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Fiscal Consolidation in Japan

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  • FUKAO Mitsuhiro

Abstract

In order to maintain the stability of its financial system, Japan must control its budget deficit by continuing with a contractionary fiscal policy. Ideally, the negative effects of a tight fiscal policy should be countered with an expansionary monetary policy. However, the effectiveness of the conventional interest-rate policy has been diluted by the zero lower bound of interest rates. Prime Minister Shinzo Abe asked the Bank of Japan to set a 2% inflation target to be achieved in two years through a massive quantitative easing of the monetary base. In this paper, we first review Japan's macroeconomic performance since the collapse of the asset-price bubble in the late 1980s. Next, we make a long-term projection of Japan's fiscal balance by estimating the macro production function for Japan. We also estimate the required increase in the government's tax revenues under a few scenarios. After presenting a possible fiscal crisis scenario, we evaluate the effectiveness of quantitative easing and highlight its limitations. Thereafter, we propose some measures to consolidate budget deficits under a deflationary environment in order to avoid such a crisis. Some policy options include a combination of a gradual increase in indirect taxes and a reduction in payroll tax. In order to overcome the zero lower bound of nominal interest rates, the introduction of the Gesell tax has also been proposed. By levying a tax on the outstanding amount of government-guaranteed financial assets including cash, it is possible to set a negative nominal return on safe assets.

Suggested Citation

  • FUKAO Mitsuhiro, 2014. "Fiscal Consolidation in Japan," Discussion papers 14015, Research Institute of Economy, Trade and Industry (RIETI).
  • Handle: RePEc:eti:dpaper:14015
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    File URL: https://www.rieti.go.jp/jp/publications/dp/14e015.pdf
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    1. Mitsuhiro Fukao, 2006. "Financial Strains and the Zero Lower Bound: The Japanese Experience," NBER Chapters,in: Monetary Policy with Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 203-232 National Bureau of Economic Research, Inc.
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