Public Debt and the Macroeconomic Stability of Japan

Recently, the outstanding debt of the Japanese government amounts to 695 trillion yen, which implies 139.5% of GDP. In this paper, we constructed three IS-LM type dynamic models and estimate the eigenvalues of their differential systems. Then we confirm whether or not the huge amount of public debt violates the stability conditions for the Japanese economy. Our estimation concludes the Japanese economy to be unstable with the existence of a saddle-point equilibrium. Our simulation also shows that severe tax reform would be required to restore the economic stability. Concretely, the government has to raise the consumption tax rate to 15% from 5%, and in addition, allowing the income elasticities of income taxes and inhabitant taxes to increase by 0.033 each, which is equivalent to tax hikes of about 8.3 trillion yen. We assert that structural reform for the government budget including a tax system is essential and emergent.