The Enigma of the Ineffectiveness of Fiscal Policy in the 1990s
As in other countries, Japanese fiscal policy has been the exclusive domain of the government, which proposes fiscal spending measures to parliament whose funding is detailed in budgets and supplementary budgets. In principle, the government has been following a balanced budget policy in the postwar era. The Finance Law of 1947 prohibited the issuance of government bonds. As a result of the 1965 recession, it was amended and government bonds were issued for the first time.1 Oil shock recessions and increased spending programmes produced sizeable deficits in the 1970s.2 The elimination of fiscal deficits (‘fiscal reconstruction’) has been a priority since the late 1970s, with the Finance Ministry pursuing a ‘zero [growth] ceiling’ on budget requests since 1982. Thanks to some tax rises (including the introduction of the consumption tax in 1989), high nominal GDP growth and asset price rises in the second half of the 1980s, the target of fiscal reconstruction was achieved in 1991.
KeywordsInterest Rate Fiscal Policy Real Interest Rate Government Bond Yield Private Demand
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- 6.Dornbusch and Fischer (1987) emphasize that ‘the distinction between selling debt to the public and selling it to the central bank is essential. The distinction between money and debt financing can be further clarified by noting that Treasury sales of securities to the central bank are referred to as monetizing the debt, meaning that the central bank creates (high-powered) money to finance the debt purchases’ (p. 584).Google Scholar
- 19.See Christ (1968), Friedman (1978), Blinder and Solow (1973), Ludvigson (1996). Those who argued that ‘portfolio crowding in’ may offset ‘transactions crowding out’ and thus produce either a positive or ambiguous effect of debt-funded fiscal stimulation (such as Friedman, 1978) do not contribute towards finding an answer to the phenomenon observed in Japan during the 1990s, namely no significant rises in interest rates, but also no significant effect of fiscal stimulation.Google Scholar
- 24.McKibbin (1996) engages in this difficult exercise, making use of a multi-country structural model to endogenize shocks to the Japanese economy. Pointing out the anticipated nature of the fiscal spending packages (and their partial overstatement), he concludes: ‘Rather than stimulating the economy, these fiscal measures acted to further slow economic activity as well as appreciate the real exchange rate’ (p. 37). In McKibbin’s model, the announcement effect of fiscal stimulation occurs immediately, appreciating the exchange rate and real long-term interest rates, while the positive effect occurs later, or to a lesser extent than announced (due to overstatement of the package). However, only data through 1995 is used, thus missing much of the 400 basis point drop in long-term interest rates over three and a half years, from about 4.7% in February 1995 to 0.7% in October 1998, not to mention the further drop to 0.43% by June 2003.Google Scholar