Front Matter


How should Japan cope with the challenges posed by a shrinking and ageing population and the quickening pace of globalization? Japan has largely overcome the legacies of the post-bubble economy of the 1990s, but ongoing demographic changes and greater financial and trade integration with the global economy call for policies that foster competitiveness, increase resilience to shocks, and safeguard growth prospects. This book brings together IMF economists to discuss the ongoing policy debate. The chapters provide a comprehensive overview of the unfinished policy issues and the unfinished agenda. For more information on how to purchase a copy of this title, please visit

Copyright Page

© 2009 International Monetary Fund

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First published 2008 by


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ISBN-13: 9780230219328 hardback

ISBN-10: 9780230219328 hardback

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Library of Congress Cataloging-in-Publication Data

Japan’s economic revival: Policy challenges in a globalized world /

edited by Daniel A. Citrin and Alessandro Zanello.

p. cm. — (International Monetary Fund)

Includes bibliographical references.

ISBN 9780230219328

1. Japan—Economic policy—1989- 2. Japan—Economic conditions—

1989- I. Citrin, Daniel. II. Zanello, Alessandro.

HC462.95.J36876 2008



10 9 8 7 6 5 4 3 2 1

17 16 15 14 13 12 11 10 09 08

Printed and bound in Great Britain by

CPI Antony Rowe, Chippenham and Eastbourne


  • List of tables and figures

  • Foreword

  • Acknowledgments

  • Notes on Contributors

  • 1. Overview

    • Daniel A. Citrin and Alessandro Zanello

  • Part I. Growth and Demographics

  • 2. Japan’s Potential Output and Productivity Growth

    • Papa N’Diaye

  • 3. Household Savings in Japan

    • Hali Edison

  • Part II. Fiscal Policy Challenges

  • 4. Strategies for Fiscal Consolidation

    • Dennis Botman, Hali Edison, and Papa N’Diaye

  • 5. Tax Policy Challenges from Globalization and Aging: Issues and Options

    • Michael Keen

  • 6. Pension Reform Issues

    • Dora Iakova

  • Part III. Monetary Policy After Deflation

  • 7. A Post-Deflation Monetary Framework

    • Charles Kramer and Mark Stone

  • 8. Practical Issues Surrounding the New Understanding of Price Stability

    • Christopher Faulkner-MacDonagh

  • Part IV. The Rise in Cross-Border Capital Flows

  • 9. Home Bias in Japan

    • W. Christopher Walker

  • 10. Recent Developments and Outlook for Japan’s Capital Flow

    • Shinobu Nakagawa and Christopher Faulkner-MacDonagh

  • Part V. Challenges for the Banking Sector

  • 11. Why is Japanese Banking Sector Profitability so Low?

    • Alexander Wolfson

  • 12. The Re-emergence of Japanese Banks in Asia

    • Shinobu Nakagawa

  • Part VI. Structural Reforms

  • 13. Priorities for Structural Reform

    • Yougesh Khatri

  • 14. Agricultural Policies in Japan: Domestic and International Repercussions

    • Bradley McDonald

  • Part VII. International Spillovers

  • 15. The Domestic and Global Impact of Japan’s Policies for Growth

    • Nicoletta Batini, Papa N’Diaye, and Alessandro Rebucci

  • 16. Capital Flows and the Yen-U.S. Dollar Exchange Rate

    • Papa N’Diaye

  • Index

  • List of Tables and Figures

  • Tables

  • 2.1 Key Structural Equations

  • 2.2 Baseline Scenario

  • 2.3 Alternative Scenario

  • 3.1 Long-Run Saving Rate Model

  • 3.2 Contribution to Change in Saving Rate, 2004-10

  • 3.3 Savings Rate of Households

  • 4.1 Key Macroeconomic Variables in the Initial Steady State

  • 4.2 Behavioral Assumptions and Key Parameters in the Initial Steady State

  • 4.3 Illustrative Fiscal Consolidation Measures

  • 4.4 Illustrative Consolidation Paths

  • 5.1 Rates of Corporation Tax

  • 7.1 Central Bank Self-Reported Indices of Inflation Focus and Discretion, 1999

  • 7.2 AFFIT and IPSA Countries, Monthly Inflation, 1990-2003

  • 7.3 Structural Indicators: Implicit Price Stability Anchor and Full-Fledged Inflation Targeting Countries

  • 7.4 Commitment-flexibility Aspects of Monetary Regime Options for Post-Reflation Japan

  • 8.1 International Inflation Trends, 1960–2005

  • 8.2 Assessing Trend Inflation Measures

  • 8.3 Forecast Performance of Trend Inflation Measures

  • 9.1 Public Pension Portfolio Allocation

  • 9.2 Correlation Matrix, 1981-2004

  • 9.3 Actual and Alternative Portfolio Allocations

  • 10.1 Foreign Assets Holdings

  • 10.2 Outward FDI Position by Region

  • 10.3 Outward FDI Position by Major Industry, 2006

  • 10.4 Tokyo Stock Exchange Trading

  • 11.1 Key Indicators of Japanese Banks

  • 11.2 Regression Results: Core Profitablility, FY1979-2003

  • 11.3 Correlation Between Profits and Economic Indicators, FY1979-2003

  • 12.1 Branch Network in 2007

  • 12.2 Top 10 Asian Jurisdictions for Japanese Banks’ External Credits

  • 12.3 Principal Assets and Liabilities of Overseas Branches of Japanese Banks

  • 13.1 Estimates of the Potential Gains from Structural Reform in GDP Terms

  • 13.2 Stock of Inward FDI

  • 14.1 Summary of Agriculture Sector

  • 14.2 Self-Sufficiency Rates of Selected Food Products, 1960–2003

  • 14.3 Japan and the OECD: Aggregate Agricultural Policy Indicators

  • 14.4 PSEs for Selected Commodities

  • 14.5 MAcMaps and OTRI Estimates for Nonagriculture

  • 14.6 OTRI Estimates for Agriculture

  • 14.7 Bull and Roberts Model: Simulated Effects on Japan of Partial Multilateral Agricultural Reform Scenario

  • 15.1 Effects of Structural Fiscal Reforms (Alternative Scenario 1)

  • 15.2 Effects of Large Structural Reforms Payoffs (Alternative Scenario 2)

  • 16.1 Recent Estimates of Japan’s Exchange Rate Misalignment

  • 16.2 Yen-US$ Bilateral Exchange Rate and Macroeconomic Variables

  • 16.A2.1 Cointegrating Equations

  • Figures

  • 2.1 Potential Output and NAIRU

  • 2.2 Inflation, Unemployment Gap, and Output Gap

  • 2.3 Potential Output and its Components—Baseline

  • 2.4 Contributions to Annual Potential Output Growth

  • 2.5 Potential Output and its Components—Sensitivity Analysis

  • 2.6 Contribution TFP Growth to Sectoral Real GDP Growth

  • 2.7 Labor Productivity Growth by Industry

  • 2.8 Potential Output Growth Over the Medium Term

  • 3.1 Household Savings Rate

  • 3.2 Saving Rates: Selected OECD Countries

  • 3.3 Net Wealth: Selected OECD Countries

  • 3.4 Old-Age Dependency Ratio

  • 3.5 Japanese Population Projection

  • 3.6 Saving Rate Projection

  • 3.7 Saving Rate: Elderly (60 and Over)

  • 3.8 Projected Saving Rate

  • 3.9 Projected Age Distribution of Population

  • 4.1 Fiscal Balance and Net Public Debt

  • 4.2 Growth Effects of Alternative Fiscal Strategies

  • 4.3 Impact on Real GDP Growth of Tax Hikes: Consumption vs. Corporate

  • 4.4 Path of Government Debt under Alternative Scenarios

  • 4.5 Effects on World GDP Growth

  • 4.6 The Effects of More Ambitious Fiscal Adjustment on Real GDP Growth

  • 4.7 The Impact of the Timing of Consolidation on Real GDP Growth

  • 4.8 Tax Reform Effect on Real GDP Growth

  • 4.9 Net Present Value of Growth

  • 5.1 Tax Structures in the G7, 2004

  • 5.2 VAT/GST Rates

  • 6.1 Elderly Dependency Ratio

  • 6.2 Government Expenditure

  • 6.3 Projected Primary Deficits of the Public Pension System, 2005-50

  • 6.4 Labor Force Participation Rate for Females (15-64 years)

  • 6.5 Labor Force Participation Rate for Elderly, 2001

  • 7.1 Current Account Balances at the BoJ, 2001-04

  • 7.2 Money Market and Reserves, 2001-04

  • 7.3 Average Credit Ratings, Major Japanese Banks

  • 8.1 Trends to Lower Inflation over the Medium Term

  • 8.2 Fiscal Balance and Inflation, 1996-2006

  • 8.3 Core Inflation Trends

  • 8.4 Inflation Trends in the Business Sector

  • 8.5 Trends in GDP Deflators

  • 8.6 Alternate Measures of Core Inflation

  • 9.1 Measures of Home Bias

  • 9.2 Risk-Return Frontier for Japanese Investors

  • 10.1 Net Receipts from Foreign Assets

  • 10.2 Foreign Assets Held by Japanese Residents

  • 10.3 Global Securities Holdings

  • 10.4 Household Financial Asset Allocation

  • 10.5 Household Holdings of Securities by Age Group

  • 10.6 Outflows by Destination, 2005-07

  • 10.7 Borrowing in the Uncollateralized Call Market

  • 10.8 Japanese Banks’ External Credits

  • 10.9 Foreign Exchange Deposits

  • 10.10 CME Yen Trading Position

  • 10.11 Japanese Assets Held by Nonresidents

  • 10.12 Major Stock Exchanges: Market Capitalization

  • 10.13 Foreign Direct Investment in Japan

  • 11.1 Net Operating Income

  • 11.2 Japanese Bank Profits

  • 11.3 Breakdown of Core Profits

  • 11.4 Bank Operating Costs

  • 11.5 Lending and Deposit Rates

  • 11.6 Bank Deposits, End 2004

  • 11.7 Core Profits and Japan Post’s Deposit Share

  • 12.1 Japanese Banks’ External Credits

  • 12.2 Shares of Regional Branches

  • 12.3 Japanese Major Banks’ Return on Assets by Region

  • 13.1 Labor Productivity Gap between Japan and the United States

  • 13.2 OECD Product Market Regulation Indicator

  • 13.3 Share of Services in Business R&D, 2003

  • 13.4 Major Industrial Countries: TFP Growth and ICT Capital Services Growth, 1995-2004

  • 13.5 Contributions to Growth

  • 14.1 Selected Countries: Overall Farm Support and Trade-Distorting Support, 1986-88 to 2001-03

  • 15.1 Productivity Growth—Baseline Scenario

  • 15.2 Productivity Growth—Alternative Scenario

  • 15.3 Structural and Fiscal Reforms (Alternative Scenario 1)

  • 15.4 Structural and Fiscal Reforms (Alternative Scenario 1)

  • 15.5 Larger Structural Reform Payoffs (Alternative Scenario 2)

  • 15.6 Larger Structural Reform Payoffs (Alternative Scenario 2)

  • 16.1 Sectoral Labor Productivity Gaps

  • 16.2 NFA and Yen-US$ Real Exchange Rate

  • 16.3 Distribution of Expected Change in the Yen

  • 16.4 Share of Foreign Securities in Total Assets

  • 16.5 Sharpe Ratio

  • 16.6 Yen-US$ Exchange Rate: Actual versus Model Prediction I

  • 16.7 Yen-US$ Exchange Rate: Actual versus Model Prediction II

  • 16.8 Effects of Increases in Volatility

  • 16.9 Temporary Increase in the Short-term Interest Rate

  • 16.A1.1 Medium-Run Fundamentals


By most assessments, Japan has closed the chapter on its Lost Decade. It has been a difficult journey, but the dislocations of the bubble-economy are, for the most part, things of the past. Policies and the global upturn that started in 2002 have broken the self-reinforcing cycle of financial instability, low growth, and entrenched deflation. For six years growth has been near potential, the financial system has regained a sound footing, and macroeconomic and structural policies have become increasingly proactive. There is little doubt that Japan is in the best position it has been in a long while to weather the period of global financial turbulence and softening world growth that had emerged at the time of this writing.

This book is about Japan’s recovery and the medium-term challenges ahead. It brings together some of the analytical work that has underpinned the IMF’s policy assessment and advice over the last four years. As such, the book also provides insights on how the IMF staff has engaged Japanese policymakers in the policy dialog that is at the heart of Fund surveillance. From this angle, a recurring theme in the book is that this engagement must be informed by both a national and an international perspective, for there is no clear boundary between the domestic and the international impact of policies in a closely interconnected world.

The breadth and depth of the relevant international linkages make the subject matter of the book more than just a “Japan story.” Japan’s stagnation in the aftermath of the bursting of the bubble contributed to a lopsided pattern of world growth and the emergence of threatening current account imbalances among the largest economies. Thus, Japan’s economic revival will have global consequences. As Japan readies itself to meet the challenges of a globalized world, a more resilient world economy will be in the making.

John Lipsky

First Deputy Managing Director

International Monetary Fund


We would like to acknowledge valuable comments on earlier versions of the chapters in this book by many colleagues at the IMF and in Japan. Fritz Pierre-Luis, Janice Lee, and Ioana Hussiada provided excellent research assistance; Kym Fisher gave extraordinary secretarial support; and Ray Addicott coordinated editing and production. Our thanks to them all.

The views expressed here, as well as any errors, are sole responsibility of the authors and do not necessarily reflect the opinions of the Japanese authorities, the Executive Board of the IMF, or other members of the IMF staff.

Notes on Contributors

Nicoletta Batini is Senior Economist, Western Hemisphere Department, International Monetary Fund.

Dennis Botman is Economist, Fiscal Affairs Department, International Monetary Fund.

Hali Edison is Senior Economist, Asia and Pacific Department, International Monetary Fund.

Christopher Faulkner-MacDonagh is Senior Economist, Asia and Pacific Department, International Monetary Fund.

Dora Iakova is Deputy Division Chief, European Department, International Monetary Fund.

Michael Keen is Advisor, Fiscal Affairs Department, International Monetary Fund.

Yougesh Khatri is Senior Economist, Asia and Pacific Department, International Monetary Fund.

Charles Kramer is Division Chief, Asia and Pacific Department, International Monetary Fund.

Bradley McDonald is Senior Economist, International Monetary Fund.

Shinobu Nakagawa is Director, Investment and Market Research, International Department, Bank of Japan.

Papa N’Diaye is Economist, Asia and Pacific Department, International Monetary Fund.

Alessandro Rebucci is Senior Economist, Research Department, International Monetary Fund.

Mark Stone is Deputy Division Chief, Monetary and Capital Markets Department, International Monetary Fund.

W. Christopher Walker is Senior Economist, Monetary and Capital Markets Department, International Monetary Fund.

Alexander Wolfson is Director, Global Country Risk Management Group, Citibank.

Policy Challenges in a Globalized World