Causes of Fiscal Multiplier Decline in Japan

In this paper we investigated the causes of recent decline in the Japanese fiscal multiplier. We first listed possible causes of multiplier decline based on a standard macroeconomic model (AD-AS Mundell-Fleming model). We then examined them one by one using basic statistical data and related preceding studies. We conclude that the causes of multiplier decline are: 1) decrease of consumption propensity, 2) increase of income tax rate, 3) decrease of investment propensity, 4) decrease of expected growth rate, and 5) increase of import propensity. On the other hand, 6) the crowding out effect, 7) the price adjustment effect, and 8) the Mundell-Fleming effect are unlikely to be the causes of recent multiplier decline. Rather, 6) to 8) might be working in the direction of increasing the multiplier under current deflation and zero interest rate environment. The underlying factors behind 1) to 5) are: the aging of the population and the resulting rise in tax and social insurance burdens; expanding fiscal deficit and the accompanying concern about future tax increase; decline in potential growth rate; and the progress of economic globalization. All these factors are historical trends in the current Japanese economy and unlikely to revert anytime soon. Therefore, it seems difficult to expect the declined fiscal multiplier to recover in the near future.