Back Matter
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

References

  • Alichi, A., Chen, H., Clinton, K., Freedman, C., Johnson, M., Kamenik, O., Kisinbay, T. and Laxton, D. (2009), “Inflation targeting under imperfect credibility”, IMF Working Paper 09/94.

    • Search Google Scholar
    • Export Citation
  • Anderson, D., Hunt, B., Kortelainen, M., Kumhof, M., Laxton, D., Muir, D., Mursula, S. and Snudden, S., (2013), “Getting to Know GIMF: The Simulation Properties of the Global Integrated Monetary and Fiscal Model”, IMF Working Paper 13/55.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Andrle, M., Kangur, A. and Raissi, M. (2018), “Italy: Quantifying the Benefits of a Comprehensive Reform Package”, IMF Working Paper 18/60.

  • Aoyagi, C. and Ganelli, G. (2013), “The Path to Higher Growth; Does Revamping Japan’s Dual Labor Market Matter?”, IMF Working Paper 13/202, International Monetary Fund.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Aoyagi, C., and Ganelli, G. (2017), “Unstash the Cash! Corporate Governance Reform in Japan,” Journal of Banking and Financial Economics, University of Warsaw, Faculty of Management, Vol. 1(7), pages 5169, May.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Arbatli, E., Botman, D., Clinton, K., Cova, P., Gaspar, V., Jakab, Z., Laxton, D., Lonkeng Ngouana, C.D. Mongardini J. and Wang H. (2016), “Reflating Japan: Time to Get Unconventional?IMF Working Paper 16/157.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Barnes, S., (2014), “Reforms and Growth: A Quantification Exercise,” OECD, Nero Meeting.

  • Bassini, A., Nunziata, L. and Venn, D. (2009), “Job Protection Legislation and Productivity Growth in OECD Countries”, Economic Policy, Vol. 24, No. 58, pp. 349402.

    • Search Google Scholar
    • Export Citation
  • Blanchard, O. (1985), “Debt, Deficits, and Finite Horizons”, Journal of Political Economy, Vol. 93, pp. 22347.

  • Botman, D., Danninger, S., and Schiff, J. (2015), “Can Abenomics Succeed? Overcoming the Legacy of Japan’s Lost Decades,” International Monetary Fund: Washington DC.

    • Search Google Scholar
    • Export Citation
  • Carton, B., Fernandez-Corugedo, E., and Hunt, B. (2017), “No Business Taxation without Model Representation”, IMF Working Paper No 17/259.

  • Carton, B., Fernandez-Corugedo, E., Hunt, B., and Portillo R. (2018), “Introducing Demographics into GIMF”, forthcoming IMF Working Paper.

    • Search Google Scholar
    • Export Citation
  • Coenen, G., C. Erceg, C. Freedman, D. Furceri, M. Kumhof, R. Lalonde, D. Laxton, J. Lindé, A. Mourougane, D. Muir, S. Mursula, J. Roberts, W. Roeger, C. de Resende, S. Snudden, M. Trabandt, J. in’t Veld (2010), “Effects of Fiscal Stimulus in Structural Models,” American Economic Journal: Macroeconomics, Vol. 4(1), pp. 2268.

    • Search Google Scholar
    • Export Citation
  • Colacelli, M., G.H. Hong (2018), “Productivity Drag from Small and Medium-Sized Enterprises in Japan?forthcoming IMF Working Paper.

    • Search Google Scholar
    • Export Citation
  • Davis, J.S. (2012), “Re-establishing Credibility: The Behavior of Inflation Expectations in the Post-Volcker United States”, Federal Reserve Bank of Dallas Globalization and Monetary Policy Institute, WP No. 117.

    • Search Google Scholar
    • Export Citation
  • Demertzis, M., Marcellino, M. and Viegu, N. (2012), “A Credibility Proxy: Tracking US Monetary Developments”, The B.E. Journal of Macroeconomics Topics, Vol 12 (1).

    • Search Google Scholar
    • Export Citation
  • Dolado, J. J., Ortigueira, Stucchi, R. (2012), “Does dual employment protection affect TFP? Evidence from Spanish manufacturing firms”, CEPR Working Paper No. 8763.

    • Search Google Scholar
    • Export Citation
  • Dolado, J.J. (2015), “EU Dual Labor Markets: Consequences and Potential Reforms”, mimeo.

  • Duval, R., Furceri, D. (2018), “The Effects of Labor and Product Market Reforms: The Role of Macroeconomic Conditions and Policies,” IMF Economic Review, Vol. 66, pp.3169.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Egert, B. and Gal, P. (2017), “The Quantification of Structural Reforms in OECD Countries: A New Framework”, OECD Economics Department WP 1354.

    • Search Google Scholar
    • Export Citation
  • Fueki, T., Fukunaga, I., Ichiue, H., and Shirota, T. (2016), “Measuring Potential Output with an Estimated DSGE Model of Japan’s Economy”, IJCB.

    • Search Google Scholar
    • Export Citation
  • Fukao, K. (2013), “Explaining Japan’s Unproductive Two DecadesAsian Economic Policy Review, Japan Center for Economic Research, Vol. 8(2), pp. 193213.

    • Search Google Scholar
    • Export Citation
  • Fukao, K., Kambayashi, R., Kawaguchi, D., Kwon, H. Kim, Y G, and Yokomaya, I. (2006), “Deferred Compensation: Evidence from Employer-Employee Matched Data from Japan,” Hi-Stat Discussion Paper Series, no. 187, Hitotsubashi University.

    • Search Google Scholar
    • Export Citation
  • Hara, H. (2014), “The Impact of Firm-provided Training on Productivity, Wages, and Transition to Regular Employment for Workers in Flexible Arrangements,” Journal of The Japanese and International Economies, Vol. 34, pp. 33659.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Higuchi, Y. (2013), “Effects of Minimum Wage and Job Training Support”, Japanese Economic Review, Vol. 64, pp. 147200.

  • International Monetary Fund (2012a), “Japan: Article IV Consultation Staff Report,” IMF Country Report No. 12/208.

  • International Monetary Fund (2012b), “Japan: Selected Issues,” IMF Country Report No. 12/209.

  • International Monetary Fund (2013a), “Japan: Article IV Consultation Staff Report,” IMF Country Report No. 13/253.

  • International Monetary Fund (2013b), “Japan: Selected Issues,” IMF Country Report No. 13/254.

  • International Monetary Fund (2014), “Japan: Article IV Consultation Staff Report,” IMF Country Report No. 14/236.

  • International Monetary Fund (2015), “Japan: Article IV Consultation Staff Report,” IMF Country Report No. 15/197.

  • International Monetary Fund (2016a), “Japan: Article IV Consultation Staff Report,” IMF Country Report No. 16/267.

  • International Monetary Fund (2016b), “Japan: Selected Issues,” IMF Country Report No. 16/268.

  • International Monetary Fund (2016c), “Time for a Supply-Side Boost? Macroeconomic Effects of Labor and Product Market Reforms in Advanced Economies,” April World Economic Outlook.

    • Search Google Scholar
    • Export Citation
  • International Monetary Fund (2017a), “Japan: Article IV Consultation Staff Report,” IMF Country Report No. 17/242.

  • International Monetary Fund (2017b), “Japan: Selected Issues,” IMF Country Report No. 17/243.

  • International Monetary Fund (2017c), “Republic of Poland: Article IV Consultation Staff Report,” IMF Country Report No. 17/220.

  • Japan Institute of Labor Policy and Training Research (2010), “Career Development of Contingent Workers – The Current Status of Ability Development and the Transition to Regular Employees” Available at http://www.jil.go.jp/english/reports/documents/jilpt-research/no.117.pdf

    • Search Google Scholar
    • Export Citation
  • Japan Institute of Labor Policy and Training Research (2015), “Trends in Non-regular Employment in Japan and Analysis of Several Related Themesin Labor Situation in Japan and Its Analysis: Detailed Exposition 2014/2015, available at www.jil.go.jp/english/lsj/detailed/2014-2015/all.pdf

    • Search Google Scholar
    • Export Citation
  • Lam, R. and Shin, J. (2012), “What Role Can Financial Policies Play in Revitalizing SMEs in Japan?”, IMF Working Paper 12/291.

  • Looi Kee, H., Nicita, A. and Olarreaga, M. (2009), “Estimating Trade Restrictiveness Indices”, Economic Journal, 119, pp. 172199.

  • Lusinyan, L. and D. Muir (2013), “Assessing the Macroeconomic Impact of Structural Reforms: The Case of Italy,” IMF Working Paper 13/22 (Washington: IMF).

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Madera Holgado, R. (2012) “Dual Labor Markets and Productivity”, Master Thesis CEMFI, January.

  • Mauro, P. and J. Zilinsky (2016), “Reducing Government Debt Ratios in an Era of Low Growth”, Peterson Institute for International Economics Policy Brief No. 16–10.

    • Search Google Scholar
    • Export Citation
  • McGrattan, E. R., Miyachi, K. and Peralta-Alva, A. (2018), “On Financing Retirement, Health, and Long-term Care in Japan”, forthcoming IMF working paper.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Ministry of Health, Labour and Welfare (2010), “Comprehensive Survey on Diversification of Employment”.

  • Kumhof, M., D. Laxton, D. Muir and S. Mursula (2010), “The Global Integrated Monetary Fiscal Model (GIMF) – Theoretical Structure”, IMF Working Paper 10/34.

    • Search Google Scholar
    • Export Citation
  • Sher, G. (2014), “Cashing in for Growth; Corporate Cash Holdings as an Opportunity for Investment in Japan”, IMF Working Paper 14/221

  • Steinberg, C. and Nakane, M. (2012), “Can Women Save Japan?”, IMF Working Paper Series, WP/12/248

  • Sugo, T. and Ueda, K. (2008), “Estimating a Dynamic Stochastic General Equilibrium Model for Japan”, Journal of the Japanese and International Economies, 22, pp 476502.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Takahashi, Koji (2014), “Regular/Non-regular Wage Gap Between and Within Japanese Firms.” Paper presented at the Section on Organizations, Occupations and Work, 109th American Sociological Association Annual Meeting, San Francisco, August 16, 2014.

    • Search Google Scholar
    • Export Citation
  • Watanabe, K. and Watanabe, T. (2018), “Why has Japan Failed to Escape from Deflation?”, Asian Economic Policy Review, Vol. 13, pp. 2341.

Appendix A. Estimation of the Impact of Mitigating Duality: An Accounting Exercise

This Appendix describes the estimation of the impact from introducing intermediate contracts – found to boost productivity by about 7 percent after 30 years. It details the data used and assumptions made to arrive at the pertinent productivity estimates.

The sharp increase in the use of non-regular workers has reduced labor productivity in Japan. With relatively high employment protection for regular workers in Japan, firms have made use of non-regular workers to contain wage costs and satisfy cyclical upsurges in demand.1 A consequence of the rapid increase in non-regular workers has been a decline in productivity as non-regular workers typically receive temporary contracts with little training, few career opportunities, and low job security.2 The left panel of Figure 9 shows the rapid increase in non-regular workers, whereas the right panel shows that wages of non-regular workers are significantly weaker than those of regular workers. Part of the wage differential reflects productivity, although other factors are also at play. 3,4

Figure 9.
Figure 9.

Japan: Regular and Non-Regular Employment and Wages

Citation: IMF Working Papers 2018, 248; 10.5089/9781484384732.001.A999

Regular to non-regular wage differentials vary by age and gender. Figure 10 shows that non-regular young workers (those below 25 years old) are paid between 80 and 85 percent of regular workers’ wages. More strikingly, the pay gap increases rapidly in middle age, demonstrating in part the lower training received by non-regular workers. The wage discrepancy declines for older workers, largely reflecting that retired former regular workers remain in employment as non-regular workers. The weighted average wage differential (i.e. the ratio between non-regular and regular workers’ wages) for all cohorts is about 0.6, implying a 40 percent overall wage gap between regulars and non-regulars.

Figure 10.
Figure 10.

Japan: Relative Wages of Non-Regular Workers, 2016

(Percent of regulars wages)

Citation: IMF Working Papers 2018, 248; 10.5089/9781484384732.001.A999

Sources: Ministry of Health, Labor and Welfare and IMF staff’s calculations.

It is assumed that “intermediate” labor market contracts are gradually introduced to replace both regular and non-regular contracts over time. More specifically, it is assumed that starting in 2019 all new contracts are intermediate contracts, with existing contracts remaining as they are for the duration of that contract. This means that employees who had regular contracts before 2019 are assumed to remain as regular workers (i.e. grandfathering of existing regular contracts). For existing non-regular contracts before 2019, we assume that those workers would remain as non-regulars for around 4 years.

The introduction of “intermediate contracts” is assumed to result in no significant changes to overall employment protection. While employment protection of intermediates is assumed to be higher than that of non-regulars, it is lower than regulars’, such that overall employment protection is left unchanged.5 The switch to hiring intermediate workers implies a transition towards a unique type of contract that will reduce labor market duality, consistent with the empirical evidence of Aoyagi and Ganelli (2013) who show that a reduction of employment protection legislation of regular workers in Japan (to levels consistent with those observed in the United Kingdom and the United States) would eradicate non-regular contracts.6

The gradual replacement of non-regular workers by intermediate workers will increase productivity. It is assumed that intermediate workers eventually become as productive as regular workers, as intermediates are expected to receive as much training and human capital investment as regular workers. To quantify the productivity increase, we use estimates from Fukao and others (2006) who find a 20 percent productivity gap between regular and non-regular workers (estimated for Japan’s manufacturing sector).7 Assuming that the productivity of intermediate workers is the same as that of regular workers, the gradual introduction of intermediate workers implies that overall productivity will grow as shown in Figure 11. In other words, the estimation assumes a full catch up of the 20 percent productivity gap. The estimated productivity gain traces the replacement of non-regular workers with intermediate workers, starting from 2019. The estimated productivity improvement over time exceeds 7 percent by 2035.8,9

Figure 11.
Figure 11.

Japan: Productivity Improvement Under Labor Market Duality Reform

(Percent)

Citation: IMF Working Papers 2018, 248; 10.5089/9781484384732.001.A999

Sources: IMF staff’s calculations.

To determine the number of workers in each type of contract, and hence compute the productivity improvement, several stylized facts were used and matched. First, we looked at the total number of individuals in each age cohort (16 to 75 years of age) for both females and males. Data come from the National Institute of Population and Social Security Research and include projections to the year 2100. We also considered the employment rates from Statistics Bureau in Japan which provides data for each cohort, where the cohorts are aggregated into the 15–24, 25–34, 35–44, 45–54, 55–64 and 65+ categories. It is assumed that the participation rates remain constant, as these are explicitly covered by other labor market reforms in this study.10 We multiply the participation rate of cohorts by the population estimates to determine the number of workers by age and gender. To the resulting number we apply the share of workers in regular (and non-regular) contracts from the Statistics Bureau. Table 1 provides values for participation rates and shares of regular/non-regular contracts by age and gender.

Table 1.

Japan: Employment Rates and Share of Regular Workers, 2017

article image
Sources: National Institute of Population and Social Security Research, Statistics Bureau, and IMF staff calculations.

Transition probabilities for Japan are used to approximate the number of individuals by age, gender and type of contract. Transition probabilities (or hazard rates) of remaining in employment, unemployment, and inactivity, plus transitioning between those states, estimated by Esteban-Pretel and others (2011), were used to approximate the total number of individuals by type of contract, age and gender. Annualized transition rates are replicated in Table 2. Using these probabilities plus information from Table 1, we matched observed data on the total number of regular/non-regular contracts by broad age ranges and gender in both 2015 and 2016, and then projected the total number of regular, non-regular and intermediate contracts.

Table 2.

Japan: Annualized Transition Probabilities in the Labor Market

article image
Notes: E = employed, U = unemployed, I = inactive, so EE is probability of staying in employment when employed. M = Male, F = Female, R = Regular and NR = Nonregular. Source: Esteban-Pretel and others (2011).

Employment rates, shares in types of contract and transition probabilities are used to project the number of workers in regular, non-regular and intermediate contracts by age and sex. It is assumed that employees on regular contracts in a given year had an 89 percent probability of remaining regular in the following year, though there are smaller probabilities of 6 and 44 percent of transitioning to unemployment or inactivity, respectively. It was then assumed that those workers that were inactive or unemployed in the previous period would be offered intermediate contracts with 100 percent probability. Similar assumptions were made for non-regular workers, but in this case, it is worth noting that the probability of remaining in non-regular employment is significantly lower (at 49 percent) relative to a regular worker (at 89 percent). The first panel of Figure 10 shows the different shares of regulars, non-regulars and intermediates, whereas the second panel breaks that share by age. Estimations deliver that, by assuming that all “new” contracts are intermediate while existing regular contracts are maintained until retirement, given projected demographics, the share of intermediate contracts reaches around 90 percent of all contracts by 2035.

Figure 12.
Figure 12.

Japan: Share of Intermediate Contracts Under Labor Market Duality Reform

Citation: IMF Working Papers 2018, 248; 10.5089/9781484384732.001.A999

Source: IMF staff’s calculations.

Appendix B. GIMF Model Summary1

The IMF’s Global Integrated Monetary and Fiscal Model (GIMF) is a multi-country DSGE model with optimizing behavior by households and firms, and full intertemporal stock-flow accounting. Frictions in the form of sticky prices and wages, real adjustment costs, liquidity-constrained households, along with finite-planning horizons of households, provide a role for monetary and fiscal policy in economic stabilization.

The assumption of finite horizons separates GIMF from standard monetary DSGE models and allows it to have well-defined steady states where countries can be long-run debtors or creditors. This allows users to study the transition from one steady state to another where fiscal policy and private saving behavior play a critical role in both the dynamics and long-run comparative statics.2

The non-Ricardian features of the model provide non-neutrality in both spending-based and revenue-based fiscal measures, which makes the model particularly suitable to analyze fiscal policy questions. Fiscal policy can stimulate the level of economic activity in the short run, but sustained government deficits crowd out private investment and net foreign assets in the long run.3 Sustained fiscal deficits in large economies can also lead to a higher world real interest rate, which is endogenous.

Asset markets are incomplete in the model. Government debt is only held domestically, as nominal, non-contingent, one-period bonds denominated in domestic currency. The only assets traded internationally are nominal, non-contingent, one-period bonds denominated in U.S. dollars that can be issued by the U.S. government and by private agents in any region. Firms are owned domestically. Equity is not traded in domestic financial markets; instead, households receive lump-sum dividend payments.

Firms employ capital and labor to produce tradable and nontradable intermediate goods. There is a financial sector a la BGG that incorporates a procyclical financial accelerator, with the cost of external finance facing firms rising with their indebtedness.

GIMF is multi-region, encompassing the entire world economy, explicitly modeling all the bilateral trade flows and their relative prices for each region, including exchange rates. The version used in this paper comprises six regions. The international linkages in the model allow the analysis of policy spillovers at the regional and global level.

A. Household Sector

There are two types of households, both of which consume goods and supply labor. First, there are overlapping-generation households (OLG) that optimize their borrowing and saving decisions over a 20-year planning horizon. Second, there are liquidity-constrained households (LIQ), who do not save and have no access to credit. All households pay direct taxes on labor income, indirect taxes on consumption spending, and a lump-sum tax.

OLG households save by acquiring domestic government bonds, international U.S. dollar bonds, and through fixed-term deposits. They maximize their utility subject to their budget constraint. Aggregate consumption for these households is a function of financial wealth and the present discounted value of after-tax wage and investment income. The consumption of LIQ households is equal to their current net income, so their marginal propensity to consume out of current income is unity. A high proportion of LIQ households in the population would imply large fiscal multipliers from temporary changes to taxes and transfer payments.

For OLG households with finite-planning horizons, a tax cut has a short-run positive effect on output. When the cuts are matched with a tax increase in the future, to leave government debt unchanged in the long run, the short-run impact remains positive, as the change will tilt the time profile of consumption toward the present. In effect, OLG households discount future tax liabilities at a higher rate than the market rate of interest. Thus, an increase in government debt today represents an increase in their wealth, because a share of the resulting higher taxes in the future is payable beyond their planning horizon. If the increase in government debt is permanent (tax rates are assumed to rise sufficiently in the long run to stabilize the debt-to-GDP ratio by financing the higher interest burden) this will crowd out real private capital by raising real interest rates.

Increases in the interest rate have a negative effect on consumption, mainly through the impact on the value of wealth. The intertemporal substitution effect from interest rate changes is moderate and has been calibrated to be consistent with the empirical evidence. The intertemporal elasticity of substitution determines the magnitude of the long-run crowding-out effects of government debt since it pins down how much real interest rates have to rise to encourage households to provide the required savings.

Demographics have been recently added to GIMF to capture features of economies with an ageing and declining population (see Carton and others, 2018). Earlier vintages of GIMF assumed constant population growth, such that each generation faced a constant probability of death (which together with population growth determined the birth rate), and the time endowment for working declined with age. In this updated version of GIMF, population growth, the probability of surviving each period and the work time endowment can be time varying to match characteristics of an ageing and shrinking population. Demographics then affect the model through household consumption and leisure decisions, as well as through the stochastic discount factor in the model which affects investment.

B. Production Sector

Firms produce tradable and nontradable intermediate goods. They are managed in accordance with the preferences of their owners, finitely-lived households. Thus, firms also have finite-planning horizons. The main substantive implication of this assumption is the presence of a substantial equity premium driven by impatience.4 Firms are subject to nominal rigidities in price setting as well as real adjustment costs in labor hiring and investment. They pay capital income taxes to governments, wages to all households, and dividends to OLG households.

Retained earnings are insufficient to fully finance investment, so firms must borrow from financial intermediaries. If earnings fall below the minimum required to make the contracted interest payments, the financial intermediaries take over the firm’s capital stock, less any auditing and bankruptcy costs, and redistribute it back to their depositors (households).

Firms operate in monopolistically competitive markets, and thus goods’ prices contain a markup over marginal cost. Exports are priced to the local destination market and imports are subject to quantity adjustment costs. There are also price adjustment costs which lead to sticky prices.

Firms use public infrastructure (which is the government capital stock) as an input, in combination with tradable and nontradable intermediate goods. Thus, government capital adds to the productivity of the economy.

C. Financial Sector

GIMF contains a limited menu of financial assets. Government debt consists of one-period bonds denominated in domestic currency. Banks offer households one-period fixed-term deposits, their source of funds for loans to firms. These financial assets, as well as ownership of firms, are not tradable across borders. OLG households may, however, issue or purchase tradable U.S.-dollar-denominated obligations.

Banks play a role in the model via the financial accelerator mechanism. Banks pay a market rate of return on deposits, and charge a risk premium on loans. Because of the costs of bankruptcy (capital can only be liquidated at a discount), the lending rate includes an external financing premium, which varies directly with the debt-to-equity (leverage) ratio—the financial accelerator effect. Non-linearities imply steep increases in the risk premium for large negative shocks to net worth.

Uncovered interest parity may not hold, due to the presence of country risk premiums. The premiums can create deviations, both in the short run and the long run, between interest rates in different regions, even after adjustment for expected changes in exchange rates.

D. International Dimensions and Spillovers

All bilateral trade flows are explicitly modeled, as are the relative prices for each region, including exchange rates. These flows include the export and import of intermediate and final goods. They are calibrated in the steady state to match the flows observed in the recent data. International linkages are driven by the global saving and investment decisions, a by-product of consumers’ finite horizons. This leads to uniquely defined current account balances and net foreign asset positions for each region. Since asset markets are incomplete, net foreign asset positions are represented by nominal non-contingent one-period bonds denominated in U.S. dollars.

Trade linkages are important for quantifying spillovers in GIMF. Along with uncovered interest parity, and long-term movements in the world real interest rate, the magnitude of the international trade linkages is the main determinant of spillover effects from shocks in one region to other regions in the world.

E. Fiscal and Monetary Policy

Fiscal policy is conducted using a variety of expenditure and tax instruments. Government spending may take the form of either consumption or investment expenditure, or lumpsum transfers to either all households or targeted towards LIQ households. In previous versions of GIMF, revenue accrued from the taxes on labor income and capital returns, consumption taxes, and lumpsum taxes. Recent versions of GIMF (Carton and others, 2017) also allow revenue to accrue from corporate income and from cash flow taxes (CFT) which also permit a destination-based component. A CFT taxes the cash flows of corporates from sales after deducting the cost of labor, investment, and intermediate inputs. Under a DBCFT, revenues from exports are not subject to tax, while the cost of imports cannot be deducted, both of which relate to the destination based component of the tax. Carton and others (2017) document all the changes that were made to introduce CFTs as well as other corporate taxes.5

The model also allows for tariffs on imported goods to be a potential source of public revenue. Government investment spending augments public infrastructure, which depreciates at a constant rate over time.

There is a fiscal policy rule which ensures long-run sustainability, while allowing for short-run counter-cyclical policies. Changes in both labor and capital income taxes provide the instrument to put the rule into effect, but this can be replaced with other tax, transfer or spending instruments if that is considered more realistic for a specific region. First, the fiscal rule ensures that in the long run, the government debt-to-GDP ratio—and hence the deficit-to-GDP ratio—eventually converges to its target level. This excludes the possibility of sovereign default, as well as the risk that out-of-control financing requirements of the government will override monetary policy. Second, the rule allows for countercyclical fiscal policy as it embodies automatic stabilizers.

When conducting monetary policy, the central bank uses an inflation-forecast-based interest rate rule. The central bank varies the gap between the actual policy rate and the long-run equilibrium rate to achieve a stable target rate of inflation over time.

Appendix C. GIMF Calibration and Simulation Strategy

This Appendix provides more details on the calibration of parameters that are important for the Japan block of the IMF’s Global Integrated Monetary and Fiscal Model (GIMF). Parameters were chosen to match several key stylized facts reported in Table 3. On the expenditure side we match the “great ratios” for Japan: consumption, private investment, government spending and trade-to-GDP. On the income side we match the labor share in total income and tax revenues to GDP. On the output side we match the share of tradeables in production.

Table 3.

Japan: “Great Ratios” and Other Shares (2012–16 average)

article image
Sources: Haver Analytics and IMF staff’s calculations.Note: Reported net debt corresponds to 2017 levels.

An important determinant of the short-run impact of the proposed structural reforms on nominal and real variables is the degree of nominal rigidity in the economy. There is ample evidence that prices are very sticky, that inflation expectations are not anchored at the Bank of Japan’s two percent target, and that the Phillips curve is relatively flat, in response to two decades of weak price growth in Japan (eg Sugo and Ueda, 2008, Fueki et al, 2016, Watanabe and Watanabe, 2018, and IMF, 2015). Two model parameters are used to capture these stylized facts. First, we set the nominal rigidities’ GIMF parameter (i.e. Rotemberg price adjustment cost) such that prices are changed on average every three years, consistent with the estimated DSGE parameters of Sugo and Ueda (2008).1,2 Second, we calibrate the inflation target parameter (which pins down long term inflation expectations) to one percent.3 The perception of a one percent inflation target implies that the Bank of Japan does not have full credibility on attainment of its two-percent inflation target. In terms of the monetary policy reaction function, we employ the estimated parameters of Kumhof and others (2010), implying a degree of interest rate inertia of 0.4 and a coefficient on (expected one-year ahead) inflation of 1.9.

Table 4 presents a summary of the GIMF simulation strategy detailed in Section II, noting the quantities and shocks used. For the case of duality, total factor productivity was increased by 7 percent (per calculations presented in Appendix A) gradually over 25 years. Product market and SME reforms also used TFP shocks. For the case of increased female (and older worker) labor force participation, labor supply was increased using labor supply shocks in GIMF such that growth rose by 0.2 percent per year over 20 years (in line with estimates reported in IMF 2013a). Labor supply shocks were also used for increased migration. For the case of corporate governance reform, shocks to borrower riskiness (to lower it) in the financial accelerator mechanism were used to increase the level of investment after 10 years (in line with estimates by Sher, 2014 and Aoyagi and Ganelli, 2017). Finally, tariff and non-tariff trade barriers shocks were used to capture trade agreements. Notably, the simulations do not assume complementarity or substitutability between structural reforms, and therefore potential interactions between them are not accounted for.

Table 4.

Japan: Structural Reform Package and GIMF Simulation Strategy

article image
Sources: IMF staff’s calculations and cited sources.

Appendix D. Decomposition of the Labor and Product Market Reforms (Fully-Credible)

Figures 13 and 14 present a decomposition of the fully-credible labor market and product market reforms.

Figure 13.
Figure 13.

Japan: Credible Labor Market Reforms

Citation: IMF Working Papers 2018, 248; 10.5089/9781484384732.001.A999

Note: Reported effects are changes relative to the baseline reported in Figure 1.Sources: GIMF simulations and IMF staff’s calculations. X-axis denotes years, LR=Long-run/steady-state (40+ years).
Figure 14.
Figure 14.

Japan: Credible Reforms in the Corporate Sector

Citation: IMF Working Papers 2018, 248; 10.5089/9781484384732.001.A999

Note: Reported effects are changes relative to the baseline reported in Figure 1.Source: GIMF simulations and IMF staff’s calculations. X-axis denotes years, LR=Long-run/steady-state (40+ years).

Appendix E. Drivers of Public Debt Reduction Under “Abenomics Redux” Scenario

This appendix presents the algebra and intuition behind the results presented in Figure 8. The analysis starts with the public debt accumulation equation:

Dt=Dt1+itDt1PSt(1)

where D is nominal public debt, i is the interest associated with the debt and PS is the public sector nominal primary surplus defined as the difference between the public sector expenditures (excluding interest payments associated with the public debt) and public sector revenues. Dividing both sides by nominal GDP, yields:

DtGDPt=Dt1GDPt1GDPt1GDPt+itDt1GDPt1GDPt1GDPtPStGDPt(2)

Defining ratios to nominal GDP in lower case letters and the growth rate of nominal GDP as φ, equation (2) is written as:

dt=dt11+φt+it1dt11+φtpst(4)

Equation (3) is re-written as:

dtdt1=itdt11+φtφtdt11+φtpst(4)

Equation (4) is close to the public debt decomposition shown in Figure 8 and has been used by others (e.g. Mauro and Zilinsky, 2016) as a framework to decompose public debt accumulation. However, this decomposition is not ideal in our case since the component typically used to measure interest costs is deflated by nominal growth, and this is an important component that dampens the interest cost (and boosts output growth terms under structural reforms). As a result, we define an alternative decomposition that we consider more appropriate in this case as follows:

intcoststit1dt1(5)
primarysurplustpst(6)
growthtdtdt1it1dt1+pst(7)

The growth contribution in (7) is computed as the residual for given values of interest costs on debt and the primary surplus. To produce Figure 8 we consider deviations from the baseline (labeled “base” below), hence:

dt+jdt1base=dt1dt1base+Σk=0j[(intcostst+kintcostt+kbase)(growtht+kgrowtht+kbase)(pst+kpst+kbase)]=Σk=0j[(intcostst+kintcostt+kbase)(growtht+kgrowtht+kbase)(pst+kpst+kbase)]

Figure 8 shows the right-hand side of equation (8), where it is observed that dt1dt1base=0 (as the level of public debt is the same as that from the baseline for the period before structural reforms and consumption tax hikes start). Note that as the level of public debt declines (as structural reforms and higher consumption tax rates take place), the contribution from interest costs can change sign despite the fact that nominal interest rates may be higher.

1

An earlier draft was presented at Japan’s Ministry of Finance and at the Bank of Japan. We would like to thank John Bluedorn, Odd Per Brekk, Benjamin Carton, Paul Cashin, Gee Hee Hong, Benjamin Hunt, Kazuaki Miyachi, Adrian Peralta-Alva, Cyril Rebillard, Masashi Saito, Todd Schneider, Niklas Westelius and seminar participants for valuable comments and suggestions. All remaining errors are our own.

2

Simulations use a recently updated version of GIMF that includes demographics. See forthcoming IMF Working Paper by Carton and others (2018) for more details.

3

Throughout the paper, the baseline simulation (or “current policies” scenario) assumes that: (i) BoJ follows a calibrated monetary policy reaction function (see Appendix C for more details), (ii) the planned 2019 consumption tax hike takes place with no subsequent additional hikes or other fiscal consolidation measures, (iii) authorities’ demographic projections and associated fiscal age-related spending projections, (iv) non-age-related government spending remains constant in per capita terms, and (v) female labor force participation and migration do not mitigate the anticipated decrease in the labor force. Note that the baseline simulation is computed relative to a simulation where the economy continues to grow at the average pace observed in 2012- 17 (1.3 percent). Given that 2017 population growth was -0.24 percent, GDP per capita growth is assumed to be close to 1.5 percent, which is the assumed TFP growth rate.

4

Demographic projections are produced by the National Institute of Population and Social Security Research. Health and pension spending projections follow McGrattan and others (2018). They estimate the impact of population ageing on government expenditure in a closed-economy overlapping-generations DSGE model, using authorities’ demographic projections. In their analysis, McGrattan and others (2018) examine fiscal policy options given the declining and ageing population and find that consumption tax increases that stabilize net government debt are welfare improving (relative to the use of other tax instruments or temporarily higher government net debt).

5

The direct effect on GDP, consumption and investment from the decline in labor inputs is due to the decline in both population and total hours worked. Per capita GDP, consumption and investment also fall, but by less than their aggregate counterparts. The per capita decline occurs because as households age, per capita productivity growth and hours worked decline as the models assumes that these decline throughout the worker’s lifetime. This assumption is consistent with observed profiles of wages and hours worked in Japan.

6

Capital declines since the existing capital stock is relatively large vis-a-vis a declining labor input, resulting in a declining return to capital and thus lower investment. Consumers, who ultimately own the capital stock, lower their savings and decumulate capital. They do so at a slow pace since they are expected to live longer and be able to work less hours in their old age.

7

With lower output, exports fall. Imports fall by less than exports as households support consumption and thus imports by dissaving. The real exchange rate appreciates as the economy requires fewer exports in response to declining imports and potential output.

8

See for example Botman et al (2015).

10

Synergies arise, for example, when reforms raise the return on investment and hence boost the capital stock and the real interest rate (since investment will exceed savings). In addition, reforms that lift labor supply – and potential growth in general – will also raise the return on investment and thereby the natural real interest rate, making a monetary policy accommodation more effective.

11

These results should be interpreted as the upper bound of the structural reform impact as they assume that economic agents fully believe the structural reform path.

12

Parallel results for GDP per capita show that fully credible structural reforms can compensate the decline in GDP per capita (by over 10 percent in around 40 years) due to demographics under current policies.

13

In Japan, labor market duality refers to the presence of regular and non-regular workers. Regular workers have contracts regarded as lifetime contracts, while non-regular workers have temporary contracts and reduced benefits.

14

See for example the Ministry of Health, Labor and Welfare’s “General Survey on Diversified Types of Employment” (2010) or “Trends in Non-Regular Employment in Japan and Analysis of Several Related Themes” (2015) by the Japan Institute of Labor Policy and Training.

15

See for example, the Japan Institute of Labor Policy and Training Research Report No 117, Higuchi (2013) or Hara (2014), Fukao and others (2012).

16

Intermediate workers are defined as those with intermediate contracts. Japan presently has intermediate or “limited regular” contracts (“gentei seishain” in Japanese), though these are not widely adopted partly because their legal framework is not clear. While intermediate contracts are specific to a position/location (unlike regular contracts which are regarded as lifetime contracts with possible changes in position and location), the court- based system in Japan, under the current legal framework, could regard intermediate contracts as regular contracts. Therefore, the present legal framework may prevent firms from dismissing intermediate workers (as it currently does for regulars).

17

The productivity growth increase amounts to 0.3 percentage points per year over twenty years.

18

Estimate computed as the average for OECD advanced economies for the period 1985–2011.

19

Colacelli and Hong (2018, forthcoming) estimate that boosting laggard SMEs’ productivity growth (output per worker) to that of the average non-laggard Japanese firm, would significantly increase average annual productivity growth of Japanese firms. In light of this work, the SME reform impact used in the present paper is conservative.

20

TPP-11 was signed in March 2018 and ratified by Japan’s Diet in July 2018, and it will come into force in December 2018 as it has been ratified by six (out of eleven) countries in October 2018. Japan and the EU concluded EPA negotiations in December 2017.

21

The assumed full removal of tariff and non-tariff trade barriers is larger than envisaged under the trade agreements and thus, the simulations provide an upper bound for the impact of the trade agreements.

22

The calibration of GIMF is discussed at length in Kumhof and others (2010), Anderson and others (2013) and Carton and others (2017), which emphasize the calibration of key global variables that pin down parameters associated with household preferences and production.

23

While assumptions are made about the credibility of structural reforms, possible commitment devices to achieve credibility are not modeled in this exercise.

24

This implies, for example, that in the case of increased female labor force participation, agents know that potential growth will be 0.2 percentage points higher every year for twenty years, or in the case of corporate governance reform, agents know that the level of investment will be 5 percent higher after ten years. Hence agents are only surprised by the announcement of the reform plans, and are not subsequently surprised when the reforms take place over time.

25

This implies, for example, that in the case of increased female labor force participation, agents will observe an annual increase in potential growth of 0.2 percentage points in the first year of the reform and would not expect further increases thereafter. In the subsequent year they are surprised by another 0.2 percentage points increase but do not expect further increases. Hence agents will be surprised each year that the reform takes place.

26

This assumption implies that private agents update their beliefs’ (increase them) about the Bank of Japan’s inflation target when realized inflation increases above previously expected levels, and is loosely based on the framework of Alichi and others (2009), Demertzis and others (2012) and Davis (2012).

27

Unlike in the case of structural reforms, the analysis models a specific mechanism to improve the credibility of BoJ’s inflation target.

28

Relative to the baseline policy rule, further monetary accommodation is achieved by slightly reducing the feedback coefficient on expected inflation and by increasing the coefficient on lagged interest rate. More specifically, we assume a coefficient on lagged interest rates of 1 and a coefficient on inflation of 0 for two years (implying full accommodation of the reforms). In the subsequent five years we move the coefficients towards the baseline policy rate, that is by lowering the degree of interest rate inertia from 1 to 0.4 and increasing the coefficient on inflation from zero to 0.9.

29

The black line shows the total impact of the reforms while the difference between the various lines shows the impact of each of the reforms: labor market reforms (blue vs axis), product/corporate reforms (red vs blue) and trade agreements (black vs red).

30

Return to capital increases because many of the reforms lead to: increases in multifactor productivity (duality, product market and SME reforms); increased size of the labor force (more female, older and migrant workers); or the cost of investment declines (corporate governance reforms).

31

Absent the assumptions made about the credibility channel, the inflation increase would be temporary, and inflation would return to its initial steady-state in the long run (one percent).

32

A reduction in tariff and non-tariff barriers lowers the price of imported investment, thereby boosting investment and potential output.

33

This occurs because Japan has relatively larger non-tariff trade barriers than other signatures of the trade deals.

34

To stabilize public debt at present levels, we increase consumption tax rates by 50 percent of the consumption tax rate path envisaged by McGrattan and others (2018). Our reduced rate hikes take into account that structural reforms, present in our scenario, boost nominal growth and tax revenues which are used to reduce the public debt, and therefore require smaller consumption tax rate hikes to stabilize public debt.

35

Cited 15 percent is the difference between the blue and black bars in the GDP panel in Figure 7.

36

Estimates of the GDP boost for Japan are of the same order of magnitude as those from similar exercises using GIMF and FSGM models for other countries, though somewhat larger. Using GIMF for Italy, Andrle and others (2018) point to reforms that boost the GDP level by 6–13 percent, whereas Lusinyan and Muir (2013), find that announced reforms could boost the level of GDP by 10.5 percent in the long-run. Using FSGM for Japan, Arbartli and others (2016) investigate a less ambitious reform package which includes components of the labor and product market reforms examined in this paper and find that those could boost annual GDP growth by 0.5 percent for five years only (as opposed to the 40 years boost in this paper). The Poland Article IV consultation (IMF, 2017c), using FSGM, points to possible long-run gains between 6.8–11.4 percent from various reform packages.

37

Interest costs associated with the public debt do not increase in the first two years after the structural reforms because monetary policy accommodates the reforms under Abenomics Redux. However, interest costs increase as the policy rate is gradually lifted after the first two years.

1

See for example the Ministry of Health, Labor and Welfare’s “General Survey on Diversified Types of Employment” (2010) or “Trends in non-regular employment in Japan and Analysis of several related themes” (2015) by the Japan Institute of Labor Policy and Training.

2

See for example, the Japan Institute of Labor Policy and Training Research Report No 117, Higuchi (2013), Hara (2014), or Fukao and others (2012).

3

Fukao and others, (2006) and Shinada (2011).

4

Hara (2014) and Higuchi (2013) find that non-regular workers that receive training have productivity improvements that do not result in higher wages but instead on a higher probability of transitioning towards a regular contract. Almost 70 percent of non-regular workers are females.

5

In parallel, we have assumed unchanged economy-wide wage mark ups. In other words, it is assumed that any wage markup change for regulars is counterbalanced by that of non-regulars.

7

While the wage gap between regulars and non-regulars is about 40 percent, estimates from Fukao and others (2006) suggest that half of it reflects productivity differences. The rest of the wage gap likely reflects other factors (see for example Hara, 2014 and Higuchi, 2013).

8

This increase corresponds to an increase in TFP growth of 0.3 percentage points per year over twenty years.

9

This estimate would be an upper bound if intermediate workers’ productivity is not to reach that of regular workers.

10

This is consistent with the assumption that overall employment protection legislation remains unchanged for the overall economy.

1

For detailed documentation on the structure of the model see Kumhof and others (2010) and the updates on corporate taxation of Carton and others (2017) and of demographics by Carton and others (2018). For details on the model’s properties see Anderson and others (2013), Carton and others (2017, 2018).

2

See Blanchard (1985) for the basic theoretical building blocks and Kumhof and Laxton (2007, 2009a, 2009b) to understand their fiscal policy implications.

3

Coenen and others (2010) show that GIMF fiscal multipliers for temporary shocks are similar to standard monetary business cycle models, but more importantly, GIMF can handle a much broader array of permanent shocks that can be used to study transitions from one steady state to another caused by permanent changes in the level of government debt.

4

This feature would disappear if equity was assumed to be traded in financial markets. The assumption of myopic firm behavior, and the resulting equity premium, are more plausible.

5

An important disclaimer pertains to the assumptions made when introducing the corporate taxes in GIMF (Carton and others (2017)), which were driven by the existing structure of GIMF and by the need to simplify the computational burden of solving the model. Thus, several channels that could affect the macroeconomic outcomes following changes in these taxes are omitted. For instance, one may expect to find that multinational firms may modify transfer prices, relocate patents, change their financial structure, or relocate production towards the country with the less distortionary tax system. In addition to the broad macroeconomic implications, the resulting tax-base shifts could potentially have large implication for corporate tax revenue in different countries. However, because the model’s framework does not incorporate multinational firms, these potential transmission channels are absent. Additionally, owing to simplifying assumptions related to the currency denomination of foreign liabilities, the model-based analysis cannot capture the balance sheet effects of exchange rate movements.

1

While Sugo and Ueda (2008) estimate Calvo parameters, we map them into Rotemberg parameters.

2

Note that the Rotemberg parameter is set at this high value in most equations that have nominal rigidities (for tradeables, non-tradeables, final consumption and investment goods and wages). Overall, this implies a high degree of nominal rigidity in the model, as is seen in Japan.

3

This corresponds with Consensus Economics’ inflation expectations which stood at 0.9 percent for five-years’ ahead and 1.2 for ten years’ ahead as of April 2018.

Macroeconomic Effects of Japan’s Demographics: Can Structural Reforms Reverse Them?
Author: Mariana Colacelli and Emilio Fernández Corugedo