Quantitative Assessment of the Impact and Risks of Fiscal Deterioration on the Japanese Economy

◆This report, the third in a three-part series titled “Fiscal Management at a Crossroads,” assesses the risks that could arise if fiscal conditions deteriorate.

◆If Japan's fiscal situation deteriorates and doubts about its sustainability intensify, there is a risk that the credit rating of Japanese government bonds could be downgraded. Should such a situation arise, it is important to note that the ratings of Japanese financial institutions could also be downgraded in tandem due to the sovereign ceiling.

◆Estimating the impact of a credit downgrade on the GDP gap over the subsequent year using a panel quantile regression model suggests that it typically reduces the GDP gap by about 1%pt, but with a 25% probability of reducing it by 1.5%pt.

◆A more serious risk is the potential occurrence of a fiscal crisis. Our estimates indicate that factors such as a country's status (whether it is an advanced or emerging economy), the public debt-to-GDP ratio, and the external public debt-to-GDP ratio significantly influence the probability of a fiscal crisis occurring.

◆Applying this model to Japan, the public debt-to-GDP ratio significantly increases the probability of a fiscal crisis occurring, while Japan's status as an advanced economy and the low external public debt-to-GDP ratio reduce the probability of a fiscal crisis occurring. However, unless fiscal consolidation efforts are advanced going forward, increased government bond issuance will not only further raise the public debt-to-GDP ratio, but the rising share held by foreign investors will also cause the external public debt-to-GDP ratio to surge substantially. Consequently, the probability of a fiscal crisis occurring could rise to around 75% in 2040.