1. The University of the Free State
Fiscal Policy Reaction in Japan
Presentation by Evelina Niishinda
B.Com Honours: Economics
29 October 2010

2. Structure of presentation
I. Objectives
II. Literature
III. Method
IV. Empirical results
V. Conclusion

3. I. Objectives
• Primary objective
• Determine how Japanese government
respond to its public debt/GDP ratio
• Secondary objective
• Estimate fiscal reaction function
• Test for public debt sustainability

4. II. Literature
• Public debt/GDP ratio
-Japan is one of the OECD
countries with the
highest public debt/GDP
ratio (Burger, unpublished
article)
- Ratio following an
upward trend since 1970
- Late 1990s to early
2000s, ratio = 90%
(Tokuoka, 2010)
- 2008/2009, ratio = 189%
(CIA world fact book, 2010)

5. Literature cont…
Cause of increase in debt is debatable
- Expansionary fiscal policy (Kuttner and Posen, 2002)
increase in primary deficit
- Increase in bond issue (Kang, 2010)
- Lower government revenue due to aging
population.
 Fiscal rules (Von Hangen, 2005., Burger and Jimmy, 2006):
 1981 - Fiscal Consolidation Agreement
 1991/92 - Fiscal Restructuring Targets
 2002 - Reform and Perspective Programme

6. III. Method
• Two methods, GMM and VAR to
estimate fiscal reaction function.
• OECD data, 1970-2008
• Fiscal reaction Function:
- >0: government respond to increase in
public debt/GDP ratio by increasing
primary surplus.

7. Method Cont...
Debt sustainability
- Determined by the relationship between real
growth(g) and real interest rate(r).
- Condition:
- If r>g, government need to run primary surplus
- If r<g, can run primary deficit without putting
pressure on debt/GDP rati o.

8. IV. Empirical results
• Stationarity tests
Table 1
KPSS PP DF-GLS ADF
CAPBY I(0) I(1) I(1) I(1)
GDY I(1) I(1) I(1) I(2)
GAP I(0) I(1) I(0) I(0)

9. Empirical results cont....
• Fiscal reaction function
Table 2, GMM estimation.
Explanatory variables Coefficients
CAPBYP(-1) 1.208***
(0.222)
GDY(-1) 0.008
(0.008)
GAP(-1) -0.457*
(0.253)
Adjusted R-squared 0.45

10. Empirical results cont….
Results provide positive but weak
reaction of primary balance to changes in
the debt/GDP ratio.
CAPBYP coefficient, =1.208, shows
that primary balance is an explosive
random walk process.

11. Empirical results cont…..
Table 3:Vector Auto Regression estimates. In parenthesis, t-ratios
CAPBYP GDY GAP
CAPBYP(-1) 0.469 -0.728 0.065
(2.230) (-1.580) (0.350)
CAPBYP(-2) 0.412 -0.000 0.089
(2.268) (-0.000) (0.551)
GDY(-1) -0.059 1.266 -0.071
(-0.566) (5.57) (-0.773)
GDY(-2) 0.0612 -0.273 0.077
(0.599) (-1.218) (0.858)
GAP(-1) 0.019 -0.814 0.695
(0.093) (-1.833) (3.857)
GAP(-2) -0.284 1.103 -0.441
(-1.507) (2.671) (-2.630)
Adjusted-R squared 0.643 0.994 0.475

12. Empirical results cont….
From CAPBY equation, only CAPBY at
lag 1 and 2 are statistically significant at
5%.
Output gap is statistically significant at
10%
Negative output gap coefficient means
that Japan fiscal policy is procyclical.

13. Impulse responses
Response of CAPBYP to GDY Response of GDY to CAPBYP
3 10
2 5
0
1
-5
0
-10
-1
-15
-2 -20
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Years after shock years after shock

14. Debt/GDP ratio. Is it/has it been
sustainable?
 Figure3: CAPBY, real GDP growth and real interest
 R > G, run primary surplus
 R< G, can run primary deficit

15. V. Conclusion
Government respond to the increase in
public/debt GDP ratio by increasing their
primary surplus (increase insignificant).
Results show evidence of unsustainable
public debt/GDP ratio.

16. Thank you