Economic Challenges and Policy Responses

in Advanced Economies:
Demography, Debt Problems, and Inflation Dynamics
Juｌｙ 5, 2023

Toshitaka Sekine
Asian Public Policy Program
Hitotsubashi University

1
 Core CPI Inflation
8 (Y/Y, %)

7 United States
Euro area
6 Japan

-1

-2

-3
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022

Note: Excluding food and energy. Japanese CPI is adjusted for the effects of consumption tax rate hikes.
Source: FRED, Ministry of Internal Affairs and Communications.
2
 Overnight Policy Interest Rates

Source: FRED

3
 Original Taylor Rule
𝑖𝑡 = 𝜋𝑡 + 𝑟𝑡∗ + 𝛼𝜋 𝜋𝑡 − 𝜋𝑡∗ + 𝛼𝑦 𝑦𝑡 − 𝑦𝑡∗
where 𝑟𝑡∗ is the natural rate of interest and 𝜋𝑡∗ is inflation target.
Taylor finds that the following simple equation fits the actual FF rate
well.
𝑖𝑡 = 𝜋𝑡 + 2 + 0.5 𝜋𝑡 − 2 + 0.5 𝑦𝑡 − 𝑦𝑡∗

Taylor, J. (1993): “Discretion and

Rule in Practice,” Carnegie-
Rochester Conference Series on
Public Policy.

4
 Taylor Rule (Update)
United States Japan

Note: Based on the original Taylor rule specification.

Source: FRED, Bank of Japan
5
 FF Rate and VIX

Source: FRED
6
 Back to
Secular
Stagnation?

https://www.piie.com/events/summers-and-blanchard-debate-future-interest-rates
7
 The Natural Rate of Interest

Source: FRBNY https://www.newyorkfed.org/research/policy/rstar

8
 The Natural Rate of Interest (JP)
3.5
(%)
3.0

2.5 Actual real interest rate

Natural rate of interest
2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Notes: 1. The natural and real rates of interest are calculated based on 10-year government bond yields.
2. The shaded area indicates the 95 percent confidence interval for the natural rate of interest.
Source: Imakubo et al. (2015), "The Natural Yield Curve: Its Concept and Measurement," Bank of Japan Working Paper Series, 15-E-5.

9
 Demographic Change

Dots correspond
to data from
1955 to 2025
(UN forecast)

Japan 2020
Japan 2025
(Forecast)

Notes: 1. Old-age dependency ratio = elderly population (aged 65 and over) / working-age population (aged 15 to 64)
2. Annual population change is the average annual rate of population change in five-year intervals.
Source: United Nations
 Demography and Low Interest Rate

Source: Blanchard, O. (2022), Fiscal Policy under Low Interest Rate, The MIT Press

11
 Financial Assets of Households by Age (JP)

Source: author’s calculation from Flow of Fund and Consumer Survey.

12
 Aging and Government Debt

JPN

ITA

GRC

USA

Source: OECD, United Nations

13
 Deteriorated Public Finance (JP)
Primary Balance Debt Outstanding

Note: General government

Source: Cabinet Office, IMF (for 2022)

14
 𝑟 < 𝑔 (Domar’s Theorem)

• By definition, Government Debt (𝐷𝑡 ) evolves

𝐷𝑡 − 𝐷𝑡−1 = 𝐺𝑡 − 𝑇𝑡 + 𝑟𝐷𝑡−1
where 𝐺𝑡 − 𝑇𝑡 is the primary balance deficit and 𝑟𝐷𝑡−1 is
interest payments.
• Using 𝐷𝑡 − 𝐷𝑡−1 = 𝑟𝐷𝑡−1 and 𝑌𝑡 = 1 + 𝑔 𝑌𝑡−1 where 𝑔 is
GDP growth rate,
𝐷𝑡 𝐷𝑡−1 𝑟 − 𝑔 𝐷𝑡−1 𝐺𝑡 − 𝑇𝑡
− = +
𝑌𝑡 𝑌𝑡−1 1 + 𝑔 𝑌𝑡−1 𝑌𝑡
• If the primary budget is balanced, Debt-GDP ratio 𝐷𝑡 /𝑌𝑡
improves as long as 𝑟 < 𝑔.

15
 𝑟 < 𝑔 (Numerical Example, JP)

Source: Cabinet Office, FRED

16
 Active and Passive Policy Regimes

Active MP Passive MP

Fiscal Regime
Active FP
Explosive Gov determined Price
(non-Ricardian)
Level
Monetary Regime
Passive FP
CB determined Price Non-determinant
(Ricardian)
Level

• Active (Passive) Monetary Policy: CB raises the policy interest

rate more (less) than inflation rate.
• Active (Passive) Fiscal Policy: Gov reduces (increases)
surplus against real debt outstanding. Under passive FP, Gov
repay debt by surplus, whereas under active FP, Gov uses
inflation to reduce real debt outstanding.

17