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Regional heterogeneity, the rise of public debt and monetary policy in post-bubble Japan: lessons for the EMU


Both Japan and parts of the European Monetary Union have experienced boom and bust in stock and real estate markets, which have been followed by a lasting crisis. The paper analyses the role of a high degree of regional heterogeneity for public debt and monetary policy in the context of crisis. It is shown for Japan that the attempts to maintain regional cohesion via a regional transfer mechanism has contributed to the unprecedented rise in public debt and persistent monetary expansion. Econometric estimations show that in Japan regional redistribution of funds has ensured homogeneous living conditions across Japanese regions pre- and post-crisis. The side condition is monetary expansion. A similar effect could emerge in Europe, if the crisis persists.

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  1. The boom phases in the southeast Asian countries were accelerated by capital inflows (in form of bank-based lending) from Japan, where the central bank kept interest rates low to facilitate the economic recovery.

  2. The groupings are shown in Table 2 in the Appendix.

  3. Note that all these numbers refer to GDP per capita after redistribution (see section 3.1)

  4. This created concerns that the EMU might be subjected to a higher likelihood of asymmetric shocks.

  5. Note that the numbers in Figure 3 refer to all now 19 EMU member states during the whole observation period.

  6. We assume for parsimony that inflation rates in Japan and euro area are similar and low.

  7. What is characterized as balance sheet recession (Koo 2003).

  8. The regional distribution of these funds was unknown by 2017.

  9. The local allocation tax is financed by a fraction of national taxes on income, liquor, tobacco and corporate profits (Shirai 2004). It is therefore collected in all Japanese prefectures. Because the tax revenues can be assumed to be larger in the rich prefectures, there is a second redistribution effect on the income side of the redistribution mechanism, which is not captured here because regional data on the income side are not available.

  10. For instance, for the public sector “education” the first of the three factors is a variable measuring the number of pupils and teachers, multiplied by a prefecture-invariant unit cost factor for the respective service branch, and multiplied by a modification factor reflecting prefecture-specific conditions like climate and population density (see Aoki 2008). This shows that the allocation of funds is strongly based on structural factors rather than year-over-year growth rates. This reduces the concern of endogeneity bias in the econometric estimations (see section 4.1.).

  11. “In order to promote its overall harmonious development, the Union shall develop and pursue its actions leading to the strengthening of its economic, social and territorial cohesion.” Art. 174 (1) TFEU

  12. The share of EMU member states is 34 billion euros.

  13. Greece (15,5%), Ireland (6,5%), Italy (47,2%), Spain (20,3%), Portugal (10,4%).

  14. A third CBPP has been set up in Oct. 2014.

  15. Note that ELA credits are reflected in TARGET2 balances.

  16. The provisions for quality of collateral are less strict than for the standard ECB monetary policy operations. The Bank of Greece got the permission by the ECB governing council to lend a maximum of 90 billion euros. When in summer 2015 this limit was rejected to be increased, the Greek authorities had to close banks and introduce capital controls (Götz et al. 2015). When in August 2015 the euro group passed a 86 billion euro resecue package, this included 25 billion euros for the recapitalization of Greek banks (what can be seen as an indication for the insolvency of the Greek banking sector).

  17. The ECB announced in March 2016 to expand the program by increasing the monthly purchases from 60 billion euros to 80 billion euros and prolonged the program until September 2018 (see ECB 2015 and ECB 2016a).

  18. In opposite to the „regular“Local Allocation Tax grants, which are supposed to compensate prefectures to assure the deployment of “basic needs” in every Japanese region, National Disbursements are meant to compensate for special events such as natural catastrophes etc. However, National Disbursements are widely a regular redistribution mechanism (see Regional Statistical Database Item Definition; RD1).

  19. Short-term interest rates are a deficient proxy for changes in the monetary policy stance since 1999 because they remain widely unchanged at the zero bound (see Figure 8).

  20. An alternative dummy (rich) is compiled for all prefectures having an income per capita higher than the median prefecture in 1990 (i.e. the year, when the crisis started). The results remain qualitatively unchanged.


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We thank Taiki Murai for the outstanding research assistance and the participants of the 2015 EEFS Conference for useful comments

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Correspondence to Raphael Fischer.



Table 2 Quintile groups in the EMU and Japan
Table 3 Data description
Table 4 Descriptive Statistics
Table 5 Unit root test results
Table 6 Wald test results for joint-significance

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Fischer, R., Schnabl, G. Regional heterogeneity, the rise of public debt and monetary policy in post-bubble Japan: lessons for the EMU. Int Econ Econ Policy 15, 405–428 (2018).

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  • Japan
  • EMU
  • Crisis
  • Regional redistribution
  • Monetary policy
  • Public debt

JEL classifications

  • H2
  • H5
  • H7