Fiscal Policy Switching in Japan, the U.S., and the U.K.
This paper estimates fiscal policy feedback rules in Japan, the United States, and the United Kingdom for more than a century, allowing for stochastic regime changes. Estimating a Markovswitching model by the Bayesian method, we find the following: First, the Japanese data clearly reject the view that the fiscal policy regime is fixed, i.e., that the Japanese government adopted a Ricardian or a non-Ricardian regime throughout the entire period. Instead, our results indicate a stochastic switch of the debt-GDP ratio between stationary and nonstationary processes, and thus a stochastic switch between Ricardian and non-Ricardian regimes. Second, our simulation exercises using the estimated parameters and transition probabilities do not necessarily reject the possibility that the debt-GDP ratio may be nonstationary even in the long run (i.e., globally nonstationary). Third, the Japanese result is in sharp contrast with the results for the U.S. and the U.K. which indicate that in these countries the government’s fiscal behavior is consistently characterized by Ricardian policy.
Recent studies about the conduct of monetary policy suggest that the fiscal policy regime has important implications for the choice of desirable monetary policy rules, particularly, monetary policy rules in the form of inflation targeting (Sims (2005), Benigno and Woodford (2007)). It seems safe to assume that fiscal policy is characterized as “Ricardian” in the terminology of Woodford (1995), or “passive” in the terminology of Leeper (1991), if the government shows strong fiscal discipline. If this is the case, we can design an optimal monetary policy rule without paying any attention to fiscal policy. However, if the economy is unstable in terms of the fiscal situation, it would be dangerous to choose a monetary policy rule independently of fiscal policy rules. For example, some researchers argue that the recent accumulation of public debt in Japan is evidence of a lack of fiscal discipline on the part of the Japanese government, and that it is possible that government bond market participants may begin to doubt the government’s intention and ability to repay the public debt. If this is the case, we may need to take the future evolution of the fiscal regime into consideration when designing a monetary policy rule.