A Quantitative Analysis for Required Adjustments for Japan fs Fiscal Policy

The purpose of this paper is to examine the feasibility of Japan fs future fiscal and social security policies from the view of government fs inter-temporal budget constraint, given the current large debt outstanding. Towards this end, we draw the long-run future trajectory of fiscal expenditure and revenue under the assumption that the current fiscal policies would be maintained throughout the future period. For that purpose, we adopt the methodology used by the European Commission (EC) which sorts out expenditure items that are automatically linked to demographic change, and obtain comprehensive bottom-up trajectories, accurately reflecting the indexation rule to price and wage levels. In addition, by using the trajectory, we calculate what is called a dynamic fiscal imbalance indicator, measuring the magnitude of required fiscal adjustment to satisfy the government fs inter-temporal budget constraint. We follow the method first proposed by Blanchard et al. (1990), later used by the EC (2012a). The calculated figure of required adjustment to achieve the same debt to GDP ratio target as the European Union is 19.9%. This magnitude and several sensitivity analyses clearly show that current fiscal policies in Japan are by far distracted from satisfying inter-temporal budget constraint and achieving efficient inter-temporal resource allocation, since the private agents must formulate expectations on uncertain significant policy change in the future.