Discussion Paper Series 2007-E-2

Fiscal Policy Switching: Evidence from Japan, the U.S., and the U.K.

Arata Ito, Tsutomu Watanabe, Tomoyoshi Yabu

This paper estimates fiscal policy feedback rules in Japan, the United States, and the United Kingdom for more than a century, allowing for stochastic regime changes. Estimating a Markov-switching model by the Bayesian method, we find the following: First, the Japanese data clearly reject the view that the fiscal policy regime is fixed, i.e., that the Japanese government adopted a Ricardian or a non-Ricardian regime throughout the entire period. Instead, our results indicate a stochastic switch of the debt-GDP ratio between stationary and nonstationary processes, and thus a stochastic switch between Ricardian and non-Ricardian regimes. Second, our simulation exercises using the estimated parameters and transition probabilities do not necessarily reject the possibility that the debt-GDP ratio may be nonstationary even in the long run (i.e., globally nonstationary). Third, the Japanese result is in sharp contrast with the results for the U.S. and the U.K. which indicate that in these countries the government's fiscal behavior is consistently characterized by Ricardian policy.

Keywords: Fiscal Policy Rule; Fiscal Discipline; Markov-Switching Regression

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2007 Bank of Japan All Rights Reserved.

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