The impact of monetary and tax policy on income inequality in Japan

• Author: Sayoko Shimizu,Naoyuki Yoshino,Farhad Taghizadeh‐Hesary
• Date: 01 October 2020
• Published date: 01 October 2020
• DOI: http://doi.org/10.1111/twec.12782

SPECIAL ISSUE ARTICLE

The impact of monetary and tax policy on income

inequality in Japan

Farhad Taghizadeh-Hesary

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Naoyuki Yoshino

2,3

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Sayoko Shimizu

4

1

Faculty of Political Science and Economics, Waseda University, Tokyo, Japan

2

Asian Development Bank Institute, Tokyo, Japan

3

Keio University, Tokyo, Japan

4

Faculty of Economics, Keio University, Tokyo, Japan

KEYWORDS

income inequality, Japanese economy, monetary policy, tax policy

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INTRODUCTION AND THE LITERATURE SURVEY

Growing inequality, especially in advanced economies, has attracted much attention from policy-

makers and in academics (Bernanke, 2015; Draghi, 2016; Yellen, 2014). Equality is considered a

significant value in most societies akin to fairness. Regardless of ideology, culture and religion,

individuals acknowledge inequality as unfavourable (Dabla‐Norris, Kochhar, Suphaphiphat, Ricka,

& Tsounta, 2015). Not only can it become a cause for instability within society, studies have

shown it can hinder economic growth.

Recent empirical works found that high levels of inequality are harmful for the pace and sus-

tainability of growth (Ostry, Berg, & Tsangaride, 2014). Also, Cingano (2014) strengthened the

finding by demonstrating through an econometric analysis on OECD countries and concluding that

income inequality has a negative and statistically significant impact on subsequent growth. The

analysis shows that the income distribution itself matters for GDP growth. Specifically, if the

income share of the top 20% increases, then GDP growth declines over the medium term. In con-

trast, an increase in the income share of the bottom 20% is associated with higher GDP growth

(Dabla‐Norris et al., 2015). Others have argued that increasing inequality may have been a critical

contributing factor to the global financial crisis (GFC henceforth). Rajan (2010) argues that

increasing inequality led to political pressure for more housing credit, which intensified the falsi-

fied lending in the financial sector. Ranciere and Kumhof (2011) present that, in the US, the Great

Depression of 1929 and the GFC of 2008 were both anticipated by a rapid rise in income and

wealth inequality and by a sharp rise in debt‐to‐income ratios among low‐income households.

In the case of Japan, it is unguarded from the gradual increase in inequality, which is also

observed in other OECD countries in the recent years (Hoeller, Joumard, & Koske, 2013). The

concerns over income inequality that have grown between the Japanese population and the wide

notion that “all Japanese are middle class”have become a concept of the past (Aoyagi, Ganelli, &

Murayama, 2015). In their study, they calculated the evidence of increasing income inequality in

Japan, showing that the Gini coefficient of Japan has continuously increased over the last three

Received: 1 August 2018

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Accepted: 10 January 2018

DOI: 10.1111/twec.12782

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© 2019 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/twec World Econ. 2019;43:2600–2621.

decades. Beginning from the lowest among the G7 countries in the 1980s, it has recently con-

verged to roughly the G7 average of 0.5. Japan's pace of rising inequality has been exceptionally

high.

Several reasons have been found by different scholars for the causes of income inequality,

including: (i) technology (Bound & Johnson, 1992), (ii) demographics (Karahan & Ozkan, 2013),

(iii) globalisation (Feenstra & Hanson, 2008 and Furceri, Loungani, & Zdzienicka, 2016) and (iv)

structure of labour market (Jaumotte & Buitron, 2015). Acemoglu and Johnson (2012) and Stiglitz

(2015) raised expansionary monetary policy as a possible contributing factor for income inequality.

However, the results of the effect of monetary policy on inequality have been ambiguous and

sometimes even contradictory. The opinions are often divided among scholars from the results

being insignificant to significant and expansionary monetary policy increasing the inequality to

reducing inequality.

In the recent study by O'Farrell, Rawdanowicz, and Inaba (2016), the effect of monetary policy

on inequality was only limited. They have taken an impact of monetary policy on income and

wealth via changes in returns on assets, debt interest payments and asset prices, rather than through

its impact on employment and inflation, in selected developed countries and, at the same time,

addressing if high inequality has a negative impact on effectiveness of monetary policy.

The effects of monetary policy on income and wealth inequality through financial channels

were found to be complex and ambiguous, only giving a limited effect on inequality. The cross‐

country difference in size and distribution of income and wealth components was accountable for

the ambiguity of the results. As for the second objective, higher inequality did not seem to signifi-

cantly affect the effectiveness of monetary policy, particularly in boosting private consumption

through wealth effects.

Similarly, Inui, Sudo, and Yamada (2017) found that both conventional and unconventional

monetary policy shocks do not have statistically significant impacts on inequality across Japanese

households in a stable manner.

On the other hand, Furceri et al. (2016) have displayed results that the expansionary monetary

policy reduces income inequality. They used data on top income shares (top 1%, 5% and 10%)

from the World Top Income Databases, the share of wage income in GDP from the OECD and

Gini coefficient in 32 advanced and emerging countries. What is unique about their study is that

they have incorporated the forecast error of the policy rates. This is implemented to overcome the

problem of “policy foresight”(Forni & Gambetti, 2010) and to eliminate the chance of capturing

the potentially endogenous response of monetary policy to the condition of the economy. The

monetary policy shock effects on inequality are observed through impulse response functions

directly from local projections introduced by Jordà (2005). Results showed that an unexpected

decline of 100 basis points in the policy rate reduces inequality by approximately 1.25% in the

short‐term and 2.25% in the medium term. According to their calculations, the effect of policy

rates is economically significant as there was a high persistence and limited variation in the Gini.

The effect is larger for countries with higher labour share of income and smaller redistribution

policies. Likewise, Coibion, Gorodnichenko, Kueng, and Silvia (2012) advocated the significance

of the effect and that the expansionary (contractionary) monetary policy reduced (increases)

inequality in the US from 1980 to 2008. Under their study, the contractionary monetary policy had

significant long‐term effects on inequality in consumption, income, expenditure and labour earn-

ings in a statistically significant manner. In their work, the transmission channels are thoroughly

examined. Earning heterogeneity channel and income composition channels were especially strong

in their outcome. After contractionary monetary policy shocks, higher earnings for high‐income

earners are observed but lower earnings for low‐income earners, demonstrating earning

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