A Framework for Macroeconomic Analysis focusing on Net Lending/Borrowing across the Government, Private, and Overseas Sectors

This paper develops a framework for macroeconomic analysis with a particular focus on net lending/borrowing across the government, private, and overseas sectors, which enables comprehensive and consistent analyses of the external balance of a country as well as the debt sustainability of public and private sectors. Specifically, we construct a partial equilibrium model for the Japanese economy that incorporates the linkages across sectors―government, households non-financial corporations, financial institutions and overseas―including both flow and stock variables. This model estimates the projection of income and outlay accounts for the public and private sectors based on a set of macroeconomic assumptions, including demographic trends, exchange rates, prices, and interest rates, and presents a consistent picture of how net lending/borrowing across sectors is expected to evolve over the long-run. The analysis of public debt sustainability, for example, can clearly illustrate the advantage of this model by presenting the long-term projection of public sector together with the overall picture of the economy, including the long-term projection of private and overseas sectors in a consistent manner. We present an illustrative scenario based on Japan’s current macroeconomic variables, including economic growth. In this scenario, the model shows that the current account surplus is projected to be sustained over the long-run, as an increase in the overseas earnings of corporate sector is expected to compensate for a gradual decline in households’ net lending and a gradual increase in fiscal deficit associated with an aging population. However, the continued current account surplus relies on corporations’ rate of return on external investments, suggesting the vulnerability to shocks from overseas economies. In contrast, under an alternative scenario that assumes increases in consumption propensity by households and investment propensity by corporations and consequent higher economic growth, the longterm projection of current account balance turns to a deficit due to a decline in net lending in the private sector and an increase in the fiscal deficit. This leads to the decline in the domestic absorbing capacity of government bonds, suggesting the increasing vulnerability of fiscal positions to interest rate shocks. Finally, this paper also employs a stochastic approach by using the probability distribution of macro variables, such as exchange rates, prices, and interest rates, for analyzing the implications of changes in these variables on the flows and stocks in each sector. The results show extremely large variations in the projections of external balances due to fluctuations in the respective macro variables and underscore the need to pay adequate attention to uncertainties associated with changes in parameters.