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Table of Contents

Vol. 144 :Macroeconomic Effects of Fiscal Policy

Summary of Articles

Why Do Interest Rates Remain Low Despite the Accumulation of Government Debt in Japan?

By TANAKA Kenji (Visiting Professor, Graduate School of Humanities and Social Sciences, Hiroshima University)

This paper conducts a quantitative analysis of the determinant factors of the nominal long-term interest rate based on panel data concerning 25 developed countries in the period from 1990 to 2019. While the main factors of the decline in long-term interest rates around the world since the 1990s are falls in the potential growth rate and the expected inflation rate that have been observed in many developed countries, there are also various other interconnected factors. In Japan, as government debts continue to grow, there is upward pressure on interest rates. However, the upward pressure on interest rates has been curbed by unconventional monetary policy.

Since the beginning of the 2000s, the nominal long-term interest rate has fallen below the nominal growth rate in many countries. The factors affecting this trend include investors' preference for safety, unconventional monetary policy, and the sovereign spillover effect.

While investors' preference for safety, which is due to a decline in expectations for future growth, is unlikely to change much in the short term, the downward pressure on interest rates due to unconventional monetary policy could change if the monetary policy changes. The sovereign spillover effect could also exert upward pressure on interest rates in Japan, depending on interest rate movements abroad. Therefore, the situation of the nominal growth rate being higher than the nominal long-term interest rate is not a permanent phenomenon.

Keywords: long-term interest rates, potential growth rate, fiscal problems, unconventional monetary policy, sovereign spillover

JEL Classification: E43, E52, H63

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Effects of Change in the Value-Added Tax Rate in Europe
—Implications for the Japanese Economy—

By KOMAKI Yasuyuki (Professor, Facultyof Economics, Osaka University of Economics)

In Europe, economic fluctuations associated with a change in the value added tax (VAT) rate are small. It has been pointed out that one reason for that is the way a VAT rate change affects prices. Many studies have been conducted on how price transfer occurs when a VAT rate changes. In Europe, there is a tendency to gradually change prices before a VAT rate change takes effect, reflecting an increase in demand. The ultimate price hike implemented at the time of a VAT rate change is equivalent to around 70% of the tax increase, and this less than full price transfer is said to be a reason for the moderate price change. However, previous studies have not made clear why a price change at the time of a VAT rate change is moderate.

The purpose of this paper is to study factors that may have kept price changes after VAT rate changes moderate in Europe. That is because price changes affect economic activity through their effects on real income (income effect). In particular, this paper's study focuses on the viewpoints of (i) the effects of the presence of multiple tax rates, including reduced rates for some particular items, and (ii) the situation of inflation in countries where VAT rates have changed.

The effects of a VAT rate change on prices identified in this paper are as follows:

1)  In cases when a VAT rate was raised by one percentage point, a price transfer equivalent to only 3.6% to 76.8% of the tax increase occurred. It was confirmed that this trend becomes more pronounced when a reduced rate is raised at the same time. Changes in VAT rates are not fully transferred to sales prices.

2)  The effects on prices before the VAT rate change takes effect are observed to a significant degree under the following conditions: (i) a high-inflation region, (ii) a tax rate hike of 2 percentage points or more, (iii) a simultaneous raising of a reduced tax rate, and (iv) application of the tax change to durable consumer goods. In other words, it may be said that the effects are significant in an environment where prices may be easily raised (a high-inflation region) or when the difference between prices of items subject to the standard tax rate and prices of other items tends not to expand (a simultaneous raising of a reduced tax rate). However, regarding durable consumer goods, prices dropped before a VAT rate change took effect in many cases.

3)  Because of the presence of reduced tax rates, items subject to the standard tax rate accounted for around 65% of overall consumption items on average. This means that if a change of one percentage point in the standard tax rate causes the same level of price transfer as the one estimated from my analysis, the effects on prices are even smaller.

As shown above, the effects of a VAT rate change on prices in Europe are small presumably because (i) the real effects of a VAT rate change are mitigated by the effects of a reduced tax rate and also because (ii) tax rate changes are not fully transferred to prices. In other words, the situation in Europe is such that consumers tend to be insulated from the effects of a tax rate change.

On the other hand, at the time of a VAT rate change, retailers are supposed to set new prices in a way that fully reflects the tax rate change, as tax-inclusive pricing is applied in the case of VAT. However, given that actual price changes after past VAT rate changes were moderate, it is possible that retailers may have shouldered part of the tax increase by cutting profits or that the quality or quantity of goods and services may have been changed. From consumers' viewpoint, this point may not emerge as a problem if they take a price change more seriously than a quantity change. However, a more detailed analysis needs to be conducted as to why the price change at the time of a VAT rate change is small relative to the tax rate change.

Keywords: VAT, standard tax rate, reduced tax rate, price transfer, income effect

JEL Classification: H62, H31

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Examination of Fiscal Sustainability Using Overlapping-Generations Model

By YAMADA Junji (Associate Professor, Faculty of Social Sciences, Academic Assembly, University of Toyama)

In this paper, we develop a general-equilibrium, overlapping-generations model and incorporate a future population distribution and productivity growth rate into the model as exogenous factors. Based on this model, we conduct a simulation analysis regarding future economic and fiscal conditions and calculate the tax rate necessary for achieving fiscal soundness. The results show that even if the productivity growth rate rises, if more and more foreign workers are accepted, and if the labor participation rate increases, a significant tax rate hike will be required in order to steadily lower the ratio of government debts to GDP.

Keywords: government debt, population, Japanese economy

JEL Classification: E62, H63, J11

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Does the Japanese Financial Market Believe in Fiscal Sustainability?
—Analysis of the Market for the JGB Futures Options—

By SHIOJI Etsuro (Professor, Faculty of Economics, Hitotsubashi University)

In recent years, although alarms have been sounded over an imminent fiscal crisis in Japan, yields on the Japanese Government Bond (hereafter JGB) have stayed stable at low levels. Does this mean that in the private sector, there is no concern over fiscal sustainability? This paper analyzes prices of the JGB futures options in order to obtain information on private-sector perceptions on the future course of the JGB market. The results show that monetary policy plays a decisive role in the movements of prices of the JGBfutures options. In particular, since the introduction of yield curve control in 2016, options trading itself has remained sluggish. This paper analyzes how the market has reacted to some particular "fiscal news events," namely newsworthy incidents that may have had a significant impact on the expected future course of the fiscal deficit. We do not find any clear evidence that concerns over the deficit have been factored into asset price formation.

Keywords: government bond futures options, volatility smile, fiscal policy, monetary policy, yield curve control

JEL Classification: E44, E52

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Economic Analysis of Public-Private Partnerships
—Theoretical and Empirical Analyses Focusing on Adverse Selection and Synergy Effect—

By FUKUDA Yukari (PhD student, Graduate School of Economics, Keio University)
By NAKAMURA Jun-ichi (General Manager, Research Institute of Capital Formation)

In Japan, the national and local governments' fiscal deficits are piling up higher and public infrastructure systems are becoming more obsolete. To overcome these problems, the role of public-private partnership, including PFI (private finance initiative), is attracting increased attention. In literature, emphasis is placed only on improving fiscal efficiency as such as VFM (value for money). However, if differences in quality between private companies and the importance of incentive rewards fail to be taken into consideration, public-private partnerships could end up creating inefficiencies of social welfare. From this point of views, our research examined under what circumstances PFI projects work effectively through theoretical and empirical analyses.

In the theoretical analysis, we looked at PFI projects in terms of a principal-agent relationship, in which the public sector (principal) entrusts business operations to the private sector (agent) under an incomplete contract. We then conducted a comparison of projects under two types of contract, namely the BOT contract (under which constructed facilities continue to be owned by the private sector until the expiry of the project) and the BTO contract (under which the ownership of constructed facilities is transferred to the public sector at the completion of construction). Through the comparison, we made clear the respective advantages and disadvantages of the two types that are brought by the difference in the timing of ownership transfer. Moreover, regarding the quality of private companies, we pointed out the importance of setting the contractor's reward at a level sufficient to avoid the adverse selection problem.

In the empirical analysis, we used data concerning PFI projects implemented in Japan from fiscal 1999 to 2018 to estimate the effects of the differences in the type of contract (BOT or BTO). We proxied the quality of project operators by the level of VFM at the planning stage (which is negatively correlated with the basic contractor's reward). We also proxied the efficiency improvement of projects by the following variables: (i) the number of companies that applied for the project, (ii) the capital size of the selected representative company and whether the company is listed or unlisted, and (iii) the degree of improvement of VFM (degree of improvement of VFM at the time of contracting relative to the level at the planning stage). We found that even when changes in the macroeconomic situation and the circumstances surrounding PFI during the analysis period are taken into consideration, BOT-type projects attracted more applicant companies compared with BTO-type projects and the degree of improvement of VFM was larger for BOT-type projects. This implies that in practice, the BOT type is superior on average, as it is likely to generate a greater synergy effect between construction and operation. We also found that the higher the level of VFM at the planning stage (the lower the basic contractor's reward is), the lower the quality of the selected representative company is and the smaller the degree of improvement of VFM is. These results indicate the importance of devising a suitable incentive mechanism in order to secure a high-quality private companies and appropriate behavior by the operator.

Keywords: public-private partnership, PFI, BTO, BOT, VFM, incomplete contract, adverse selection, synergy effect

JEL Classification: H40, H43, H72, H83

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Causes of Fiscal Multiplier Decline in Japan

By MIHIRA Tsuyoshi (Associate Professor, Faculty of Economics, Toyo University)

In this paper we investigated the causes of recent decline in the Japanese fiscal multiplier. We first listed possible causes of multiplier decline by 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.

Keywords: fiscal policy, multiplier effect, consumption propensity, anxiety about social security, fiscal deficit, aging population

JEL Classification: E12, E21, E22, E62, H31, H32, H62

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Evaluation of Macro-Fiscal Policy and Challenges in Japan

By FUKUDA Shin-ichi (Professor, Graduate School of Economics, University of Tokyo)
By SOMA Naoto (Associate Professor, Faculty of International Social Sciences, Division of International Social Sciences, Yokohama National University)

The purpose of this paper is to conceptually examine the effectiveness of macro-fiscal policy to derive empirical implications for the Japanese economy. Since the middle of the 1990s, Japan has remained stuck in a liquidity trap, a situation in which interest rates fall to or below zero. On the other hand, not only have the cumulative fiscal deficits increased to an unprecedented level, but also, many structural problems have emerged. Under these circumstances, previous empirical findings are inconclusive as to whether fiscal policy has worked effectively in the Japanese economy. This paper reexamined the findings of previous studies based on data for the period since 1980 and considered challenges for such analyses. When a reduced form equation or a VAR model was estimated, we found that the effects of fiscal expenditure which had declined over a medium to long term may have increased since the fourth quarter of 2010. This finding suggests that the effects of fiscal expenditure that had continued to fall may have recovered under ultra-low interest rates. When the ESP Forecast Survey, which represents forecast data prepared by private-sector economists, was used, it was also confirmed that those economists assumed the presence of a significant correlation between fiscal expenditure and GDP under ultra-low interest rates. However, it must be carefully interpreted with respect to the limitations of the estimation method, including outliers, the reference year for GDP used in the analysis, and the robustness of the sample period. As the conclusion of this paper was arrived at based on a short sample period whose estimation efficiency is not necessarily high, it is far from clear whether the effects of fiscal expenditure will continue to improve. In addition, it should be kept in mind that the results obtained through a reduced form equation or a VAR model indicate the presence of a Granger causality but not the presence of a true causal relationship. In the field of macroeconomics, the effectiveness of fiscal policy is an old and new question that has been discussed for many years. The conclusion of this paper should be further verified in the future in order to check its robustness.

Keywords: fiscal policy, structural changes, ultra-low interest rates, ESP forecast

JEL Classification: E62, H30, E3

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Ministry of Finance, Policy Research Institute.