The Optimum Quantity of Debt for Japan
Japan's net government debt reached 130% of GDP in 2013. The present paper analyzes the welfare implications of the large debt for Japan. We use an Aiyagari (1994)-style heterogeneous-agent, incomplete-market model with idiosyncratic wage risk and endogenous labor supply. We find that under the utilitarian welfare measure, the optimal government debt for Japan is -50% of GDP and the current level of debt incurs the welfare cost that is 0.22% of consumption. Decomposing the welfare cost by the Flodén (2001) method reveals substantial welfare effects arising from changes in the level, inequality, and uncertainty. The level and inequality costs are 0.38% and 0.52% respectively, whereas the uncertainty benefit is 0.68%. Adjusting consumption taxes instead of the factor income taxes to balance the government budget substantially reduces the overall welfare cost.
Japan's net government debt reached 130% of GDP in 2013 and the debt to GDP ratio is the highest among developed countries. A large number of papers, including Hoshi and Ito (2014), Imrohoroğlu, Kitao, and Yamada (2016), and Hansen and Imrohoroğlu (2016), analyze Japan's debt problem. However, the welfare effect of the large government debt has been less understood. Flodén (2001) finds that the optimal government debt for the United States is 150% of GDP. Is the optimal debt for Japan similar and hence should Japan accumulate more debt? Or does the current debt exceed the optimal level? How much is the welfare benefit of having the optimal level of debt instead of the current debt?