The Sustainability of Budget Deficit in Japan

After overviewing the performance of the Japanese economy since the end of the bubble era of the late 1980s, we estimate the potential growth rate of Japan by using a production function for its economy. We conclude that the potential growth rate is only about 0.5 % due to the rapidly declining working-age population. Based on this estimate, we then provide a few scenarios for the future path of the debt-to-GDP ratio. We found that it is necessary to raise the consumption tax rate from the current 5% to at least 25% to stabilize the debt-to-GDP ratio. We also note that the net interest payments are likely to rise very rapidly in the near future because the government has depleted the benefit of declining interest rates since the 1990s. In the appendix, we analyze the effects of various monetary policy measures designed to stimulate the weak economy.