Why Did Japan's Fiscal Condition Deteriorate Markedly in the 1990s?: Changes in the Political Environment and Fiscal Policy

By focusing on the changes that were taking place in the political environment the 1990s, this article tries to explain why Japan's fiscal condition deteriorated markedly during this decade. The analysis demonstrates that a substantial portion of the actual budget deficit can be understood as an appropriate reaction (tax smoothing) to the shocks that hit the economy during this period. However, it also suggests that the deficit was excessively large in comparison with the optimal level for tax smoothing, and that the deficit may have expanded due to noneconomic factors. A series of studies on the relationship between budget deficits and the political environment has shown that a shift to a coalition government and the weakening of a regime's political base may contribute to an increase in the budget deficit. A regression analysis examining the impact of political factors on Japan's "excess" budget deficit show that the cabinet's approval rating and the share of seats in the Lower House of the Diet (parliament) held by the Liberal Democratic Party (LDP) are significantly and negatively correlated with that "excess" deficit. These results suggest that the large deficit in the 1990s was partly due to the shift to a coalition government and the weakening of the LDP's power base.