A Study of Budget Deficits and Interest Rates for Japan: Evidence from an Extended Loanable Funds Model

Transcription

1 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, A Study of Budgt Dficits and Intrst Rats for Japan: Evidnc from an Extndd Loanabl Funds Modl Yi-Chi Chn National Chng Kung Univrsity Abstract This papr xamins th bhavior of th long-trm intrst rat in Japan basd on a sampl during 1972Q Q3. Applying to th xtndd opn conomy loanabl funds modl, this papr finds that a highr govrnmnt dficit as a prcnt of GDP lads to a lowr long-trm intrst rat in Japan. In addition, th ral mony markt rat, th GDP growth rat, th xpctd inflation rat, th world long-trm intrst rat, and th xpctd dprciation of th yn hav positiv ffcts on th Japan s long-trm intrst rat. Finally, inclusion of th world intrst rat and th xchang rat in th modl may bttr captur th bhavior of th long-trm intrst rat in Japan. Kywords: govrnmnt dficits, long-trm intrst rats, loanabl funds modl, xpctd inflation, world intrst rats, xchang rats JEL Classification: P43, E43, E62 1. Introduction Th widning fiscal dficits in rspons to th rcnt global slowdown hav rkindld a growing amount of rsarch on th ffcts of govrnmnt dficit on intrst rats. 1 On viw holds that highr govrnmnt dficit lads to an incras in th long-trm intrst rat, crowding out th privat invstmnt and thus a lowr conomic growth. On th othr hand, th proponnts of th Ricardian quivalnc contnd that th ffct of govrnmnt dficit may b offst by privat saving. Thus, govrnmnt dficit dos not affct th capital accumulation, and th intrst rat rmains intact. Whil most mpirical studis indicat th positiv association of th govrnmnt dficit and th intrst rat (to nam a fw, Fldstin, 1982; Holschr, 1986; Wachtl and Young, 1987; Cbula and Koch, 1989; Cbula, 1997, 2003), th othrs do not find any significant links

2 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, (for xampl, Aschaur, 1989; Barro, 1987; Evans, 1985; Gupta, 1989; Darrat, 1990, Findlay, 1990; Ostrosky, 1990). Ovrall, thr is littl mpirical consnsus about th magnitud of th ffct. Japan is a particular subjct of intrst. Japan s ballooning budgt dficit and vr-rising public dbt hav rnwd anxitis about th country s futur solvncy. As a rsult, Standard & Poor s has downgradd th country s crdit ratings and a numbr of warnings from othr rating agncis follow suit for lacking crdibl plans to rsolv th dbt problms. With th dficit widning sharply to ovr 7% of GDP in 2010 and th conomy is still sluggish in th wak of th global financial crisis, Japan is facing mor dir fiscal problms. Th IMF is projcting that th dbt will approach 225% of GDP by th nd of 2010 (IMF, 2009). Japan s growing dbt pil is unsustainabl in th long trm although its bonds ar likly to avoid spculativ attacks in th markt du to high domstic savings, th suffocating lgacis of massiv public dbt, sclrotic rgulation and an aging and shrinking population will likly consign Japan's nxt dcad to a painful procss of managing long-trm conomic dclin. (Garrtt, 2010, p. 31) Th shr scal of th dbt and its likly trajctory th IMF is also projcting that th dbt will climb to 222% of GDP by 2014 ar by far th largst among th major advancd conomis. This papr attmpts to invstigat th ffcts of th govrnmnt dficit on th long-trm intrst rat in Japan. Our work focuss on svral ky aspcts. First, basd on th thortical framwork w us th xchang rat and th world intrst rat as proxy for intrnational capital flows. Scond, w offr a comparativ-static analysis of th quilibrium long-trm intrst rat, whr th various partial drivativs ar usful to dtrmin th ffcts of th xognous shocks. Third, using up-to-datd tim sris allows to addrss th timly issus that hav now mrgd as critical ons for rsarchrs and policy-makrs. 2. Th Modl A sris of studis us th loanabl funds modl to xamin th possibl ffct of govrnmnt dficits on intrst rats (Holschr, 1986; Tran and Sawhny, 1988; Thomas and Abdrrzak, 1988; Cbula, 1988, 1997, 1998, 1999, 2000, 2003; Quays and Jamal, 2007; Barns, 2008; Hsing, 2010a, 2010b). Holschr (1986) dvlopd th closd-conomy loanabl funds modl, whras Cbula (1988, 1997, 1998, 1999, 2003) considrd th opn-conomy loanabl funds modl with th intrnational capital flows in th supply of loanabl funds.

3 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Following Dvrux and Saito (2006) and D Santis and Luhrmann (2009), w us th rlativ intrst rat and th xchang rat to masur nt capital inflows. A lowr US long-trm intrst rat than th Japan s long-trm intrst rat, or an incras in th valu of th Japans yn (JPY) than th US dollar (USD), would lad to an incras in nt capital inflow to Japan. In that sns that th supply of loanabl funds shifts to th right and thus dcrass th Japan s long-trm intrst rat. Both th dmand for loanabl funds and th supply of loanabl funds ar assumd to b th function of th long-trm intrst rat, th ral short-trm intrst rat, th xpctd inflation rat, th prcnt chang in ral GDP, and th govrnmnt dficit. Ths variabls affct th dmand and th supply in opposit dirctions. For xampl, dmand is invrsly rlatd to th long-trm intrst rat, whras supply is positivly associatd with th long-trm intrst rat. Th ral short-trm intrst rat, th xpctd inflation rat, th world long-trm intrst rat, and th xpctd xchang rat hav positiv dmand ffcts. This is contrary to th supply-sid ffcts. Thus, following Hsing (2010a, 2010b), th xtndd opn-conomy loanabl funds modl, considring th dmand for and th supply of loanabl funds, can b xprssd as 2 d S LF = D( R, R, π, Y, B) (1) * LF s = S( R, R S, π, R, ε ) (2) whr d LF = th dmand for loanabl funds in Japan, s LF = th supply of loanabl funds in Japan, R = th long-trm intrst rat in Japan, S R = th ral short-trm intrst rat in Japan, π = th xpctd inflation rat in Japan, Y = prcnt chang in ral GDP in Japan, B = th govrnmnt dficit in Japan, * R = th world long-trm intrst rat, and ε = th xpctd JPY/USD xchang rat. (An incras mans dprciation of th Japans yn.) In th quilibrium loanabl funds ( LF ), both long-trm intrst rat d LF and s LF dtrmins th quilibrium R RBR Y R S * = (,,, π,, ε ) (3) By taking th partial drivativ of th rducd-form in quation (3) with rspct to a givn

4 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, xognous variabl, an xprssion is obtaind that rlats th rspons of R R B= DB J > 0 (4) S R R = ( D S ) J >0 (5) S R S R R Y = DY J > 0 (6) R π = ( D S ) J >0 (7) π π = > 0 (8) * R R S * J R R ε = S J > 0 (9) ε whr J is th Jacobian and is xpctd to b a positiv. As shown in quations (4) (9), th quilibrium long-trm intrst rat dpnds positivly on th govrnmnt dficit, th ral short-trm intrst rat, th prcnt chang in ral GDP, th xpctd inflation rat, th world intrst rat, or th xpctd xchang rat. 3. Empirical Rsults Th data wr obtaind from Datastram, covring from 1972Q1 to 2010Q3 at a quartrly frquncy. Th dpndnt variabl is Japans 10-yar govrnmnt bond (JGB) yild. To allow for possibl substitution ffcts, th Japan s ral mony markt rat is usd as th short-trm intrst rat. Th xpctd inflation rat is masurd by th avrag inflation rat of th past tn quartrs, 3 whr th inflation rat is basd on th consumr pric indx (CPI). Y dnots th growth rat of ral GDP in prcnt. B is th govrnmnt budg dficit normalizd by GDP in prcnt form. To facilitat th intrprtation of th rsults, th dficit was multiplid by -1. Thus, a ris in B is intrprtd as a rising dficit-to-gdp ratio. W also us th dbt-to-gdp ratio as altrnativ proxy for fiscal policy in Japan. 4 Th US long-trm govrnmnt bond yild is chosn to b th world intrst rat. Th xpctd xchang rat is givn by th avrag xchang rat of th past four quartrs, and th xchang rat is quotd as JPY pr USD. Th variabls, R, R * and ε, ar ntrd th modl in log form. Figurs 1a and 1b show th scattr diagrams btwn th JGB yild in log form and th fiscal

5 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, variabls of intrst, with a lin of bst fit suprimposd on th data points. Th diagrams clarly suggst that th long-trm intrst rat is invrsly rlatd to both th fiscal dficit and th public dbt as a shar of GDP. Although th prliminary xamination of th data may sm countr-intuitiv, mor analysis of th rgrssion will b conductd. Figur 2 illustrats th rlationship btwn th JGB yild and th xpctd inflation rat. As prdictd, thr xists a clar positiv corrlation. Th Phillips-Prron (PP) unit root tsts wr conductd for th sris of intrst. Th tst rsults show that, xcpt for th govrnmnt dficit and th ral GDP growth, th variabls contain a unit root in th lvl form and ar stationary in first diffrnc. In ordr to tst whthr a stationary linar combination xists among th variabls, w us th Johansn cointgration tst. Th cointgration rsults ar givn in Tabl 1 and show that th significant numbr of cointgrating vctors is 2. Thus, th variabls shar a long-run quilibrium rlationship. Th rgrssion modl was first stimatd by last squars mthods. Howvr, th rsults ar not robust to svral diagnostic tsts. Although th Jarqu-Bra normality tst indicats that th rgrssion rsiduals tnd to follow a normal distribution, th Brusch-Godfry srial LM tst suggsts that thr xists autocorrlation. In addition, th Engl ARCH (Autorgrssiv Conditional Htroscdasticity) tst was conductd for possibl htroskdastic rrors. Th LM statistics could not rjct a null hypothsis of no ARCH ffcts up to ordr 4 in th rsiduals. To account for th possibl volatility clustring (i.., tim-varying varianc), w considr a GARCH(1,1) modl for th long-trm bond yild. ARCH modls wr first introducd by Engl (1982) and thn gnralizd as GARCH (Gnralizd ARCH) by Bollrslv (1986) and Taylor (1986). To allow for fat-taild rsiduals, w will assum that th rrors follow a Studnt's t-distribution. In Tabl 2 paramtrs stimation of GARCH(1,1) modl, using th Brdnt, Hall, Hall and Hausman (1974) algorithm, ar prsntd. As shown in Modl 1 of Tabl 2, 84.7% of th variation in th JGB yild can b xplaind by xplanatory variabls undr considration with significant cofficints at th 1% lvl. For most cofficints, th ffcts on th yild ar as prdictd. Th JGB yild is positivly associatd with th ral mony markt rat, th ral GDP growth, th xpctd inflation rat, th US govrnmnt bond yild, and th xpctd dprciation of th JPY vis à vis th USD. Th ffct from th govrnmnt dficit is, howvr, ngativ and statistically significant, 5 suggsting that a on prcntag point incras in govrnmnt dficit as a shar of GDP is associatd with a dcras of 0.5 basis point of th 10-yar JGB intrst rat. In comparing to th prvious studis which tst fiscal dficits across countris, th stimat found in this study is rlativly small. 6 Th low

6 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, snsitivity of th govrnmnt bond yild to changs in fiscal dficits is attributabl to Japan s larg pool of houshold savings, stabl institutional invstors, and a strong hom bias (Tokuoka, 2009). To dtrmin whthr th stimatd rgrssion is robust, th Jarqu-Bra normality and th Engl ARCH tsts ar applid. Th tst rsults suggst that, at th 5% lvl of significanc, th standardizd rsiduals ar whit noiss and no additional ARCH lft in th standardizd rsiduals. Thus, th GARCH(1,1) spcification corrctly dscribs th variability of th JGB yild. W also tst whthr th stimats ar snsitiv to altrnativ masurs of th variabls undr considration. First of all, w us diffrnt proxis for th xpctd inflation rat and summariz th rgrssion rsults in Modl 2-4 of Tabl 2. π t-4 is calculatd from th last four quartrs, whras π t-8 from th last ight quartrs. It is intrsting to not that th lattr producs a positiv cofficint on th xpctd inflation rat and is significant at th 5% lvl (Modl 3) although th GDP growth is not statistically significant. In contrast, avraging ovr th past four quartrs dos not produc significant cofficints on th GDP growth and th xpctd inflation (Modl 2). 7 It sms that a longr-trm moving avrag of th inflation rats has a gratr impact on th long-trm intrst rat than a short-trm moving avrag. If th last four quartrs of th GDP dflator (π DEF ) rplacs th CPI-basd masur for inflationary xpctations, its cofficint and th GDP growth bcom significant at th 1% and 5% lvl, rspctivly (Modl 4). Scond, if th ratio of th govrnmnt dbt to GDP is usd to rflct th fiscal imbalanc, th ngativ ffct of th public dbt on th JGB yild rmains significant at th 1% (Modl 5). Howvr, th cofficint on th output growth is not significant and th xpctd xchang rat turns into an opposit sign. Finally, w attmpt to us th trad-wightd nominal ffctiv xchang rat (NEER) instad of th nominal xchang rat. 8 Th Japan s NEER is a wightd avrag of th yn against a baskt of currncis of its major trading partnrs. A fall in th NEER mans Japan is trading intrnationally on worsning trms and thus costing mor to buy goods and srvics from abroad. Inclusion of th xpctd NEER (ε NEER ) as shown in Modl 6 of Tabl 2, th xpctd inflation bcoms ngativ although it is not statistically significant. Othr rsults ar similar, th ral GDP growth, howvr, is not significant. In gnral, th ngativ rlationship btwn fiscal imbalancs and th long-trm intrst rat is robust to a numbr of altrnativ spcifications. Th stimatd impact of fiscal policy is rmarkably stabl across ths rgrssions, with a point stimat avrag of 0.006, and statistically significant at th 1% lvl.

7 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Conclusion This papr attmpts to mpirically xamin th rlationships btwn th Japan s long-trm intrst rat and macroconomic prformanc. In so doing, w first us th comparativ-static analysis for xtndd opn-conomy loanabl funds modl to dtrmin th possibl dirction of th xognous shocks to th long-trm intrst rat, and thn adopt a GARCH(1,1) modl to charactriz th tim-varying varianc of th JGB yild. Th rsults show that th fiscal dficit or dbt as a shar of GDP is ngativly associatd with th JGB yild. A highr ral mony markt rat, a growing conomy, highr inflationary xpctations, a highr US govrnmnt bond yild, and xpctd dprcation of th JPY would caus th long-trm intrst rats to ris. Our rsults hav important policy implications. Th ngativ ffct of th govrnmnt borrowing implis that pursing xpansionary fiscal policy by raising govrnmnt dbts rducs th long-trm intrst rat sinc agnts switch from lowr quality issus. Strong hom bias in Japan may also play a rol. JGBs hav bn financd largly by domstic invstors who ar traditionally inclind to mak saf and low-risk invstmnts (Tokuoka, 2010), which in turn may add to domstic dmand raising th pric of th issu and so rducing th yild. Nvrthlss, this rsult dos not srv as an xcus for laxity in Japan s fiscal policy. Inxorabl ris in govrnmnt dbt would lad to financial tipping points that could put svr downward prssur on ratings. It could sharply rais th risk prmium for JGBs and ntail rprcussions such as domstic invstors rluctanc to buy JGBs du to th hightnd risks of dfault. This finding chos th rcnt warnings mad by ratings agncis that th Japan govrnmnt nds to pursu ffctiv fiscal rform in ordr to bring th vr-rising public dbt undr control (Rutrs, 2011). In addition, th Bank of Japan nds to carfully contain xpctations of pric ris and th yn dvaluation to avoid undsirabl ffcts on th long-trm intrst rat. In th opn-conomy loanabl funds modl, th world intrst rat and th xchang rat nd to b considrd as intrnational invstors sarch for bttr rturns in dtrmining supplying loanabl funds to Japan or othr countris. Th rsults for th output growth and th xpctd inflation ar snsitiv to diffrnt masurs of th variabls. Thus, furthr study may b ncssary to dtrmin thir links to th long-trm intrst rat in loanabl funds. Th rsults prsntd in this papr should b intrprtd with caution. As argud by Eugn and Hubbard (2004) and Laubach (2009), th chang of th bond yild today may b confoundd by th currnt businss cycl conditions, which ar not capturd compltly by th output growth or th intrst rats. Idally, considring futur yilds and official forcasts for dficits in longr trm should mitigat th problms (Tokuoka, 2010). Unfortunatly, th Japans Cabint Offic

8 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, has only startd 5-yar forcasts for th dficit in rcnt yars. It will b yars from now to produc sufficintly long sris to compar with th outcoms in this papr. Endnots Dpartmnt of Economics, National Chng Kung Univrsity, Tainan, Taiwan yichi@ncku.du.tw. Th author is gratful to Profssor Yu Hsing for his invaluabl commnts and inspiration during th work. Th author is also thankful to th anonymous rfr for insightful commnts. Any rrors ar th author s sol rsponsibility. 1 S Engn and Hubbard (2004) and Quays and Jamal (2007) for a rviw. 2 Th notations and drivation draw havily on th work of Hsing (2010a, 2010b). 3 W adopt svral altrnativ masurs for th xpctd inflation, including th wightd inflation rat (Cbula, 1997), th laggd inflation rat, and th avrag inflation rat ovr th last n quartrs, whr n = 4, 6, 8, 10, 12. W also us th masur basd on th GDP dflator. In this study w draw our conclusion basd on th 10-quartr avrag as it producs significant rgrssion rsult. 4 Du to th data availability, th govrnmnt dbt bgins from 1982Q2. 5 W ar not th first study to produc a ngativ cofficint on fiscal variabls. Similar rsults ar also found in Caporal and Williams (2002), Ardagna t al. (2007), Ardagna (2009) and Tokuoka (2010). On xplanation for th opposit sign is du to a portfolio ffct. That is, whn th sovrign dbt is high quality and low risk, invstors may switch from low quality to sovrign dbt. This lads to high dmand for nw issus of sovrign dbt and thrfor lowring th yild (Caporal and Williams, 2002). 6 Th rcnt stimats of th impact of fiscal dficits ar in th rang of 10 to 60 basis points. S Brooks (2003), Haunr and Kumar (2006), and Ardagna t al. (2007). 7 Using th wightd inflation rat lads to similar rsult as Modl 2. If th laggd inflation rat rplacs th avrag inflation rat of past priods as th xpctd masur, its cofficint is positiv, but is not significant at any snsibl lvls. Th rsults ar availabl upon rqust. 8 Th nominal ffctiv xchang rats (2005 = 100) wr downloadd from th Bank of Japan wbsit,

9 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Rfrncs Ardagna, S., F. Caslli, and T. Lan Fiscal Disciplin and th Cost of Public Dbt Srvic: Som Estimats from OECD Countris, B.E. Journal of Macroconomics, 7, Ardagna, S Financial Markts Bhavior around Episods of Larg Changs in th Fiscal Stanc, Europan Economic Rviw, 53, Aschaur, D. A Dos Public Capital Crowd Out Privat Capital? Journal of Montary Economics, 24, Barns, B. J A Cointgrating Approach to Budgt Dficits and Long-Trm Intrst Rats, Applid Economics, 40, Barro, R. J Govrnmnt Spnding, Intrst Rats, Prics, and Budgt Dficits in th Unitd Kingdom, , Journal of Montary Economics, 20, Brndt, E., B. Hall, R. Hall, and J. Hausman Estimation and Infrnc in Nonlinar Structural Modls, Annals of Economic and Social Masurmnt, 3, Bollrslv, T Gnralizd Autorgrssiv Conditional Htroscdasticity, Journal of Economtrics, 31, Brook, A.-M Rcnt and Prospctiv Trnds in Ral Long-Trm Intrst Rats: Fiscal Policy and Othr Drivrs, OECD Economics Dpartmnt Working Papr No Caporal, G. M., and G. Williams Long-trm Nominal Intrst Rats and Domstic Fundamntals, Rviw of Financial Economics, 11, Cbula, R. J Fdral Govrnmnt Budgt Dficits and Intrst Rats: an Analysis for th Unitd Stats , Public Financ, 43, Cbula, R. J Th Impact of Nt Intrnational Capital Flows on Nominal Long-trm Intrst Rats in Franc, Atlantic Economic Journal, 25, Cbula, R. J Budgt Dficits and Long-trm Intrst Rats: , Intrnational

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11 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Findlay, D. W Budgt Dficits, Expctd Inflation and Short-trm Ral Intrst Rats: Evidnc for th Unitd Stats, Intrnational Economic Journal, 4, Garrtt, G G2 in G20: China, th Unitd Stats and th World aftr th Global Financial Crisis, Global Policy, 1, Gupta, K. L Budgt Dficits and Intrst Rats in th US, Public Choic, 60, Haunr, D. and M. S. Kumar Fiscal Policy and Intrst Rats: How Sustainabl Is Th Nw Economy? IMF Working Papr No. 06/112. Holschr, G Nw Evidnc on Dficits and Intrst Rats, Journal of Mony, Crdit, and Banking, 18, Hsing, Y. 2010a. Dos Mor Govrnmnt Dficit Lad to a Highr Long-Trm Intrst Rat? Application of an Extndd Loanabl Funds Modl to Estonia, Amfitatru Economic, 12, Hsing, Y. 2010b. Govrnmnt Dbt and th Long-Trm Intrst Rat: Application of an Extndd Opn-Economy Loanabl Funds Modl to Poland, Managing Global Transitions, 8, Intrnational Montary Fund (IMF) Companion Papr Th Stat of Public Financs: Outlook and Mdium-Trm Policis aftr th 2008 Crisis. Laubach, T Nw Evidnc on th Intrst Rat Effcts of Budgt Dficits and Dbt, Journal of th Europan Economic Association, 7, Ostrosky, A. L Fdral Govrnmnt Budgt Dficits and Intrst Rats: Commnt, Southrn Economic Journal, 56, Quays, S. and A. M. M. Jamal Budgt Dficits and Intrst Rats: Th US Evidnc Sinc 1946, Singapor Economic Rviw, 52, Rutrs Moody s Warns of Japan Ratings Cut if No Rforms, Fbruary 22.

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13 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Figur 1a. Scattr diagram btwn govrnmnt bond yild and dficit-to-gdp ratio for Japan during 1972Q1 2010Q Dficit-to-GDP ratio (%) Govrnmnt bond yild (%)

14 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Figur 1b. Scattr diagram btwn govrnmnt bond yild and dbt-to-gdp ratio for Japan during 1982Q2 2010Q Dbt-to-GDP ratio (%) Govrnmnt bond yild (%)

15 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Figur 2. Scattr diagram btwn govrnmnt bond yild and xpctd inflation rat for Japan during 1972Q1 2010Q3 5 4 Expctd inflation rat (%) Govrnmnt bond yild (%)

16 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Tabl 1. Unrstrcitd Conitgration Rank Tst (Maximum Eignvalu) Hypothsizd Max-Eign 0.05 No. of CE(s) Eignvalu Statistic Critical Valu Prob.** Non * At most 1 * At most At most At most At most At most Nots: Max-ignvalu tst indicats 2 cointgrating qn(s) at th 0.05 lvl * dnots rjction of th hypothsis at th 0.05 lvl **MacKinnon-Haug-Michlis (1999) p-valus

17 Chn, Journal of Intrnational and Global Economic Studis, 4(1), Jun 2011, Tabl 2. GARCH(1,1)-t Distribution Rsult of th Long-Trm Bond Yild (Quartrly, 1972Q1~2010Q3) Variabl Modl 1 Modl 2 Modl 3 Modl 4 Modl 5 Modl 6 B *** (0.001) *** (0.001) *** (0.001) *** (0.001) D *** (0.001) R s 0.043*** 0.070*** 0.063*** 0.011** 0.142*** (0.007) (0.013) (0.012) (0.004) (0.014) Y 0.033*** ** (0.009) (0.021) (0.020) (0.016) (0.017) π t *** 0.342*** (0.027) (0.113) π t-4 π t-8 π DEF (0.034) 0.092** (0.042) * (0.002) 0.032*** (0.010) (0.002) (0.033) 0.105*** (0.027) log(r*) 0.866*** (0.066) 0.799*** (0.106) 0.850*** (0.101) 1.050*** (0.085) 0.676*** (0.130) 0.598*** (0.007) log(ε t-4 ) 0.467*** (0.085) 0.520*** (0.101) 0.417*** (0.113) 0.617*** (0.098) *** (0.121) log(ε NEER ) *** (0.003) Varianc quation ARCH(-1) 0.352*** (0.119) (0.120) (0.115) (0.141) 0.357** (0.158) 0.605*** (0.165) GARCH(-1) 0.347** (0.156) 0.661** (0.300) 0.670** (0.301) 0.589* (0.327) (0.170) (0.157) 2 R AIC SC N Nots: Th dpndnt variabl is log(r) whr R dnots th Japan s 10-yar govrnmnt bond yild. B is th Japan s govrnmnt dficit (or surplus) as a shar of GDP in prcnt, whras D is th dbt-to-gdp ratio and is availabl from 1982Q2. R s is th Japan s ral mony markt rat. Y is th prcntag chang of Japan s ral GDP. π t-10, π t-4, and π t-8 ar th xpctd inflation rats for Japan basd on th avrag inflation rat of th past tn, four and ight quartrs, rspctivly. π DEF is calculatd from th GDP dflator of th past four quartrs. R* is th US 10-yar govrnmnt bond yild. ε t-4 is th xpctd JPY/USD xchang rat basd on th avrag xchang rat of th past four quartrs, whras ε NEER is masurd by th Japan s nominal ffctiv xchang rat. Th rgrssion constant is ignord for brvity. Th numbrs in parnthss ar standard rrors. *, ** and *** dnot th 10%, 5% and 1% significanc lvl, rspctivly.