Japanese macroeconomic dilemmas: The implications of demographics for growth and stability

Abstract

Japan's post-WWII baby boom and the subsequent drop in fertility resulted in a series of sharp demographic transitions. The macroeconomic impact is large. Due to labor force changes, growth in the 1990s would in any event have been in the range of 1-2%, little better than actual performance; poor monetary and fiscal policy are secondary in importance. Demographic changes also led to swings in domestic savings and investment balances and in the flow-of-funds among sectors. With hindsight it should not be surprising that policymakers made major blunders or that financial institutions incurred large losses attempting to adapt to swings in the structure of their balance sheets. Finally, Japan now faces the demographic transition to an old-age society, from a starting point of large fiscal deficits and with a large stock of government debt. Restoring fiscal sustainability on top of the need to increase revenues to cover age-related transfers will require net taxes to increase by 19% of GDP. Accomplishing that will be a major political and administrative challenge and will inevitably hold growth below its 1% potential level during the coming decade