Fading Ricardian Equivalence in Ageing Japan

IMF Working Papers, September 27, 2016

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Japan appears to be turning less Ricardian, and the trend is set to continue.
Two main developments underpin this change:
- The discount wedge seems to have risen, suggesting that consumers have become more myopic.
- Some evidence points to the possibility that an increasing number of households are liquidity constrained.
If these developments continue, the impact of fiscal policy on the economy will gradually rise.
While a rising fiscal impact facilitates using fiscal policy to manage the economic cycle, it also calls for starting fiscal consolidation soon and in a gradual and steady manner, given the unsustainable public debt and the likely increasing challenges in funding the government's rising debt domestically.

Discount wedge increase:
- The discount wedge seems to have risen, implying greater consumer myopia.
Liquidity constraints:
- Evidence suggests an increasing number of households may be liquidity constrained.
Fiscal multiplier implications:
- A decline in Ricardian behavior would raise the effectiveness (impact) of fiscal policy over time.
Fiscal sustainability concern:
- Rising effectiveness of fiscal policy does not obviate the need for consolidation because public debt is characterized as unsustainable and domestic funding of rising debt will likely face increasing challenges.

Begin fiscal consolidation soon.
Implement consolidation in a gradual and steady manner to manage risks associated with unsustainable public debt and potential funding challenges.
Recognize that greater fiscal effectiveness can be used to manage the economic cycle, but it should not postpone consolidation efforts.

Source: IMF Working Paper “Fading Ricardian Equivalence in Ageing Japan” by Ikuo Saito (September 27, 2016).

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