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Fiscal inflation in Japan: the role of unfunded fiscal shocks
AbstractWe investigate the extent to which fiscal factors have contributed to inflation in Japan over the past four decades. Despite sustained fiscal expansion and rising debt since the 1990s, inflation remained low until recent years. Using the medium-scale DSGE model developed by Bianchi et al. (Q J Econ 138(4):2127–2179, 2023), we estimate the model with Japanese data and find that, in contrast to the U.S. case, unfunded fiscal shocks are not the main drivers of inflation in Japan. Instead, real demand and supply shocks, along with accommodative monetary policy, have played more significant roles in shaping inflation dynamics. 1 IntroductionWe investigate the extent to which fiscal factors have contributed to inflation in Japan over the past four decades, encompassing the bubble economy and the so-called “lost three decades.” Figure 1 plots the inflation rate and the debt-to-GDP ratio for Japan and the United States. In Japan, a prolonged period of low inflation has persisted since the bursting of the asset price bubble in the early 1990s, despite the Bank of Japan’s implementation of large-scale monetary easing. More recently, after the COVID-19 pandemic crisis in 2020, signs of rising inflation have emerged amid global inflationary pressures; however, it remains uncertain whether this trend will be sustained.Throughout this period, Japan’s government debt has steadily increased, accompanied by repeated large-scale fiscal stimulus measures. Concerns about the sustainability of government debt may give rise to inflation, as suggested by the Fiscal Theory of the Price Level (FTPL) (among many others, Cochrane, 1998; Leeper, 1991; Sargent and Wallace, 1981; Sims, 1994; Woodford, 1994). Thus, analyzing fiscal determinants of inflation is essential not only for understanding the current inflationary environment, but also for explaining the persistently low inflation observed in the past.Fig. 1Inflation and Debt-to-GDP ratio: Japan vs. USWe employ a new general equilibrium model to examine the fiscal origins of inflation in Japan. The model demonstrates that inflation can be driven by shocks to government transfers that lack future repayment guarantees, under which the Ricardian equivalence does not hold, and households receiving cash transfers spend rather than save them for future tax increases, thereby causing demand and raising inflation. We refer to such shocks as unfunded fiscal shocks.Using the estimated model based on Japanese data, we find that the...
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