The Impact of Monetary and Tax Policy on Income Inequality in Japan

We assess the effects of the most recent monetary policy behavior of the Bank of Japan (BOJ), in particular, zero interest rate policy and negative interest rate policy, and the Japanese tax policy on income inequality during the first quarter (Q1) of 2002 to Q3 2017. The vector error correction model developed in this research shows that increase in money stock through quantitative easing and the quantitative and qualitative easing policies of the BOJ significantly increases income inequality. On the contrary, Japanese tax policy was effective in reducing income inequality. Variance decomposition results show that after 10 periods almost 87.15% of the forecast error variance of the inequality is accounted for by its own innovations and 3.76% of the forecast error variance can be explained by exogenous shocks to monetary policy shock—the money stock. The short-term interest rate also accounts for the increase in inequality by 0.47%. On the other hand, the total tax and real gross domestic product contributed in reducing the inequality measure, respectively, by 6.65% and 1.96% after 10 periods.

WORKING PAPER NO: 837