apologise.

Happy 2026 to everyone except those that cause us grief.

That is enough for today!

(c) Copyright 2026 William Mitchell. All Rights Reserved.