Declined Effectiveness of Fiscal and Monetary Policy

faced with Aging Population in Japan

Naoyuki Yoshino (ADBI)
Hiroaki Miyamoto (University of Tokyo)
November 2016
The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian Development Bank Institute
(ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data
included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official
terms.

Motivation
1. Japanese economy has been stagnated after the burst of the bubble of
1990.
2. Fiscal and monetary policies had been implemented in order to recover
Japanese economy. However, they are successful so far.
ZIRP, QQE, large expansionary fiscal packages

3. The effectiveness of monetary and fiscal policies has been diminished.

Nakahigashi and Yoshino, 2016; Yoshino et al., 2016

4. It is pointed out that the deep cause of Japanese recession relies on

population aging and lack of new startups.
Yoshino and Farhad Taghizadeh-Hesary, 2014

Population aging of Japan

Current
Figures

Forecast
(2012)

14,000

70.0

12,000

60.0

10,000

50.0
40.0

8,000
6,000

30.0

4,000

20.0

2,000

10.0

Peak of the Population

2004, 127.8 million
Age 65 and
over
Age 15
64
Age 14 and
less
Aged
Population
Ratio

0.0

2060

2050

2040

2030

2020

2010

2000

1990

1980

1970

1960

1950

General account budget - breakdown of expenditure

National Debt
Service
23,270.2
Interest Payments
10,131.9
24.3%
10.6%
Social Security
Redemption of the
30,517.5
National Debt
31.8%
13,138.3
13.7%
General Account
Primary Expenses
Others
9,656.8
10.1%

Food Supply

1,050.7

(1.1)

Promotion of SMEs
Energy
Former Military Personal Pensions
Economic Assistance
Miscellaneous
Contingency Reserves

185.3
964.2
444.3
509.8
6,152.6
350.0

(0.2)
(1.0)
(0.5)
(0.5)
(6.4)
(0.4)

Total Expenditures
95,882.3
(100.0%)

72,612.1
75.7%

National Defense
Local Allocation Tax
4,884.8
Grants, etc.
Public Works
5.1%
161,424
5,968.5
16.8%
Education & 6.2%
Science
5,442.1
5.7%

Note1Figures may not add up to the totals due to rounding.

Note2The ratio of Social Security expenses to General Expenditures*54.0%
*General Expenditures equals to the Primary Expenditure minus Local Allocation Tax Grants, etc.

Spillover effects Return to investors

1956-60 1961-65 1966-70

1971-75

1976-80

1981-85

Direct Effect (Kg)

0.696

0.737

0.638

0.508

0.359

0.275

Indirect Effect (Kp)

0.453

0.553

0.488

0.418

0.304

0.226

Indirect Effect (L)

1.071

0.907

0.740

0.580

0.407

0.317

0.3048

0.292

0.2456

0.1996

0.1422

0.1086

43.8

39.6

38.5

39.3

39.6

39.5

2001-05

2006-10

20% Returned
% Increment

1986-90 1991-95 1996-00

0.215

0.181

0.135

0.114

0.108

0.195

0.162

0.122

0.1

0.1

0.193

0.155

0.105

0.09

0.085

0.0776

0.0634

0.0454

0.038

0.037

36.1

35.0

33.6

33.3

34.3

Objective
Study how population aging affects an economy and the
effectiveness of monetary and fiscal policies.
Develop a New Keynesian DSGE model with heterogeneous
households, young and old.

The model
1. A New Keynesian DSGE model with heterogeneous households.
Young (worker): supply labor services, earn wages, and pay taxes
Old (retiree): dont work, receive social security benefits

2. Workers maximize their intertemporal utility subject to a budget

constraint.
3. Retirees consume only social security benefits in each period of
time.
4. The proportion of working population is denoted by .
8

The model

Government consumption & investment

Households
Final goods
producer

Social security
benefits

retirees

consumption
Intermediate goods

Government
&
Central bank

Bonds
Lump-sum tax

Fiscal and monetary policies

workers

Labor &
capital
Wage &
rental cost

Intermediate
goods firms

Monopolistic
competitive
Calvo-price

Households problem (2.1)

Workers problem:

Retirees problem:
10

Final good producers problem (2.2.1)

Perfect competition
Final good producers problem:
Production function is given by

Y: final goods
yj: intermediate good j
11

Intermediate goods firms problem (2.2.2)

Monopolistic competitive market
Production function of firm j is

An intermediate good firm is subject to price setting friction a la

Calvo (1983)

: Calvo parameter
12

Aggregation

13

Fiscal policies
Government budget constraint:

Fiscal policy rules:

Future research: debt/GDP and deficit/GDP are incorporated.

14

Monetary policy
Monetary policy rule:

which can be linearized as

where

15

Calibration
Target economy: Japan
Model period: one quarter

16

The long-run effect of population aging

Population aging (worker)

Output, Consumption, Labor supply, Investment
Note: Population size is normalized to one
17

Gov. consumption shock

Gov. spending shock boost
output, hours of work,
consumption
Population aging weakens the
effectiveness of fiscal stimulus
Tax will rise but the impact of fiscal
spending is larger
Gov. spending shock increases the
real interest rate which reduces
private investment
18

Gov. investment shock

Gov. investment shock boost output,
hours of work, consumption
Population aging weakens the
effectiveness of the fiscal policy
Inflation will rise due to higher
aggregate demand
Private investment is pushed out by
government investment due to a rise
in the real interest rate
19

Monetary policy

Population aging reduces the effectiveness of a monetary policy shock on aggregate

consumption
When retirees start working, they can enjoy an increase of money transfers.

Since inflation rises, the real interest rate falls down which increases private output for
5 quarters.
20

Summary & Policy Implications

Population aging (a decline of working population) reduces
output and aggregate consumption in the long-run.
Population aging weakens the effectiveness of fiscal and
monetary policies in the short-run because retirees receive
social security benefits and consume all of them.
Implication: necessary policy to cope with population aging is to
keep the elderly people working and productivity base wage
rate rather than seniority wage system.
21