Regime Switches in Japan's Fiscal Policy: Markov-Switching VAR Approach

This paper empirically investigates the changing dynamics of fiscal policy shocks on Japan's macroeconomy. By estimating a Markov-switching vector-autoregressive (VAR) model, regime switches in both automatic fiscal responses to output and discretionary fiscal shocks are endogenously investigated. The main findings are summarized as follows. First, structural changes occurred in the mid-1970s, early 1990s, late 1990s and late 2000s. Second, in contrast to the other regimes, expansionary fiscal shocks depress output and consumption in the third regime. Third, the twin-deficit hypothesis holds in the second to fourth regimes.