Efficacy of Fiscal Policy in Japan: Keynesian and Non-Keynesian Effects on Aggregate Demand

There are two ways of analyzing the efficacy of fiscal policy: the VAR approach and the nonlinear approach. The important difference between them is that the former assumes a linear effect of fiscal policy whereas the latter assumes a nonlinear effect. However, it has never been tested whether the effect is linear or nonlinear. This should first be confirmed so that the efficacy of fiscal policy can be evaluated precisely. This paper examines whether Japanese fiscal policy is effective, and whether the effect is linear or nonlinear. Our results reveal that an increase in government expenditure causes a decrease in private consumption when the government debt/GDP ratio is high, whereas when the ratio is low, it has a positive effect. Our results support the nonlinear effect, and indicate that an increase in government expenditure had a Keynesian effect before around 1998, but after that, it had a non-Keynesian effect.