Aging Population and Fiscal Stability condition faced with population Aging

Naoyuki Yoshino, Ph.D. Dean, ADB Institute, yoshino@econ.keio.ac.jp

Tetsuro Mizoguchi, Ph.D. Reitaku University, tmizo@reitaku-u.ac.jp

Farhad Taghizadeh-Hesary, Ph.D. Keio University, farhadth@z3.keio.jp

Tokyo Fiscal Forum IMF-ADBI-PRI June 11, 2015

Background (Background) • Japan entered into the aged-society Japan faces the huge increases of social security. • Japan accumulate the huge budget deficits → Managing the demand for government bonds are very important. (Main Purpose) We propose the fiscal policy rules that attain both the fiscal sustainability and the economic recovery facing with aging-society.

Objectives & Main Results 1. Domar rule(interest rate < economic growth) Bohn’s condition 𝑷𝑷𝒕 = 𝑷𝑷𝟏 + 𝝁 𝒃𝒕−𝟏 − 𝒃𝟎 Obtained from Government Budget Constraint 2. Supply of Government bond Demand for Government bond is neglected Bohn’s condition does not satisfy economic recovery Objective loss function focuses only on the stability of the budget and not on economic growth. 3. New Fiscal Policy Rules need to be estabilished.

General Questions Japan’s gross Debt/GDP ratio is around 230% Greece gross Debt/GDP ratio is 188%. Why did Greece go into trouble ? Why does JGB interest rate be lowerest? ⇒Three reasons: the demand structure for government bonds; Low Sale Tax Rate(large fiscal space); Independent Monetary Policy

1995 2014

95.1% 229.6%

Japan’s Debt /GDP Ratio

5

1995 2014 101.2% 188.7%

Greece Debt / GDP Ratio

Source: OECD Economic Outlook

Gross Debt/GDP ratio, 2014 Selected OECD Countries

6

Source: OECD Economic Outlook

229.6

188.7

147.2

111.1

35.2 31.6

13.0

0.0

50.0

100.0

150.0

200.0

250.0Ja

pan

Gree

ceIta

lyPo

rtug

alIre

land

Fran

ceO

ECD-

Tota

lSp

ain

Belg

ium

Uni

ted

Stat

esU

nite

d Ki

ngdo

mIc

elan

dCa

nada

Hung

ary

Aust

riaN

ethe

rland

sSl

oven

iaGe

rman

yFi

nlan

dSl

ovak

Rep

ublic

Czec

h Re

publ

icPo

land

Denm

ark

Swed

enSw

itzer

land

New

Zea

land

Kore

aN

orw

ayAu

stra

liaLu

xem

bour

gEs

toni

a

perc

ent

7

0

50

100

150

200

250

Japan Canada Italy U.S.A Greece

Gross Debt/GDP ratio (2013) (Selected Countries)

Data Source：OECD Outlook

General Government Net Debt (International Comparison)

0

20

40

60

80

100

120

140

160

1999200020012002200320042005200620072008200920102011201220132014

Japan U.K. Germany France Italy Canada

Source: MOF

Japan 148.7

Japan

• First we would like to show the Flow of Fund in Japan.

• Who held JGB? How much? How about Greece?

• The demand for government bond and holders create different consequences.

9

Recent Money Flow of Japan

10

Source: BOJ Flow of Funds

0

500000

1000000

1500000

2000000

2500000

3000000

3500000

4000000

Jul-9

1Ju

n-92

May

-93

Apr-

94M

ar-9

5Fe

b-96

Jan-

97De

c-97

Nov

-98

Oct

-99

Sep-

00Au

g-01

Jul-0

2Ju

n-03

May

-04

Apr-

05M

ar-0

6Fe

b-07

Jan-

08De

c-08

Nov

-09

Oct

-10

Sep-

11Au

g-12

Jul-1

3Ju

n-14

Bank Loan (City Banks)

Bank Loans (RegionalBanks I & II)

Bank Loans of Japan

11

Source: BOJ billion Large Banks : 202 trillion yen Regional banks: 216 trillion yen (2014, Nov)

Declining Bank Loans in Japan

1. Stricter Basel Capital Requirement (Basel III) 2. Government Bonds = Zero Risk 3. Declining Domestic Demands for Bank Loans Shift production from Japan to other Asia Low expected rate of return 4. Corporations’ Surplus Profits from Overseas’ production Cash rich companies

12

Changes in Japan’s Money Flow High Growth Period Households Savings Corporate Capital Investment Stock S I K Recent Period Corporate Savings Government Elderly people S G(B) Abolish Retirement Age Increase working population Pension payment will start 65 or later Wage rate be based on marginal productivity

13

FY 2012 General Account Initial Budget (Japan)

Source: MOF

Local Allocation Tax Grants, etc.

161,424 16.8%

Public Works 5,968.5

6.2% Education & Science 5,442.1

5.7%

National Defense 4,884.8

5.1%

Others 9,656.8 10.1%

（Note1）Figures may not add up to the totals due to rounding.

（Note2）The ratio of Social Security expenses to General Expenditures*：54.0% *General Expenditures equals to the Primary Expenditure minus Local Allocation Tax Grants, etc.

Social Security 30,517.5

31.8% General Account

Total Expenditures 95,882.3 (100.0%)

Redemption of the National Debt

13,138.3 13.7%

Interest Payments 10,131.9

10.6%

Primary Expenses 72,612.1

75.7%

National Debt Service

23,270.2 24.3%

General Account Budget for FY2014 -Breakdown of Expenditure-

Food Supply 1,050.7 (1.1)

Promotion of SMEs 185.3 (0.2)

Energy 964.2 (1.0)

Former Military Personal Pensions

444.3 (0.5)

Economic Assistance 509.8 (0.5)

Miscellaneous 6,152.6 (6.4)

Contingency Reserves 350.0 (0.4)

Total Account (Initial General and Special Account, 2014)

[分類名] 91.4

[パーセンテージ]

[分類名] [値]

[パーセンテージ]

[分類名], [値]

[パーセンテージ]

[分類名] [値] [パーセンテージ]

[分類名] [値]

[パーセンテージ]

Total 234.7

Unit: trillion Yen

Budget Allocation of Central Government (Japan, 1985-2011)

17

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Bond Expenditure

Education

Social Securities

Defense

Exp of Local Government

National land conservationand development

Source: MOF Billion yen

Trends in Interest Payments and Interest Rate

18

Source: MOF

0

100

200

300

400

500

600

700

800

900

0

2

4

6

8

10

12

14

16

18

20

1975 1980 1985 1990 1995 2000 2005 2010

Government Bond Outstanding

Interest Rate

Interest Payment

(trillion Yen) (%)

Trends in General Account Tax Revenues, Total Expenditures and Government Bond Issues

0

20

40

60

80

100

120

Special Deficit-Finanicing BondIssues

Construction Bond Issues

Tax Revenue

Total Expenditure

Source: MOF

Crocodile’s Mouth

Population Aging of Japan

20

Source：Ministry of Internal Affairs and Communication

Forecast (2012) 10 of Thousands

Current Figures

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000Age 65 andover

Age 15～64

Age 14 andless

AgedPopulationRatioWorkingPopulationRatio (15-64)Total FertalityRate (TFR)

FY

Peak of the Population 2004, 127.8 million

Total Fertility Rate (TFP) of Major Countries (1980-2015)

21

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

1980-1985 1985-1990 1990-1995 1995-2000 2000-2005 2005-2010 2010-2015Korea U.S.A France United KingdomGermany Japan India Brazil

Source: UN

Aged Dependency Ratio of Major Countries (1980-2040)

22

0

10

20

30

40

50

60

70

1980 1987 1994 2001 2008 2015 2022 2029 2036

Korea U.S.A France United Kingdom Germany

Japan India Brazil China Russia

Source: UN

Aged Population of Major Countries (1980-2040)

23

0

50

100

150

200

250

300

350

400

1980 1990 2000 2010 2020 2030 2040

Korea U.S.A France United Kingdom Germany

Japan India Brazil China Russia

(2010=100)

Source: UN

Households’ Savings Ratio

24

0

2

4

6

8

10

12

14

16

18

20

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014Canada Japan United States Euro area (15 countries)

Source: OECD

Effects on Population Aging and Declining Birthrate

(1) GDP Growth Rate↓(Working Population Declining) → Debt/GDP Ratio↑

(2) Life Cycle Saving Households’ Saving Rate↓ → Demand of Government Bond ↓ (3) Pay-as-you-go System (Pension)→Broadening the generation disparity→It will be burdened

25

Generational Inequality Aged People have strong VOICE→Voting Right Young generation do not have any Voting Right. Young people do not go for Voting. Aged People wants to receive benefits. Japanese Pension Scheme -- Pay as you go system In 1950s, Retirement Age 55, Life expectancy 59 In 2010, Retirement Age 60,65, Life expectancy 88 We proposed to start pension payments from 60->65->70 by allowing old people to work Japanese Survey shows many people want to work

26

MOF’s JGB management policy

(1) Dialogue between MOF and market participants (esp, Institutional investors) (2) Diversification the JGB holders and it’s variety (3) Improvement of Liquidity in JGB (4) Sophistication of Debt Management

27

Issues of Various Government Bond

Short term 1 to 5 years (Banks, Postal Saving) 10 years (Trust Banks, Insurance) Inflation indexed bond 15 year (floating bond) 20 year (Insurance, Pension Funds, Kampo) 30 year (Insurance, Pension funds) 40 year (Pension fund, Insurance)

28

Market Issuance Plan by JGB Types

29

Unit：trillion Yen Source: MOF Source: MOF

Japanese Debt (2012) HOLDERS %

Banks and Postal Savings 45% Life and Non-life Insurances 20% Public Pension funds 10% Private Pension Funds 4% Central Bank of Japan 8% Overseas’ Investors 8% Households 5% Others 3%

30 Source: BOJ

Japanese Debt, 92% are held by Domestic Investors (2014)

HOLDERS %

Banks and Postal Savings 27.8% Central Bank of Japan 21.2% Life and Non-life Insurances 19.3% Overseas’ Investors 8.5% Public Pension funds 6.4% Private Pension Funds 3.4% General Government 2.6% Households 2% Others 1.5% 31

Source: BOJ Flow of Funds

Abenomics

BS of BOJ

Long term JGB

89

Others

Banknotes 87

Current deposit 47

ETF etc. 6.6

Long term JGB

142

Others

Banknotes 90

Current deposit

107

Long term JGB

200

Others

Banknotes 87

Current deposit

177 ETF etc. 8

ETF etc 9.3

Total Asset: 158

Total Asset: 224

Total Asset: 297

FY2012 FY2013 FY2014

Data Source：BOJ

Unit: Trillion Yen

Monetary Base (Seasonally Adjusted / Average amounts outstanding)

34

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

Source: BOJ

Unit: 100 million yen

Greece, 72% of their debts are held by overseas’ Investors (2011)

HOLDERS ％ Eurozone 15% ECB 15% IMF 6% Greek banks & non-banks 23% Other European Banks 10% Non European Banks 8% Non-Greek non-Banks 23%

Source：Financial Times 35

where

𝒓𝒕=Interest Rate 𝜼𝒕=Growth rate

36

𝒃𝒕 − 𝒃𝒕−𝟏 = 𝒓𝒕 − 𝜼𝒕 𝒃𝒕−𝟏 + 𝒈𝒕 − 𝒕𝒕

𝒃𝒕 =𝑷𝒕𝒀𝒕

,𝒃𝒕−𝟏 =𝑷𝒕−𝟏𝒀𝒕−𝟏

,𝒈𝒕 =𝑮𝒕𝒀𝒕

, 𝒕𝒕 =𝑻𝒕𝒀𝒕

Domar Condition

Interest rate and Economic growth rate （1995-2013）

Source: MOF and Ministry Cabinet 37

Domar Condition does not hold in Japan 19

95Q

119

95Q

319

96Q

119

96Q

319

97Q

119

97Q

319

98Q

119

98Q

319

99Q

119

99Q

320

00Q

120

00Q

320

01Q

120

01Q

320

02Q

120

02Q

320

03Q

120

03Q

320

04Q

120

04Q

320

05Q

120

05Q

320

06Q

120

06Q

320

07Q

120

07Q

320

08Q

120

08Q

320

09Q

120

09Q

320

10Q

120

10Q

320

11Q

120

11Q

320

12Q

120

12Q

320

13Q

120

13Q

3

-10

-8

-6

-4

-2

0

2

4

6

Interest Rate

GDP Growth Rate

Bohn’s Condition

38

• 𝑃𝑃𝑡 = 𝑔𝑡 −𝑡𝑡 Primary Balance（PB） • 𝑷𝑷𝒕 = 𝑷𝑷𝟏 + 𝝁 𝒃𝒕−𝟏 − 𝒃𝟎 Bohn’s Rule: Primary

Balance improvement Rule at t

∑ 𝑃𝑃𝑡𝜆 𝑡

∞𝑡=1 = 𝑏0

• Bohn’s Rule satisfied with “transvesarity condition”.

Implication of Bohn’s condition • Bohn’s condition only gives that the budget

balance is retained in the long run.

→ Bohn’s condition attains the fiscal sustainability. However, it cannot exclude the economic contraction equilibrium where people’s income will decrease and government expenditure will be cut. → That is the reason why we propose the fiscal policy rule with both economic recovery and fiscal sustainability.

39

Japanese Government Bond Yields

0

0.5

1

1.5

2

2.5

5 year

10 year

Source: MOF

Interest rate in selected OECD countries

41

0

5

10

15

20

25

30

35

Jan-

2000

May

-200

0Se

p-20

00Ja

n-20

01M

ay-2

001

Sep-

2001

Jan-

2002

May

-200

2Se

p-20

02Ja

n-20

03M

ay-2

003

Sep-

2003

Jan-

2004

May

-200

4Se

p-20

04Ja

n-20

05M

ay-2

005

Sep-

2005

Jan-

2006

May

-200

6Se

p-20

06Ja

n-20

07M

ay-2

007

Sep-

2007

Jan-

2008

May

-200

8Se

p-20

08Ja

n-20

09M

ay-2

009

Sep-

2009

Jan-

2010

May

-201

0Se

p-20

10Ja

n-20

11M

ay-2

011

Sep-

2011

Jan

-201

2 M

ay-2

012

Sep

-201

2 J

an-2

013

May

-201

3 S

ep-2

013

Jan

-201

4 M

ay-2

014

Sep

-201

4

Perc

ent p

er a

nnum

France

Germany

Greece

Italy

Japan

Portugal

Spain

UnitedKingdom

United States

Source: Monthly Monetary and Financial Statistics (MEI), OECD statistics

Japan’s Supply and Demand for Bonds

tr StB∆

DtB∆

tB∆

4321 EEEE →→→

1E2E

3E4E

42

Greece Supply and Demand for Government bonds

43

tB∆

tr StB∆

DtB∆

Greece

1E

2E3E

4E

4321 EEEE →→→

Greek Case and Japanese Case • Greek Case Foreign fund → large Domestic Deposits →Small →In GGB market, Foreign funds flow out →Interest Rate goes up • Japanese Case Foreign fund → Small Domestic Deposits →Large →In JGB market, Domestic deposits flow into the JGB market →interest rate deflates, whereas the supply of JGB is sufficiently large.

Macroeconomic Model (Supply and Demand for Gov. Bonds)

𝑮𝒕 + 𝒓𝒕𝑷𝒕−𝟏 = 𝚫𝑷𝒕 + 𝑻𝒕 Government Budget Constraint 𝒀𝒕 − 𝑻𝒕 + 𝒓𝒕𝑷𝒕−𝟏 + 𝜽𝑮𝒕 = 𝑪𝒕 + 𝑺𝒕 where 𝑺𝒕 = 𝚫𝑷𝒕 + 𝚫𝑾𝒕

𝑫 − ∆𝑾𝒕𝑭 and 𝜽𝑮𝒕: Public

Investment for elder people 𝒀𝑫𝒕 = 𝒀𝒕 + 𝜽𝑮𝒕 + 𝒓𝒕𝑷𝒕−𝟏 − 𝑻𝒕 = 𝑪𝒕 + 𝑺𝒕 Disposable Income 𝑪𝒕 = 𝒄𝟎 + 𝒄𝟏𝒀𝑫𝒕 Consumption Equation 𝑾𝒕 = 𝒅𝟎 + 𝒅𝟏𝒀𝑫𝒕 + 𝒅𝟐𝒓𝒕 Deposit Equation

45

The long-run interest rate and the long run equilibrium level of debt

𝑷𝒕 = 𝒅𝟐 𝑮�−𝑻�

𝟏−𝒄𝟏−𝒅𝟏 𝒀𝒕𝒇− 𝟏−𝜽 𝑮� +𝑾𝑫+𝑾𝑭− 𝒄𝟎+𝒅𝟎

𝒓𝒕�

=𝒄𝟎 + 𝒅𝟎 + 𝟏 − 𝜽 𝟏 − 𝒄𝟏 − 𝒅𝟏 𝑮� − 𝟏 − 𝒄𝟏 − 𝒅𝟏 𝒀𝒕

𝒇 −𝑾𝑫 −𝑾𝑭

𝒅𝟐

Objective Loss Function of the Government

Minimize the following loss function: 𝐿 𝑃𝑡,𝑌𝑡,𝐺𝑡,𝑇𝑡,∆𝑃𝑡

=12𝑤1 𝑃𝑡 − 𝑃𝑡∗ 2 +

12𝑤2 𝑌𝑡 − 𝑌𝑡

𝑓 2

+12𝑤3 𝐺𝑡 − 𝐺𝑡−1 2 +

12𝑤4 𝑇𝑡 − 𝑇𝑡−1 2

+12𝑤5 ∆𝑃𝑡 − ∆𝑃𝑡∗ 2

𝑤𝑖 (𝑖 = 1,⋯ , 5) are the policy weights where government can set up.

47

Objective Loss Function of the Government

(i) Sustainable Debt /GDP ratio (ii) Stable Economic Growth (iii)Smooth Government Spending (iv)Smooth Tax Revenue (v) Smooth change of flow of bonds

48

Fiscal Policy Rule to stabilize Government Budget Deficits

Our Proposed Government Spending Rule is 𝐺𝑡 − 𝐺𝑡−1

= 𝛼1 𝑃𝑡 − 𝑃𝑡∗ + 𝛼2 ∆𝑃𝑡 − ∆𝑃𝑡∗ + 𝛼3 𝑌𝑡 − 𝑌𝑡𝑓

where𝛼1 = 𝑤1𝑤3

𝑑2− 1−𝜃 1−𝑐1−𝑑1 𝑃𝑡−1𝑑2− 𝑐1+𝑑1 𝑃𝑡−1

,𝛼2 =𝑤5𝑤3

𝑑2− 1−𝜃 1−𝑐1−𝑑1 𝑃𝑡−1𝑑2− 𝑐1+𝑑1 𝑃𝑡−1

,𝛼3 = −𝑤2𝑤3𝜃

49

Optimal Taxation Rule

Our Proposed Government taxation Rule is 𝑇𝑡 − 𝑇𝑡−1 = 𝛽1 𝑃𝑡 − 𝑃𝑡∗ + 𝛽2 ∆𝑃𝑡 − ∆𝑃𝑡∗ +

𝛽3 𝑌𝑡 − 𝑌𝑡𝑓

where𝛽1 = 𝑤1𝑤4

𝑑2𝑑2− 𝑐1+𝑑1 𝑃𝑡−1

,𝛽2 = 𝑤5𝑤4

𝑑2𝑑2− 𝑐1+𝑑1 𝑃𝑡−1

,𝛽3 = 𝑤2𝑤4

50

Fiscal Policy Rule to stabilize Government Budget Deficits

(i) Current Debt – Desired Debt (ii) GDP-gap (iii) Smooth change of government spending (iv) Smooth change of taxation (v) Affordability of Financial Wealth which can be allocated to hold Government Bonds →𝑷𝒕∗

51

Augmented Bohn’s Rule • From our proposed Government spending rule and

taxation rule, we have the following augmented Bohn’s Rule:

𝑷𝑷𝒕 − 𝑷𝑷𝒕−𝟏= 𝜶𝟏 − 𝜷𝟏 𝑷𝒕 − 𝑷𝒕∗+ 𝜶𝟐 − 𝜷𝟐 ∆𝑷𝒕 − ∆𝑷𝒕∗

+ 𝜶𝟑 − 𝜷𝟑 𝒀𝒕 − 𝒀𝒕𝒇

• This is the version of considering both Economic recovery and fiscal sustainability.

52

Policy Implications from the rule

• Bohn’s condition does not satisfy economic recovery. It only gives a condition that the budget balance is retained.

• The fiscal policy rule has to watch how the government debt diverges from the desired level and the GDP gap.

53

Empirical Survey

( ) )(13364558444390 tt rB +=∆

[ ])(212585153)( tt rI ∆−=∆

)(53.09445 tt YDC +=

)(675616)(22.0-10828237)( ttD

t rYDW −+=∆

Demand of government Bond

Investment function,

Consumption Equation

Deposit Equation

55

Theoretical equilibrium GDP and the actual real GDP of Japan (2003Q4 – 2013Q4)

60

70

80

90

100

110

120

130

Y_r Y*

Noted: Y* (constant line) is the obtained income in the short-run equilibrium. Y_r (dashed line) is the real income seasonally adjusted.

56

Theoretical equilibrium interest rate and the actual interest rate on bond (2003Q4 – 2013Q4)

0.00%0.20%0.40%0.60%0.80%1.00%1.20%1.40%1.60%1.80%2.00%

r* r

Noted: r* (constant line) is the obtained interest rate in the short-run equilibrium. r (dashed line) is the long-run JGB interest rate.

57

Government Expenditures and Tax

80

85

90

95

100

105

110

115

1994

Q1

1994

Q3

1995

Q1

1995

Q3

1996

Q1

1996

Q3

1997

Q1

1997

Q3

1998

Q1

1998

Q3

1999

Q1

1999

Q3

2000

Q1

2000

Q3

2001

Q1

2001

Q3

2002

Q1

2002

Q3

2003

Q1

2003

Q3

2004

Q1

2004

Q3

2005

Q1

2005

Q3

2006

Q1

2006

Q3

2007

Q1

2007

Q3

2008

Q1

2008

Q3

2009

Q1

2009

Q3

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

2013

Q1

2013

Q3

2014

Q1

TAX Gov. Expenditures

Conclusion １．We must consider the fiscal policy rules that attain both fiscal sustainability and economic recovery facing with aging & declining birthrate society. ２．From flow of funds, we observed that the private sector’s money flow finances the government debt. However these private sector’s money flow should go not to the government debt finance but to the private economic activity in order to attain the economic growth for fiscal sustainability.

58

Conclusion 3. Because Japan will enter the aged-society, we should postpone the retirement age in order to increase the working-age section and reduce the top portion. And to base wage rates on productivity rather than seniority, as is traditionally the case in most Japanese firms. 4. Using the hometown investment trust fund (Yoshino 2013). The goal of the fund is to connect investors with their hometowns. Since the bank lending still be low, the hometown investment trust fund will be another way to finance SMEs which are needed the funding.

59

References • Bohn, H. (1998) “The Behavior of US Public Debt and Deficits”, Quarterly Journal of Economics, Vol.113, No.3,

pp. 949-963. • Bohn, H. (2005) “The Sustainability of Fiscal Policy in the United States,” CESifo WP No. 1446. • Domar, E. D. (1944) “The Burden of the Debt and the National Income”, American Economic Review, Vol.34,

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Thank you very much for your attention.

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