Local Government Investments and Ineffectiveness of Fiscal Stimulus during Japan's Lost Decades

This paper provides an explanation of the reason why previous works suggest that the effect of fiscal stimulus measure is, if any, small during the lost decades in Japan. To show this, it focuses on public investment by local governments which occupies a substantial portion of the total investment. Specifically, we divide it into subsidized and non-subsidized expense, and empirically study the differences between their decision-making processes from the perspective of fiscal stimulus measures. The results of this analysis reveal that subsidized expense is countercyclical to the economic situation of the nation as a whole, but on the other hand, no connection with business cycles is seen at prefectural level. Contrastingly, non-subsidized expense shows no reaction to the state of the macro economy. In the 2000s, in particular, it is shown to be procyclical in relation to economic fluctuation at prefectural level, due to the fiscal rigidity of local governments. Based on the fact that the majority of Japan's public investment is carried out by local governments, it becomes clear that, as a problem prior to the evaluation of its policy effects, public investment is not implemented with adequate timing to offset business cycles in the first place.