Fiscal Policy Switching in Japan - Case Study Example

Japanese Debt-to-GDP Ratio Name Instructor Course Date Abstract According to researchers, Japan has the utmost debt to GDP ratio accounting the developed countries. Additionally, its population has been projected over the years to age hastily, and over the next few decades it will greatly increase the ration of government expenditures to GDP. The paper will explore the effects of the country’s economic growth driven by the total factor productivity on the Japanese debt in the face of higher future social security and among the businesses. It will also examine the sustainability of Japan’s fiscal policy and situations where the debt-to-GDP will be unsustainable. The findings using The Standard Neoclassical Growth Model, is that a decade of rapid growth of total factor of production, using an average of 6% pa annum, might help the country eradicate the debt issue. This means that, the country’s policy makers should focus on the Japan’s growth, for instance inducing policies such as minimal distorting taxation and structural reforms that incentivize the entrepreneurial activities and innovation that will drive growth. In this case, the paper will highlight some of the future steps Japan should do to reduce the increasing debt-to-GDP Japanese Debt-to-GDP Ratio Debt-to- gross domestic product ratio is defined to be a country’s debts, which are divided by the size of its economy. In this case, the ratio can measure and incorporate all debts that is government, corporate, personal, in a country. According to economists, the ratio is viewed as the signal that indicates if a country’s is on its financial stability, in addition, whether the debt burden is reaching dangerous levels (Ito, Tsutomu, &, Tomoyoshi 2011, p.2-5). Generally, the lower the debt-to-GDP ratio, the healthier a country fiscal outlook is, and the vice versa is true. Additionally, mounting a country’s debt is usually a serious issue in several countries in U.S, Europe, and Japan. The main concern here is on the sustainability of the increasing government debt, for instance that already put Greece into crisis where other European countries had to bail it out twice. Other countries, such as Italy, Spain, Ireland, and Portugal, have had serious increased debts and alleviating economic growth, but over the years they have been able to control the issue by sharing the deficit reduction (Ito, Tsutomu, &, Tomoyoshi 2011, p.2-5). However, Japan has one of the worst-case scenarios and suffers a severe problem, which is government debt, which is evident after analyzing its gross debt to GDP ratio. According to the 2010 statistics, Japan’s debt to its GDP ratio had risen to 198% that higher that the France 92%, U.S 93%, Greece 129%, and Germany 80%. According to research, Japan’s problems are because of continuous accumulation of deficits of several years compared to Europe or U.S (Nersisyan, & Wray 2013, p. 5-10). The problem comes back to the fiscal stimulus packages in the year 1990 when its economy suffered a collapse of assets prices, despite their continued efforts to mend that, they have not been in a position to achieve their initial objects, thus resulting to debt increase over the years. According to reports, the government has been leaning on the Japan’s, to buy bonds, a strategy that seem not to be working out well recently. The country’s long-term yields in bonds have been falling this is because the banks are redden with cash putting the economy to a grip of chronic deflation (Nersisyan, & Wray 2013, p. 10). Raising the tax rate to stabilize debt-to-GDP approach The main issue in this approach is whether the government can raise the tax rate significantly to stabilize the debt-to-GDP ratio. To respond to the question, it is important to examine how the fiscal policy has respond to the increasing government debt over the years (Doi, Hoshi, & Okimoto 2011, p. 19-21). By observing the government tendency to diminish the general deficit adequately, in response to the increasing government debt, for example, by deducing that the government can increase its tax rate to stabilize the debt-increasing rate, it will be simple to understand how the government will play the cards in the near future to achieve that. Intuitively, the debt-to-GDP ratio grows over time at the rate of the interest rate, minus the growth rate of GDP even with the primary balance is zero. Therefore, in order for the debt-to-GDP ratio to stabilize in the end, the main surplus should be at least as large, meaning “if the GDP ratio is greater that the interest rate minus the growth rate, the government debt will be sustainable” (Doi, Hoshi, & Okimoto 2011, p. 19-21). The Standard Neoclassical Growth Model This paper aims at exploring the quantitative effects of the economic growth on the government debt and its sustainability on fiscal policy in Japan, due to its increased expenditure, for instance because of the aging population and the due to the government leaning on the bonds from the banks that are day-by-day failing them. To study these effects, The Standard Neoclassical Growth Mode (SNGM), will help analyze the Japanese economy model. This model will help measure how fast Total Factor Productivity (TFP) growth affects Japan’s government indebtedness (Imrohoroglu, & Sudo 2011, p. 2-3). Although this theory does nto have consensus yet, TFT, it is known that economic institutions and policies can assist produce rapid growth; mainly those linked with higher accretion of human capital, openness, increase in competition, and more incentive to innovation are most importantly considered important to a country dealing with debt problem. According to the theory, if a decade of a 6% economic growth per year, will reduce the Japan’s debt to zero by 2050. Consequently, while the debt amounts to 100% of the country’s GDP in 2010, a sufficiently higher Total Factor Productivity growth increases the tax revenue and in turn improves the government’s budget balance (Imrohoroglu, & Sudo 2011, p. 3-10). However, SNGM is an infinite horizon and a complete markets layout that has been successfully used over the years to address various economic issues about Japan’s economy. The model provides how a representative household chooses its decisions rules for saving and consumptions, where they are affected by prices and government policies (Imrohoroglu, & Sudo 2011, p. 3-10). For example, a stand-in firm takes full advantage of its profits, setting factor prices equal to their marginal productions. Whilst in this case, there is a government that finance exogenously provided the government purchases, interest payments, and transfer payments on government debts by taking into considerations factors such as income and consumptions or either by issuing new short-term or long-term bonds. In this case, therefore, agents in the environment will take into account future policy and their prices and then maximize their objective responsibilities. Consequently, the model will be a useful tool in measuring the responsiveness of the private industry to the potential demographics changes and the fiscal policy experimentations of the government’s expenditure (Imrohoroglu, & Sudo 2011, p. 3-10) Japanese Unsustainable debt Debt is several cases is said to be unsustainable for some countries if their debt-to-GDP ratio is projected to be growing without a limit given the existing policies. According to studies, the ratio of the debt-to-GDP that certain country can sustain without incurring a sovereign debt risk crisis, is determined by the primary surplus, that is, the country’s revenue minus the expenditure without considering the repayment costs (Ito, Tsutomu, &, Tomoyoshi 2011, p. 20). There have been several cases securitizing Japan that its debt-to-GDP is not sustainable claiming that, it high the ratios are high enough to cause a macroeconomic instability, which is not good for the growth of the economy considering the fact that their bonds and securities they have been leaning on are starting to fail. In addition, after analyzing the Japanese debt-to-GDP ratio in terms of its net liabilities, some studies show that it is large enough to be dangerous and cannot be sustainable through the efforts of securing a viable level of the government revenue-to-GDP ratio (Chen, Imrohoroglu & Imrohoroglu 2007, p. 87). The future solutions of how to reduce the debt-to-GDP ratio in Japan Japan is currently facing serious fiscal policy challenges that simply are summarized in the unprecedentedly high current government debt. The paper has generally explored the impact of production growth rate on Japan’s government accounts using the standard growth model. Primarily, the model is a general equilibrium model that has complete markets and a perfect foresight. In this case, a representative household and a stand-in firm take factor prices, fiscal policy, and demographics as given and maximize their goals functions with respect to their budget constraints (Imrohoroglu, & Sudo 2011, p. 22). In addition, the government finances its exaggerated spending that includes interest payments, with taxes being a factor on the incomes and consumptions. However, being too quick to cutting down expenditure and rising taxes may not bring to control the high ratio; the focus should be subjected to boosting GDP. This can be done by concentrating on increasing the denominator thus getting a smaller number for debt-to-GDP ratio (Broda, & Weinstein 2004, p. 13) Additionally, the paper has examined the fiscal sustainability of the Japanese using the approaches. According to the approaches, the results seem to concur, that is the Japan’s government debt can create serious challenges. Therefore, to stabilize the debt-to-GDP ratio, the government also needs to implement a tax rate hike that has amazing magnitude. As a result, the tax increase will make the fiscal policy sustainable thus representing a drastic departure from the Japanese fiscal policy that has been there over the years (Doi, Hoshi, & Okimoto 2011, p. 31-32). According to the approaches, the fiscal policy in Japan’s situation is said to be unsustainable even after allowing the possibility of regime changes. Therefore, if the government does not reduce the general deficit through increasing its taxes, reducing transfer of payments, and expenditures, in the few coming decades Japan’s government would be forced to reduce the value of its debts through inflation, which is not the best-case scenario (Ihori, Doi, & Kondo 2001, p. 351). In addition, efforts of ending deflation as a result, achieving stronger nominal GDP growth would also be an important step for Japanese to take to reduce the large gross financing requirements and relieve the burden on fiscal austerity, consequently helping release savings for more productive private sector investment. In this case, therefore, a revived economy with a smaller fiscal deficit would in turn stabilize and reverse the current upward trajectory in debt. However, through all this solutions, Japan will not be in a position to reduce its debts, but it will be in, a position to balance them with its continued growth (Broda, & Weinstein 2004, p. 2-3). References Broda, C., & Weinstein, D. E. (2004). Happy news from the dismal science: reassessing the Japanese fiscal policy and sustainability (No. w10988). National Bureau of Economic Research. Chen, K., A. ·Imrohoroglu & S. ·Imrohoroglu (2007). The Japanese Saving Rate between 1960-2000: Productivity, Policy Changes, and Demographics. Economic Theory Vol. 32 (1), 87-104. Doi T., Ihori, T. and K. Mitsui (2006). Sustainability, Debt Management, and Public Debt Policy in Japan, NBER Chapters, in: Fiscal Policy and Management in East Asia, NBER-EASE. Volume 16, pages 377-412. National Bureau of Economic Research, Inc. Doi, T., Hoshi, T., & Okimoto, T. (2011). Japanese government debt and sustainability of fiscal policy. Journal of the Japanese and international economies, 25(4), 414-433. Ihori, T., Doi, T., & Kondo, H. (2001). Japanese fiscal reform: fiscal reconstruction and fiscal policy. Japan and the World Economy, 13(4), 351-370. Imrohoroglu, S., & Sudo, N. (2011). Will a Growth Miracle Reduce Debt in Japan?. Keizai Kenkyu, 62, 44-56. Ito, A., Tsutomu, W. &, Tomoyoshi, Y. (2011). “Fiscal Policy Switching in Japan, the U.S., and the U.K.” Journal of the Japanese and International Economies, forthcoming. Nersisyan, Y., & Wray, L. R. (2013). Does Excessive Sovereign Debt Really Hurt Growth? A Critique of'This Time is Different', by Reinhart and Rogoff. A Critique of'This Time is Different', by Reinhart and Rogoff (June 21, 2010). The Levy Economics Institute Working Paper, (603). Read More