Policy Uncertainty in Japan

Author Name ITO Arata (Fellow, RIETI)
Creation Date/NO. June 2017 17-P-019
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I present a detailed description of the Japan Economic Policy Uncertainty (EPU) index from January 1987 onwards constructed by Arbatli et al. (2017). The index reflects the frequency of newspaper articles that contain certain terms related to the economy, uncertainty, and policy. The Japan EPU index rises around contested national elections and major leadership transitions in Japan. It also shows a large increase during the Asian Financial Crisis and in reaction to the Lehman Brothers collapse, European sovereign debt crisis, U.S. debt downgrade in 2011, an introduction of negative interest rate policy by the Bank of Japan in 2016, Brexit referendum, and Japan's recent decision to defer a consumption tax rate hike. Uncertainty indices for fiscal, monetary, trade and exchange rate policy co-vary positively but also display distinct dynamics. Fiscal policy-related matters are the most important proximate source of policy uncertainty in Japan. Vector autoregression (VAR) models imply that upward EPU innovations foreshadow deteriorations in Japan's macroeconomic performance, as reflected by impulse response functions for investment, employment, and output. These empirical results add to evidence that credible policy plans, strong policy frameworks, and stable political administration can favorably influence macroeconomic performance by, in part, reducing policy uncertainty.