## wp18248

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### Key findings and projections
- Demographics:
  - Official projections anticipate that Japan’s population will decline by just over 25 percent in the next 40 years.
  - IMF staff GIMF simulations estimate the level of real GDP will decline by over 25 percent in about 40 years due to demographics under current policies (with an average annual GDP growth rate of about -0.8 percent) relative to a projection where productivity and population grow at their recent pace.
  - 2017 population growth was -0.24 percent.
  - 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).
  - GDP per capita growth in the baseline is assumed to be close to 1.5 percent, which is the assumed TFP growth rate.

- Macroeconomic effects under current policies (GIMF baseline):
  - Significant declines in real GDP, consumption, investment, and real wages.
  - Notable increase in the public-debt-to-GDP ratio and deterioration of the external current account.
  - Capital stock declines in response to shrinking labor inputs, leading to lower investment and private savings; households decumulate capital as they expect to live longer and work fewer hours in old age.

- Reform impact (credibility matters):
  - Fully-credible structural reforms can boost the level of real GDP by about 15 percent in 40 years relative to the “current policies” scenario.
  - Fully-credible reforms mitigate 0.5 of the 0.8 percentage point drag to annual GDP growth from demographic factors.
  - 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.
  - When reforms are “not-fully believed” by agents, the near-term GDP boost, improvements in inflation, and public debt dynamics are substantially smaller.

- Baseline simulation assumptions (current policies scenario):
  - (i) BoJ follows a calibrated monetary policy reaction function.
  - (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.
  - (v) Female labor force participation and migration do not mitigate the anticipated decrease in the labor force.

### The proposed structural reform program (three categories)
- Labor market reforms (address duality and boost labor supply):
  - Gradual replacement of regular and non-regular contracts by “intermediate” contracts, where intermediates are assumed to be as productive as regular workers:
    - Estimated to boost the level of labor productivity (currently growing by around 1.5 percent per annum) by over 7 percent in the long-run.
    - Productivity growth increase amounts to 0.3 percentage points per year over twenty years.
  - Increased female labor force participation:
    - 2010 level: 63 percent.
    - Increasing to G7 average (70 percent, excluding Italy and Japan) by 2030 would increase potential growth by up to 0.2 percentage points per year.
    - Increasing towards northern European levels (75 percent) would increase potential growth by an additional 0.2 percentage points.
    - Given female participation was just shy of 70 percent in 2017, the paper assumes increasing toward northern European levels would lift potential growth by around 0.2 percentage points each year over 20 years.
  - Increased participation of older workers (aged 60 and above):
    - A further 3 percentage point increase in participation is assumed to increase the labor force by around 0.5 percentage points, with a small impact on potential output growth.
  - Increased migration by one percent of the labor force:
    - Increases potential growth by 0.15 percentage points over 10 years.

- Corporate and product market reforms (boost productivity and investment):
  - Product market reform:
    - A 20 percent reduction in product market regulation is assumed to deliver a 2.4 percent increase in multi factor productivity (MFP) after five years.
  - SME reforms:
    - Restructuring SMEs to raise smaller firms’ productivity to about 80 percent of large firms translates to a 2.5 percent improvement in overall productivity (TFP) after ten years.
  - Corporate governance reform:
    - Allowing surplus cash to be used for investment is assumed to increase the level of investment by 5 percent after ten years.

- International trade reforms (CPTPP and Japan-EU agreements):
  - Assumed unwinding of all tariff and non-tariff barriers between Japan, CPTPP signatories, and the EU over five years.
  - Equivalent reductions (as measured using Kee and others (2009) trade restrictiveness measures):
    - Tariffs: 9 percent reduction for Japan, 6 percent for Europe, around 10 percent for CPTPP countries.
    - Non-tariff barriers: 23 percent reduction in Japan, 6 percent in Europe, around 9 percent in CPTPP countries.

### GIMF calibration, implementation, and scenarios
- Model setup:
  - Reforms are implemented in a six-region version of GIMF that allows for demographics and matches Japan’s stylized facts.
  - Six regions: Japan, the United States, the Euro Area, Emerging Asia, Latin America, and the rest of the world.
  - Japan calibration features a high degree of nominal rigidity, which influences short-run impacts of reforms.

- Mapping reforms into GIMF:
  - Reforms are mapped to changes in GIMF’s structural parameters and shocks: total factor productivity shocks, labor supply, investment shocks, and trade shocks.
  - “Off-model” estimates (labor productivity, labor supply, investment, trade cost changes) feed into GIMF calibration and simulation strategy.

- GIMF Japan calibration highlights (2012–16 averages and parameters preserved exactly):
  - Consumption 57.0 (percent)
  - Private Investment 16.4 (percent)
  - Government Consumption 21.1 (percent)
  - Government Investment 5.4 (percent)
  - Exports 15.6 (percent)
  - Labor 64.0 (percent)
  - Tradeables 40.0 (percent)
  - Tax Revenue 31.2 (percent)
  - Net government debt 194.0 (percent)
  - Rotemberg price adjustment: prices change on average every three years.
  - Inflation target parameter calibrated to one percent.
  - Monetary policy reaction function parameters: degree of interest rate inertia 0.4; coefficient on expected one-year ahead inflation 1.9.

### Credibility, assumptions, and scenario definitions
- Credibility of reforms:
  - Fully credible: agents expect reforms to be fully implemented over several years (perfect foresight of the path of the reform).
  - Not fully believed: agents only believe the reforms at the time they are implemented and realized (imperfect foresight).

- Bank of Japan credibility:
  - Any persistent increase in inflation above the “perceived” inflation target (of one percent) improves credibility of the Bank of Japan’s two-percent inflation target via private agents updating beliefs.

- Fiscal assumptions:
  - Age-related government spending grows with ageing; non-age-related government spending remains constant over time in per capita terms.
  - Overall government spending is the same under the baseline and under all reform scenarios.
  - All tax rates are constant in most scenarios, except for one scenario where debt stabilization is achieved by a higher consumption tax rate.

- Scenarios (four cases):
  - Case A: Fully-credible reforms, no monetary policy support, no full stabilization of public debt.
  - Case B: Not-fully-believed reforms (agents only believe reforms upon realization; imperfect foresight).
  - Case C: Fully-credible reforms plus monetary policy accommodation.
    - Monetary accommodation specifics: coefficient on lagged interest rates of 1 and coefficient on inflation of 0 for two years; subsequently lower lagged-interest coefficient from 1 to 0.4 and increase inflation coefficient from 0 to 0.9 over five years.
  - Case D ("Abenomics Redux"): Fully-credible reforms + monetary accommodation + full public debt stabilization (via higher consumption tax rate).
    - To stabilize public debt at present levels, increase consumption tax rates by 50 percent of the consumption tax rate path envisaged by McGrattan and others (2018).

### Results — Aggregate effects and channels (preserved quantitative highlights)
- Case A (Fully-Credible Reforms, no monetary support):
  - Fully-credible structural reforms boost GDP by over 10 percent above the baseline after ten years.
  - Reforms help inflation reach the Bank of Japan’s two-percent inflation target.
  - Near-term channels: immediate increases in investment and household consumption due to anticipation effects; demand boost exceeds contemporaneous supply boost → inflation rises; nominal interest rate increases; relative increase in imports → current account deterioration in first seven years.
  - Long-run: consumption, investment and GDP increase as potential expands; inflation increases via improved BoJ credibility (otherwise would return to one percent); public-debt-to-GDP declines; current account improves in the long run as exports increase and real depreciation of the yen occurs.
  - Trade agreement effects: removal of barriers reduces import prices, boosting investment and consumption; imports increase and real exchange rate depreciates; current account remains weakened in the long run due to large short-run trade balance deterioration lowering net foreign asset position.

  - Decomposition (level effects):
    - Labor market reforms (dual labor market reform): almost 6.5 percent contribution to level of output.
    - Increased domestic labor force participation: 3.5 percent.
    - Product market reforms: 2 percent.
    - SME reforms: 1.7 percent.
    - Partial productivity catch-up case: if only half of productivity gap is closed, long-run real GDP gain smaller by about 3 percentage points.

- Case B (Not-Fully-Believed Reforms):
  - Much lower near-term impact on GDP; do not help inflation reach BoJ target; less government debt reduction in long run.
  - Long-run GDP, consumption, investment and real wage impacts close to fully-credible scenario.
  - Mechanism: weaker short-term boost because agents are surprised each year; demand increases broadly in line with potential output → less inflationary pressure; inflation remains at one percent in long run; smaller nominal GDP increase → lower reduction in public-debt-to-GDP.

- Case C (Fully-Credible Reforms with Monetary Accommodation):
  - Monetary accommodation strengthens near-term activity and further boosts inflation.
  - Near-term real interest rate falls → consumption and investment brought forward → exchange rate depreciates → inflation increases more and public debt declines more rapidly.
  - Long-run impacts same as Case A.

- Case D (Abenomics Redux: Fully-Credible Reforms + Monetary Accommodation + Public Debt Stabilization):
  - Fully-credible structural reforms boost the level of GDP by about 15 percent in 40 years relative to the demographic headwinds from the “current policies” scenario (which showed a 25 percent decline).
  - Activity is lower in response to public debt stabilization (national savings rise and current account increases, though still shows a small decrease in the long-run).
  - Inflation exhibits a similar boost as Case C; consumption tax rate hikes only slightly upgrade inflation.
  - Public-debt-to-GDP stabilization drivers:
    - Near-term: higher nominal GDP growth from structural reforms and monetary accommodation.
    - Long-term: interest cost savings and primary surpluses.

### Appendix A — Labor-market duality mitigation (intermediate contracts) — estimation highlights
- Headline estimate:
  - Intermediate contracts found to boost productivity by about 7 percent after 30 years (presented as an upper bound if intermediate workers fully catch up to regular workers).
  - Corresponds to an increase in TFP growth of 0.3 percentage points per year over twenty years.
- Background and assumptions:
  - Weighted average wage differential (non-regular vs regular) for all cohorts is about 0.6 (a 40 percent overall wage gap).
  - Fukao and others (2006) estimate a 20 percent productivity gap between regular and non-regular workers in Japan’s manufacturing sector.
  - Policy experiment: starting in 2019 all new contracts are intermediate; existing contracts grandfathered; existing non-regular contracts before 2019 remain non-regular for around 4 years.
  - Intermediate workers assumed to eventually become as productive as regular workers (full catch-up of the 20 percent productivity gap).
- Timing and magnitude:
  - Gradual introduction implies overall productivity improvement exceeds 7 percent by 2035.
  - Share of intermediate contracts reaches around 90 percent of all contracts by 2035 under the assumptions.

### Appendix B — GIMF model summary (key structural features preserved)
- Model type and frictions:
  - Multi-country DSGE with optimizing households and firms; full intertemporal stock-flow accounting; sticky prices and wages; real adjustment costs; liquidity-constrained households; finite-planning horizons.
- Household types:
  - OLG households: 20-year planning horizon; save via domestic government bonds, international U.S. dollar bonds, fixed-term deposits.
  - LIQ households: do not save; marginal propensity to consume out of current income = unity.
- Production and financial sectors:
  - Firms produce tradable and nontradable intermediates; monopolistic competition; price markups; firms borrow from intermediaries; financial accelerator with external finance premium rising with leverage.
- International and fiscal features:
  - Six-region model with explicit bilateral trade flows and exchange rates; net foreign assets represented by U.S.-dollar bonds.
  - Fiscal instruments include government consumption, investment, transfers, and a range of taxes; fiscal rule ensures convergence of debt-to-GDP and deficit-to-GDP ratios.
- Limitations noted:
  - Omits channels related to multinational firm behavior (transfer pricing, relocation, etc.); simplifying assumptions on currency denomination of foreign liabilities.

### Appendix E — Public-debt-to-GDP drivers and decomposition
- Public debt accumulation identity (nominal) and ratios preserved exactly:
  - DD_t = DD_{t−1} + i_t DD_{t−1} − PS_t
  - d_t = d_{t−1} / (1+φ_t) + i_{t−1} d_{t−1} / (1+φ_t) − psp_t
  - d_t − d_{t−1} = i_t d_{t−1} / (1+φ_t) − φ_t d_{t−1} / (1+φ_t) − psp_t
- Decomposition and deviations:
  - Growth contribution computed as residual given interest costs and primary surplus.
  - For deviations from the baseline, cumulative deviations in public debt-to-GDP express as summed deviations of interest-cost contributions, growth contributions, and primary surplus contributions over the simulation horizon.
  - Important observation: d_{t−1} − d_{t−1}^{base} = 0 for the period before structural reforms and consumption tax hikes start.
  - As level of public debt declines (due to reforms and higher consumption tax rates), the contribution from interest costs can change sign even if nominal interest rates are higher.
- Figure 8 summary points:
  - Interest costs associated with public debt do not increase in the first two years after structural reforms because monetary policy accommodates the reforms under Abenomics Redux.
  - Interest costs increase as the policy rate is gradually lifted after the first two years.
  - Reported effects are changes to the baseline reported in Figure 1.

### Main conclusions and policy implications
- Japan’s economic prospects remain weak in the face of strong demographic headwinds.
- Baseline GIMF simulations show demographics expected to reduce real GDP by over 25 percent in about 40 years under current policies relative to a projection with recent productivity and population growth.
- Role and credibility of structural reforms:
  - Fully-credible reforms (upper bound) boost real GDP by about 15 percent in 40 years relative to the baseline when combined with monetary accommodation and public debt stabilization.
  - Not-fully-believed reforms deliver a smaller near-term boost and weaker improvements in inflation and debt dynamics; long-run impacts lie between fully-credible and not-fully-believed cases.
- Policy implications:
  - Coordinated and decisive (“fully-credible”) reforms, combined with monetary accommodation and debt stabilization, yield the largest macroeconomic gains.
  - Structural reforms that boost GDP levels can materially help stabilize debt dynamics when paired with appropriate policy accommodation.
  - Higher consumption tax rates are likely to be needed to stabilize Japan’s public debt, relative to those rates estimated under the scenario with fully-credible reforms with monetary accommodation and public debt stabilization.

*Source: wp18248 — Section II (GIMF simulations and IMF staff’s calculations) — canonical PDF content.*

### References _______________________________________________________________________________________ 24

### References

### Key findings and projections
- Demographics:
  - Official projections anticipate that Japan’s population will decline by just over 25 percent in the next 40 years.
  - IMF staff GIMF simulations estimate the level of real GDP will decline by over 25 percent in about 40 years due to demographics under current policies (with an average annual GDP growth rate of about -0.8 percent) relative to a projection where productivity and population grow at their recent pace.
  - 2017 population growth was -0.24 percent.
  - 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).
  - GDP per capita growth in the baseline is assumed to be close to 1.5 percent, which is the assumed TFP growth rate.

- Macroeconomic effects under current policies (GIMF baseline):
  - Significant declines in real GDP, consumption, investment, and real wages.
  - Notable increase in the public-debt-to-GDP ratio and deterioration of the external current account.
  - Capital stock declines in response to shrinking labor inputs, leading to lower investment and private savings; households decumulate capital as they expect to live longer and work fewer hours in old age.

- Reform impact (credibility matters):
  - Fully-credible structural reforms can boost the level of real GDP by about 15 percent in 40 years relative to the “current policies” scenario.
  - Fully-credible reforms mitigate 0.5 of the 0.8 percentage point drag to annual GDP growth from demographic factors.
  - Parallel results show 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.
  - When reforms are “not-fully believed” by agents, the near-term GDP boost, improvements in inflation, and public debt dynamics are substantially smaller.

- Baseline simulation assumptions (current policies scenario):
  - (i) BoJ follows a calibrated monetary policy reaction function.
  - (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.
  - (v) Female labor force participation and migration do not mitigate the anticipated decrease in the labor force.

### The proposed structural reform program (three categories)
- Labor market reforms (address duality and boost labor supply):
  - Gradual replacement of regular and non-regular contracts by “intermediate” contracts, where intermediates are assumed to be as productive as regular workers:
    - Estimated to boost the level of labor productivity (currently growing by around 1.5 percent per annum) by over 7 percent in the long-run.
    - Productivity growth increase amounts to 0.3 percentage points per year over twenty years.
  - Increased female labor force participation:
    - 2010 level: 63 percent.
    - Increasing to G7 average (70 percent, excluding Italy and Japan) by 2030 would increase potential growth by up to 0.2 percentage points per year.
    - Increasing towards northern European levels (75 percent) would increase potential growth by an additional 0.2 percentage points.
    - Given female participation was just shy of 70 percent in 2017, the paper assumes increasing toward northern European levels would lift potential growth by around 0.2 percentage points each year over 20 years.
  - Increased participation of older workers (aged 60 and above):
    - A further 3 percentage point increase in participation is assumed to increase the labor force by around 0.5 percentage points, with a small impact on potential output growth.
  - Increased migration by one percent of the labor force:
    - Increases potential growth by 0.15 percentage points over 10 years.

- Corporate and product market reforms (boost productivity and investment):
  - Product market reform:
    - A 20 percent reduction in product market regulation is assumed to deliver a 2.4 percent increase in multi factor productivity (MFP) after five years.
  - SME reforms:
    - Restructuring SMEs to raise smaller firms’ productivity to about 80 percent of large firms translates to a 2.5 percent improvement in overall productivity (TFP) after ten years.
  - Corporate governance reform:
    - Allowing surplus cash to be used for investment is assumed to increase the level of investment by 5 percent after ten years.

- International trade reforms (CPTPP and Japan-EU agreements):
  - Assumed unwinding of all tariff and non-tariff barriers between Japan, CPTPP signatories, and the EU over five years.
  - Equivalent reductions (as measured using Kee and others (2009) trade restrictiveness measures):
    - Tariffs: 9 percent reduction for Japan, 6 percent for Europe, around 10 percent for CPTPP countries.
    - Non-tariff barriers: 23 percent reduction in Japan, 6 percent in Europe, around 9 percent in CPTPP countries.

### GIMF calibration, implementation, and scenarios
- Model setup:
  - Reforms are implemented in a six-region version of GIMF that allows for demographics and matches Japan’s stylized facts.
  - Six regions: Japan, the United States, the Euro Area, Emerging Asia, Latin America, and the rest of the world.
  - Japan calibration features a high degree of nominal rigidity, which influences short-run impacts of reforms.
- Mapping reforms into GIMF:
  - Reforms are mapped to changes in GIMF’s structural parameters and shocks: total factor productivity shocks, labor supply, investment shocks, and trade shocks.
  - “Off-model” estimates (labor productivity, labor supply, investment, trade cost changes) feed into GIMF calibration and simulation strategy.

### Policy implications and coordination
- Synergies from coordinated policy:
  - Reforms that raise labor supply and potential growth increase the return on investment and the natural real interest rate, making monetary accommodation more effective.
  - Coordinated and decisive (“fully-credible”) reforms, combined with monetary accommodation and debt stabilization, yield the largest macroeconomic gains.
- Fiscal considerations:
  - Demographic-driven declines in output, tax revenues, and rising age-related spending raise public debt pressures.
  - Structural reforms that boost GDP levels can materially help stabilize debt dynamics when paired with appropriate policy accommodation.

*Source: wp18248 - References (IMF working paper content provided in the supplied PDF excerpt).*

### Section II. As Andrle and others (2018) note in a related exercise for Italy, several papers provide

### wp18248 - Section II. As Andrle and others (2018) note in a related exercise for Italy, several papers provide

### Assumptions
- Credibility of reforms:
  - Fully credible: all (private sector) agents expect the reforms to be fully implemented over several years (perfect foresight of the path of the reform).
    - Example: agents know that potential growth will be 0.2 percentage points higher every year for twenty years in the case of increased female labor force participation; or that the level of investment will be 5 percent higher after ten years in the case of corporate governance reform.
    - Implication: anticipation effects support near-term economic activity and inflation because the implied demand boost (as firms and households increase investment and consumption due to higher expected capital returns and permanent income) exceeds the contemporaneous supply boost from the reform plan.
  - Not fully believed: agents only believe the reforms at the time when these are implemented and realized (imperfect foresight of the reform path).
    - Example: agents observe an annual increase in potential growth of 0.2 percentage points in the first year of the reform and do not expect further increases thereafter; they are surprised each year the reform takes place.
- Bank of Japan credibility:
  - Assumed that any persistent increase in inflation above the “perceived” inflation target (of one percent) improves credibility of the Bank of Japan’s two-percent inflation target, thereby resulting in higher inflation in the long-run.
  - Private agents update beliefs about the BoJ’s inflation target when realized inflation increases above previously expected levels (based on frameworks in Alichi and others (2009), Demertzis and others (2012) and Davis (2012)).
- Fiscal assumptions:
  - Age-related government spending grows with ageing; non-age-related government spending remains constant over time in per capita terms. Overall government spending is the same under the baseline and under all reform scenarios.
  - All tax rates are constant in most scenarios (higher tax revenue due to structural reforms is assumed to be used to reduce the public debt), except for one scenario where debt stabilization is achieved by a higher consumption tax rate (as proposed by McGrattan and others, 2018).

### Scenarios (four cases)
- Case A: Fully-credible reforms, no monetary policy support, no full stabilization of public debt.
- Case B: Not-fully-believed reforms (agents only believe reforms upon realization; imperfect foresight).
- Case C: Fully-credible reforms plus monetary policy accommodation.
  - Monetary accommodation mechanics: relative to the baseline policy rule, further accommodation achieved by slightly reducing the feedback coefficient on expected inflation and increasing the coefficient on lagged interest rate.
    - Specifically: 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 move the coefficients towards the baseline policy rate by lowering the degree of interest rate inertia from 1 to 0.4 and increasing the coefficient on inflation from zero to 0.9.
- Case D ("Abenomics Redux"): Fully-credible reforms + monetary accommodation + full public debt stabilization (via higher consumption tax rate).
  - To stabilize public debt at present levels, increase consumption tax rates by 50 percent of the consumption tax rate path envisaged by McGrattan and others (2018). The reduced rate hikes take into account that structural reforms boost nominal growth and tax revenues, reducing the needed consumption tax increases.

### Results — Aggregate effects and channels
- Case A (Plain Vanilla Fully-Credible Reforms):
  - Credible structural reforms boost GDP by over 10 percent above the baseline after ten years.
  - Reforms help inflation reach the Bank of Japan’s two-percent inflation target.
  - Near-term channels:
    - Firms immediately increase investment to build capital stock due to anticipated higher return to capital.
    - Households increase consumption in anticipation of higher permanent income.
    - Demand boost exceeds contemporaneous supply boost → pressure on production costs (real wages, cost of capital) → inflation rises.
    - Nominal interest rate increases as central bank seeks to contain inflationary pressure in the near term.
    - Relative increase in imports → deterioration of the current account balance relative to baseline in the first seven years.
    - Public-debt-to-GDP declines due to GDP increase and higher reform-generated tax revenue used to reduce public debt.
  - Long-run:
    - Consumption, investment and GDP continue to increase gradually as potential output expands.
    - Inflation increases in the long run via increased credibility of the BoJ’s inflation target (otherwise inflation would return to one percent).
    - Public-debt-to-GDP declines in the long run due to interest savings from reduced debt and primary surpluses.
    - Current account improves in the long run as exports increase in response to higher potential output and real depreciation of the yen; significant decline in public debt leads households to substitute domestic assets for foreign ones, increasing net foreign asset position.
  - Trade agreements:
    - Removing tariff and non-tariff trade barriers results in a sizeable reduction to import prices, boosting investment and consumption.
    - Imports increase; real exchange rate must depreciate to bring trade balance back to equilibrium.
    - Current account remains weakened in the long run (difference between black and red lines) due to large short-run trade balance deterioration lowering net foreign asset position and income flows.
  - Decomposition of reform impacts on GDP (level effects):
    - Labor market reforms (dual labor market reform) contribute almost 6.5 percent to the level of output (largest output effect).
    - Increased domestic labor force participation contributes 3.5 percent to the level of GDP (second-largest).
    - Within product market/corporate reforms:
      - Product market reforms yield output increase of 2 percent.
      - Reforms to small and medium enterprises (SME) yield output increase of 1.7 percent.
  - Uncertainty:
    - Results assume productivity of non-regular workers catches up fully with that of regulars and may represent an upper bound to GDP gains.
    - If only half of the productivity gap is closed, the long-run real GDP gain is smaller by about 3 percentage points.
- Case B (Not-Fully-Believed Reforms):
  - Not-fully-believed reforms have significantly lower near-term impact on GDP, do not help inflation reach the BoJ target, and result in less government debt reduction in the long run.
  - Long-run GDP, consumption, investment and real wage impacts are nevertheless close to the fully-credible scenario.
  - Mechanism:
    - Weaker short-term boost because firms and households do not expect further reform efforts to materialize; are surprised when reforms are implemented, delivering gradual increases in investment and consumption.
    - Demand increases broadly in line with potential output during implementation → less inflationary pressure.
    - Without sustained near-term inflation pickup, the central bank cannot increase inflation expectations toward two percent; inflation remains at one percent in the long run.
    - Smaller nominal GDP increase → lower reduction in public-debt-to-GDP ratio relative to Case A.
- Case C (Fully-Credible Reforms with Monetary Accommodation):
  - Monetary accommodation plus fully-credible reforms results in stronger near-term activity and further boosts inflation.
  - Near-term real interest rate falls → households and firms bring forward consumption and investment → exchange rate depreciates in the near term.
  - Inflation increases by more and public debt declines more rapidly.
  - Long-run impacts are the same as in Case A.
- Case D (Abenomics Redux: Fully-Credible Reforms + Monetary Accommodation + Public Debt Stabilization):
  - Structural reforms with monetary accommodation and public debt stabilization can partially offset demographic headwinds.
  - Simulation insight:
    - Fully-credible structural reforms boost the level of GDP by about 15 percent in 40 years relative to the demographic headwinds from the “current policies” scenario (which showed a 25 percent decline).
      - Cited 15 percent is the difference between the blue and black bars in the GDP panel in Figure 7.
    - Activity is lower in response to public debt stabilization (black versus red lines); increase in national savings raises the current account (though it still shows a small decrease in the long-run).
    - Inflation exhibits a similar boost as Case C; consumption tax rate hikes only slightly upgrade inflation.
    - Overall, fully-credible structural reforms plus public debt stabilization and monetary accommodation undo much of the damaging demographic effects.
  - Public-debt-to-GDP stabilization drivers:
    - Near-term: higher nominal GDP growth from structural reforms and monetary accommodation drives reduction in public-debt-to-GDP ratio.
    - Long-term: interest cost savings and primary surpluses also contribute to the reduction in the public-debt-to-GDP ratio.

### Key quantitative highlights (preserved exactly as in the source)
- Potential growth increase examples: 0.2 percentage points every year for twenty years.
- Investment level example: 5 percent higher after ten years.
- Perceived inflation target: one percent; Bank of Japan’s inflation target: two-percent.
- Fully-credible reforms boost GDP by over 10 percent above the baseline after ten years.
- Labor duality reform contribution to output: almost 6.5 percent.
- Domestic labor participation contribution: 3.5 percent.
- Product market reform contribution: 2 percent.
- SME reform contribution: 1.7 percent.
- Partial labor productivity catch-up scenario: delivers a smaller real GDP gain by about 3 percentage points in the long run.
- Monetary accommodation rule specifics:
  - Coefficient on lagged interest rates of 1 and coefficient on inflation of 0 for two years.
  - Subsequently lower lagged-interest coefficient from 1 to 0.4 and increase inflation coefficient from 0 to 0.9 over five years.
- Abenomics Redux: fully-credible structural reforms boost the level of GDP by about 15 percent in 40 years relative to demographic headwinds (baseline showed a 25 percent decline).
- Consumption tax increase for debt stabilization: increase consumption tax rates by 50 percent of the consumption tax rate path envisaged by McGrattan and others (2018).
- Long-run/steady-state horizon used: LR = Long-run/steady-state (40+ years).

*Source: wp18248 — Section II (GIMF simulations and IMF staff’s calculations) — canonical PDF content.*

### Appendix E shows the

### wp18248 - Appendix E shows the

### Public-debt-to-GDP drivers and Figure 8 summary
- Appendix E shows the derivation of each driver of the public-debt-to-GDP ratio reduction.
- Figure 8 (Japan: Public Debt Consolidation from Credible Structural Reforms and Consumption Tax Increase) notes:
  - 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.
  - Interest costs increase as the policy rate is gradually lifted after the first two years.
  - Reported effects are changes to the baseline reported in Figure 1.
  - Sources: GIMF simulations and IMF staff's calculations.

### Main conclusions (Section V)
- Japan’s economic prospects remain weak in the face of strong demographic headwinds.
- Baseline model simulations show that Japan’s demographics — the declining and the ageing of the population — are expected to reduce real GDP by over 25 percent in about 40 years under current policies, relative to a projection where productivity and population continue to grow at their recent pace.
- Role and credibility of structural reforms:
  - The paper uses the IMF’s Global Integrated Monetary and Fiscal Model (GIMF) to evaluate structural reforms and emphasizes the importance of reform credibility.
  - Upper bound (fully credible reforms): boost real GDP by about 15 percent in 40 years relative to the baseline scenario, while accounting for monetary accommodation and public debt stabilization.
  - Not-fully-believed reforms: deliver a smaller near-term boost to real GDP and weaker improvements in inflation and public debt dynamics.
  - In practice, impacts likely fall between fully-credible and not-fully-believed cases, given difficulty of achieving full credibility.
  - Policy implication: higher consumption tax rates are likely to be needed to stabilize Japan’s public debt, relative to those rates estimated under the scenario with fully-credible reforms with monetary accommodation and public debt stabilization.

### Appendix A — Estimation of the impact of mitigating labor-market duality
- Purpose and headline estimate:
  - Describes estimation of the impact from introducing intermediate contracts — found to boost productivity by about 7 percent after 30 years.
- Background on dual labor market:
  - Rapid increase in non-regular workers has reduced labor productivity in Japan.
  - Non-regular workers typically receive temporary contracts with little training, few career opportunities, and low job security.
  - Almost 70 percent of non-regular workers are females.
- Wages and productivity differentials:
  - The weighted average wage differential (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.
  - Non-regular young workers (below 25 years old) are paid between 80 and 85 percent of regular workers’ wages.
  - Fukao and others (2006) estimate a 20 percent productivity gap between regular and non-regular workers (Japan’s manufacturing sector); about half of the observed wage gap reflects productivity differences.
- Policy experiment: intermediate contracts
  - Assumption: starting in 2019 all new contracts are intermediate contracts; existing contracts remain as they are for the duration of that contract (grandfathering of existing regular contracts).
  - Existing non-regular contracts before 2019 assumed to remain non-regular for around 4 years.
  - Intermediate contracts: employment protection higher than non-regulars but lower than regulars, so overall employment protection is left unchanged.
  - Intermediate workers are assumed to eventually become as productive as regular workers (full catch-up of the 20 percent productivity gap).
- Quantified impacts and timing:
  - The gradual introduction of intermediates implies overall productivity improvement shown in Figure 11; the estimated productivity improvement over time exceeds 7 percent by 2035.
  - This increase corresponds to an increase in TFP growth of 0.3 percentage points per year over twenty years.
  - The estimated 7 percent after 30 years is presented as an upper bound if intermediate workers’ productivity fully reaches that of regular workers.
  - Given projected demographics and the assumption that all new contracts are intermediate while existing regular contracts are maintained until retirement, the share of intermediate contracts reaches around 90 percent of all contracts by 2035.
- Data and methodology highlights:
  - Population cohorts: individuals aged 16 to 75 by sex, from the National Institute of Population and Social Security Research (projections to 2100).
  - Employment rates by cohort from the Statistics Bureau in Japan; cohorts aggregated into 15-24, 25-34, 35-44, 45-54, 55-64 and 65+ categories; participation rates assumed constant.
  - Employment rates and shares of regular workers (Table 1) used to determine numbers of workers by age and gender.
  - Transition probabilities (annualized hazard rates) from Esteban-Pretel and others (2011) used to approximate numbers by contract type, age and gender (Table 2).
  - Key transition-probability assumptions:
    - Employees on regular contracts in a given year had an 89 percent probability of remaining regular in the following year.
    - Probability of remaining in non-regular employment is 49 percent (significantly lower than regulars’ 89 percent).
    - It is assumed that those workers that were inactive or unemployed in the previous period would be offered intermediate contracts with 100 percent probability.
  - Using these probabilities and shares, projections matched observed data for 2015 and 2016 and projected regular, non-regular and intermediate contracts over time.

*Source: IMF staff calculations and GIMF simulations as described in wp18248 - Appendix E*

### APPENDIX B. GIMF MODEL SUMMARY

### APPENDIX B. GIMF MODEL SUMMARY

### Overview
- 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.
- Key frictions: sticky prices and wages, real adjustment costs, liquidity-constrained households, finite-planning horizons of households.
- Finite horizons allow well-defined steady states where countries can be long-run debtors or creditors and permit analysis of transitions between steady states driven by fiscal policy and private saving behavior.
- Non-Ricardian features make fiscal measures non-neutral: spending-based and revenue-based fiscal measures have non-neutral effects.
- Sustained government deficits:
  - Stimulate activity in the short run.
  - Crowd out private investment and net foreign assets in the long run.
  - In large economies can lead to a higher world real interest rate (endogenous).
- Asset market structure:
  - Government debt: domestic, nominal, non-contingent, one-period bonds denominated in domestic currency (held domestically).
  - Internationally traded assets: nominal, non-contingent, one-period bonds denominated in U.S. dollars 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; households receive lump-sum dividend payments.
- Financial sector includes a BGG-style financial accelerator: external finance costs rise with firm indebtedness.
- Version used in this paper comprises six regions; all bilateral trade flows and relative prices (including exchange rates) are explicitly modeled, enabling analysis of regional and global policy spillovers.

### A. Household Sector
- Two household types:
  - Overlapping-generation households (OLG): optimize over a 20-year planning horizon; save via domestic government bonds, international U.S. dollar bonds, and fixed-term deposits; aggregate consumption is a function of financial wealth and the present discounted value of after-tax wage and investment income.
  - Liquidity-constrained households (LIQ): do not save, have no access to credit; consumption equals current net income; marginal propensity to consume out of current income = unity.
- Fiscal incidence and OLG features:
  - A tax cut has a short-run positive effect on output for OLG households.
  - If cuts are matched with future tax increases that leave long-run government debt unchanged, the short-run impact remains positive due to time-profile tilting of consumption toward the present.
  - OLG households discount future tax liabilities at a higher rate than the market rate; an increase in government debt today can represent an increase in their wealth because some future taxes fall beyond their planning horizon.
  - Permanent increases in government debt (with long-run tax rises to stabilize debt-to-GDP) crowd out real private capital by raising real interest rates.
- Interest rate effects:
  - Increases in the interest rate reduce consumption mainly through wealth valuation effects.
  - Intertemporal substitution effect is moderate and calibrated to empirical evidence.
  - The intertemporal elasticity of substitution determines the magnitude of long-run crowding-out effects of government debt.
- Demographics:
  - Recent addition: time-varying population growth, survival probabilities, and work time endowment to match ageing and shrinking populations (Carton and others, 2018).
  - Demographics affect household consumption, leisure decisions, and the stochastic discount factor, which affects investment.

### B. Production Sector
- Firms:
  - Produce tradable and nontradable intermediate goods.
  - Managed according to preferences of finitely-lived households (firms have finite-planning horizons), generating a substantial equity premium driven by impatience.
  - Subject to nominal rigidities in price setting and real adjustment costs in labor hiring and investment.
  - Pay capital income taxes, wages to households, and dividends to OLG households.
- Financing and bankruptcy:
  - Retained earnings insufficient to finance investment fully; firms borrow from financial intermediaries.
  - If earnings fall below contracted interest payments, intermediaries take over capital stock (less auditing and bankruptcy costs) and redistribute to depositors (households).
- Market structure and pricing:
  - Monopolistic competition with price markups over marginal cost.
  - Exports priced to local destination markets; imports face quantity adjustment costs.
  - Price adjustment costs produce sticky prices.
- Public infrastructure:
  - Firms use public infrastructure (government capital stock) as an input; government capital augments productivity.

### C. Financial Sector
- Asset menu limited:
  - Government debt: one-period domestic-currency bonds.
  - Banks offer one-period fixed-term deposits to households and use these funds for loans to firms.
  - Financial assets and firm ownership are not tradable across borders.
  - OLG households may issue or purchase tradable U.S.-dollar-denominated obligations.
- Banks and financial accelerator:
  - Banks pay market return on deposits and charge a risk premium on loans.
  - Lending rate includes an external financing premium that 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.
- International interest parity:
  - Uncovered interest parity may not hold due to country risk premiums, creating short-run and long-run deviations between regional interest rates, even after adjusting for expected exchange rate changes.

### D. International Dimensions and Spillovers
- Explicit modeling of all bilateral trade flows, relative prices, and exchange rates for each region; flows include exports and imports of intermediate and final goods.
- Steady-state calibration matches observed flows in recent data.
- International linkages driven by global saving and investment decisions, a by-product of consumers’ finite horizons, leading to uniquely defined current account balances and net foreign asset positions.
- Net foreign asset positions are represented by nominal non-contingent one-period bonds denominated in U.S. dollars due to incomplete asset markets.
- Determinants of spillovers:
  - Magnitude of trade linkages.
  - Uncovered interest parity deviations.
  - Long-term movements in the world real interest rate.

### E. Fiscal and Monetary Policy
- Fiscal instruments:
  - Government spending: consumption or investment expenditure, or lump-sum transfers to all households or targeted to LIQ households.
  - Revenue instruments (previous versions): taxes on labor income and capital returns, consumption taxes, lump-sum taxes.
  - Recent versions (Carton and others, 2017): corporate income and cash flow taxes (CFT) including destination-based components (DBCFT).
    - CFT: taxes corporate cash flows from sales after deducting cost of labor, investment, and intermediate inputs.
    - DBCFT: revenues from exports not subject to tax; cost of imports cannot be deducted.
  - Tariffs on imported goods can be a revenue source.
  - Government investment augments public infrastructure, which depreciates at a constant rate.
- Fiscal rule:
  - Ensures long-run sustainability and allows short-run counter-cyclical policies (embodies automatic stabilizers).
  - Rule ensures government debt-to-GDP and deficit-to-GDP ratios converge to target levels, excluding sovereign default risk.
  - Instruments: changes in labor and capital income taxes (can be replaced by other tax, transfer, or spending instruments).
- Monetary policy:
  - Central bank uses an inflation-forecast-based interest rate rule, varying the gap between the actual policy rate and the long-run equilibrium rate to stabilize inflation over time.
- Important model limitations and disclaimers for corporate taxes (Carton and others, 2017):
  - Model omits channels from multinational firm behavior: transfer pricing, patent relocation, financial structure changes, relocation of production.
  - Absence of multinational firms means tax-base shifts across countries are not captured.
  - Simplifying assumptions on currency denomination of foreign liabilities prevent capturing balance sheet effects of exchange rate movements.

### Calibration and Simulation Strategy (Japan block)
- Calibration targets: Japan “great ratios” and shares (2012–16 average) used to match consumption, private investment, government spending, trade-to-GDP, labor share, tax revenues to GDP, and share of tradeables in production (Table 3).
- Key Japan shares and ratios to GDP (2012–16 average):
  - Consumption 57.0 (percent)
  - Private Investment 16.4 (percent)
  - Government Consumption 21.1 (percent)
  - Government Investment 5.4 (percent)
  - Exports 15.6 (percent)
  - Labor 64.0 (percent)
  - Tradeables 40.0 (percent)
  - Tax Revenue 31.2 (percent)
  - Net government debt 194.0 (percent)
- Nominal rigidity and inflation expectations in Japan:
  - Rotemberg price adjustment cost set so prices change on average every three years (mapping from Calvo estimates of Sugo and Ueda (2008)).
  - Rotemberg parameter set at a high value across equations with nominal rigidities (tradeables, non-tradeables, final consumption, investment goods, wages) implying high nominal rigidity.
  - Inflation target parameter calibrated to one percent (reflects perception that Bank of Japan does not have full credibility on achieving two-percent target).
  - Monetary policy reaction function parameters: degree of interest rate inertia 0.4; coefficient on expected one-year ahead inflation 1.9 (parameters of Kumhof and others (2010)).

### GIMF Simulation Strategy for Japan Structural Reforms (Table 4 summary)
- Simulation notes:
  - For "duality" case, total factor productivity (TFP) increased by 7 percent gradually over 25 years (per Appendix A calculations).
  - Product market and SME reforms used TFP shocks.
  - Increased female (and older worker) labor force participation: labor supply shocks such that growth rose by 0.2 percent per year over 20 years (in line with IMF 2013a).
  - Migration: labor supply shocks producing 0.1pp output growth for 10 years.
  - Corporate governance reform: shocks to borrower riskiness (lowering it) in the financial accelerator to increase investment level after 10 years (5 percent increase in level of investment after 10 yrs).
  - Tariff and non-tariff barrier shocks used to capture trade agreements (removals with respect to CPTPP and EU countries over 5 yrs).
  - Simulations do not assume complementarity or substitutability between structural reforms; interactions are not accounted for.
- Table 4: Reform area, Shock, Magnitude, Reference
  - Labor market duality — TFP — 7.5 percent increase after 30 yrs — Authors' calculation (Appendix A)
  - Labor Force Participation — Labor supply — 0.2pp output growth for 20 yrs — IMF AIV (2013)
  - Migration Participation — Labor supply — 0.1pp output growth for 10 yrs — IMF AIV (2013)
  - Product Market — TFP — 2.4 percent increase after 5 yrs — OECD (2017)
  - SME — TFP — 0.2pp potential output growth increase for 10 yrs — IMF AIV (2013)
  - Corporate Governance — Investment/Credit — 5 percent increase in level of investment after 10 yrs — Sher (2014), Aoyagi and Ganelli (2017)
  - Trade Policy — Tariff, NTB — Tariff and NTBs removal wrt CPTPP and EU countries over 5 yrs — Kee et al (2009)

### Appendix D: Decomposition of Labor and Product Market Reforms (fully-credible)
- Figures 13 and 14 (not reproduced here) present decompositions of fully-credible labor market and product market reforms.
- Effects reported are changes relative to the baseline; X-axis denotes years, LR = Long-run/steady-state (40+ years).
- Outcomes shown in the decompositions include: Current account/GDP (pp difference), GDP (% difference), Consumption (% difference), Business Investment (% difference), Real Wage (% difference), CPI Inflation (pp difference), Interest rate (pp difference), Real Effective Exchange Rate (% difference, +=depreciation), Public Debt/GDP (pp difference).

### Appendix E: Drivers of Public Debt Reduction under “ABENOMICS REDUX” scenario
- Public debt accumulation identity (nominal):
  - DD_t = DD_{t−1} + i_t DD_{t−1} − PS_t
    - where D is nominal public debt, i is the interest associated with the debt, PS is the public sector nominal primary surplus (public sector expenditures excluding interest payments minus public sector revenues).
- Dividing by nominal GDP and defining lowercase ratios and nominal GDP growth φ yields:
  - d_t = d_{t−1} / (1+φ_t) + i_{t−1} d_{t−1} / (1+φ_t) − psp_t
- Rewritten as:
  - d_t − d_{t−1} = i_t d_{t−1} / (1+φ_t) − φ_t d_{t−1} / (1+φ_t) − psp_t
- Alternative decomposition definitions used:
  - iiicc pi p?_{t} ≡ i_{t−1} d_{t−1}   (equation numbering in source: (5))
  - pppp_{t} ≡ psp_{t}   (equation (6))
  - gpgigih_{t} ≡ d_{t} − d_{t−1} − i_{t−1} d_{t−1} + psp_{t}   (equation (7))
- Growth contribution in (7) computed as residual for given interest costs on debt and primary surplus.
- For deviations from the baseline, equation (8) expresses cumulative deviations in public debt-to-GDP in terms of summed deviations of interest-cost contributions, growth contributions, and primary surplus contributions over the simulation horizon.
- Important observation:
  - d_{t−1} − d_{t−1}^{base} = 0 for the period before structural reforms and consumption tax hikes start (levels match baseline).
  - As the level of public debt declines (due to structural reforms and higher consumption tax rates), the contribution from interest costs can change sign even if nominal interest rates are higher.

*Source: APPENDIX B. GIMF MODEL SUMMARY (from wp18248 - APPENDIX B. GIMF MODEL SUMMARY).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2018/wp18248.pdf_