Policy Uncertainty and the Cost of Delaying Reform: A case of aging Japan

Author Name KITAO Sagiri (Keio University)
Creation Date/NO. February 2016 16-E-013
Research Project On Monetary and Fiscal Policy under Structural Changes and Societal Aging
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In an economy with aging demographics and a generous pay-as-you-go social security system established decades ago, reform to reduce benefits is inevitable unless there is a major increase in taxes. Often times, however, there is uncertainty about the timing and structure of reform. This paper explicitly models policy uncertainty associated with a social security system in an aging economy and quantifies economic and welfare effects of uncertainty as well as costs of delaying reform. Using the case of Japan, which faces the severest demographic and fiscal challenges, we show that uncertainty can significantly affect economic activities and welfare. Delaying reform or reducing its scope involves a sizeable welfare tradeoff across generations, in which middle to old-aged individuals gain the most at the cost of young and future generations.

Published: Kitao, Sagiri, 2018. "Policy uncertainty and cost of delaying reform: The case of aging Japan," Review of Economic Dynamics, Vol. 27, pp. 81-100