Is Abe's Fiscal Policy Ricardian? What Does the Fiscal Theory of Prices Mean for Japan?

• Date: 01 January 2018
• DOI: http://doi.org/10.1111/aepr.12199
• Published date: 01 January 2018
• Author: Takero Doi

Is Abe’s Fiscal Policy Ricardian? What Does

the Fiscal Theory of Prices Mean for Japan?

Takero DOI†

Keio University

The second arrow of Abenomics is flexible fiscal policy. However, it does not mean just fiscal

stimulus as the Abe administration decided on the fiscal consolidation target of achieving a pri-

mary surplus by fiscal year 2020. Improving the primary balance implies making government

debt more sustainable. Although the consumption tax rate was raised from 5% to 8% in April

2014, the Abe administration has decided twice to postpone increasing the consumption tax

from 8% to 10%. In addition, a fiscal stimulus package was implemented. We use a Fiscal Stance

Index to examine fiscal policy from the viewpoint of fiscal sustainability and a Markov switching

model to examine fiscal policy from the viewpoint of the fiscal theory of the price level, and find

that the Abe’sfiscal stance is not Ricardian.

Key words: fiscal and monetary policy regime, fiscal stance index, fiscal sustainability, Japanese

fiscal policy, the fiscal theory of the price level

JEL codes: E62, E63, H62, H63

Accepted: 17 August 2017

1. Introduction

Since December 2012, the Abe administration has adopted a comprehensive economic

policy package that has been called “Abenomics.”Abenomics consists of the three

“policy arrows”: aggressive monetary policy; flexible fiscal policy; and a growth strat-

egy. The aim of Abenomics is to sustainably revive the Japanese economy while main-

taining fiscal discipline. The second arrow of Abenomics does not mean just a fiscal

stimulus as the Abe administration decided on a fiscal consolidation target in the

“Basic Policies for the Economic and Fiscal Management and Reform 2014”issued in

June 2014. The target is to halve the ratio of the primary deficit of the central and local

I would like to thank the Editors, Takatoshi Ito, Colin McKenzie, Shujiro Urata, and the desig-

nated discussants, Motohiro Sato, and Chalongphob Sussangkarn, for their fruitful comments

and suggestions. I also wish to acknowledge Ippei Fujiwara, Hal Hill, Takeo Hoshi, Kazumasa

Iwata, Kazuo Ueda, and Tsutomu Watanabe and participants in the Twenty Fifth Asian Eco-

nomic Policy Review Conference for their valuable comments. This work was supported by JSPS

Grants-in-Aid for Scientific Research (KAKENHI) Grant Numbers JP20285059 and JP20285065.

Of course, all remaining errors are my own.

†Correspondence: Takeo Doi, Faculty of Economics, Keio University, 2-15-45 Mita, Minato-ku,

Tokyo 108-8345, Japan. Email: tdoi@econ.keio.ac.jp

46 © 2018 Japan Center for Economic Research

doi: 10.1111/aepr.12199 Asian Economic Policy Review (2018) 13, 46–63

governments to gross domestic product (GDP) by fiscal year 2015 from the ratio in fis-

cal year 2010 and to achieve a primary surplus by fiscal year 2020.

As shown in Figure 1, the primary balance has improved considerably under the

Abe administration. The target for fiscal year 2015 of halving the primary deficit to

GDP ratio from the ratio in fiscal year 2010 has been achieved. Improving the primary

balance implies making government debt more sustainable. Bohn (1998) finds that fis-

cal policy satisfies the intertemporal budget constraint, that is, the condition on the

sustainability of government debt, if the primary balance to GDP ratio improves com-

pared to the start-of-period gross debt to GDP ratio.

1

Christiano and Fitzgerald (2000)

point out that such a policy is a Ricardian policy, following Woodford (1995) in the lit-

erature of the fiscal theory of the price level (FTPL). A Ricardian policy means that

primary balance is chosen so that the intertemporal budget constraint is satisfied no

matter what price level is realized. If the Abe administration commits to such a fiscal

policy, it seems to be Ricardian.

On the other hand, although consumption tax rate was raised from 5% to 8% in

April 2014, the Abe administration has decided twice to postpone a further increase of

the consumption tax from 8% to 10%. In addition, a fiscal stimulus package including

13.5 trillion yen of fiscal measures was implemented as the “Economic Measures for

Realizing Investment for the Future”in August 2016, even though the unemployment

rate has reached historically low levels.

2

Moreover, Prime Minister Abe and his closest advisers have intimated an interest

in a policy proposal in Sims (2016), based on the FTPL. They interpreted Sims (2016)

as arguing that monetary policy alone would not be adequate to overcome deflation

and that fiscal policy that increases the budget deficit would also be necessary.

-10

-8

-6

-4

-2

0

2

4

6

2000 2005 2010 2015

%

Figure 1 Primary Balance to gross domestic product ratio. ( ) Japan; ( ) USA; ( ) UK;

() Germany; ( ) France; ( ) Italy; ( ) Canada.

Source: Organisation for Economic Cooperation and Development Economic Outlook.

Note: A positive (negative) amount indicates a surplus (deficit).

Takero DOI Is Abe’s Fiscal Policy Ricardian?

© 2018 Japan Center for Economic Research 47