Comment on “Is the Sky the Limit? Can Japanese Government Bonds Continue to Defy Gravity?”


  • Chalongphob Sussangkarn

    Corresponding author
    1. Thailand Development Research Institute
    • Correspondence: Chalongphob Sussangkarn, Thailand Development Research Institute, 565 Soi Ramkhamhaeng 39, Wangthonglang District, Bangkok 10310, Thailand. Email:

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The ability of Japan to continue to finance her huge and ballooning public debt is a very important issue. If a public debt crisis hits Japan, as has afflicted many other countries with lower levels of public debt in the past, the consequences for the world economy will be very severe. The main focus of Hoshi and Ito (2013) is to assess the sustainability of Japan's public debt. Simulation exercises are carried out with varying assumptions about growth rates, inflation rates, and consumption tax rates. Public debt is deemed to be unsustainable if the total outstanding amount of Japanese government bonds (JGBs) exceeds an upper ceiling given by the total amount of domestic private sector financial assets that can potentially be used to finance JGBs. The model and results are very interesting and show the importance of increasing the consumption tax rate to around 20% for fiscal sustainability.

My first comment is about the rationale for the sustainability ceiling. The explanation seems to be that once the ceiling is reached, foreign investors will be needed to absorb additional JGBs and that, based on past regression results, this will lead to sharp increases in interest rates. This needs further discussion as foreign holdings of JGBs are now quite significant and yields on JGBs are still very low. Foreign holdings of JGBs rose from about 3.0% at the end of 2003 to 7.8% in the third quarter of 2008 prior to the closure of Lehman Brothers. During the global financial crisis, foreign holdings declined, but have risen fairly quickly since 2010 and reached a highest ever level of 9.1% in the third quarter of 2012. At the same time, as foreign holdings of JGBs increased, yields on JGBs have declined. The yield on 10-year JGBs fell from about 1.3% at the beginning of 2010 to almost 0.6% in the first quarter of 2013. It could be that foreign investors' willingness to invest in JGBs at low interest rates during the period since 2010 (prior to the Abe government) was based on the expectation of a yen appreciation. As the yen has depreciated substantially since the Abe government was elected, the situation may have now changed, and foreign investors may now demand a higher yield in order to buy JGBs. However, this is not yet clearly observed from the trend of JGB yields. In any case, there should be more discussion of this matter in relation to the assumed sustainability ceiling.

The next point relates to the current policies of the Abe government and how this may affect the likelihood of a public debt crisis for Japan. A key policy relates to the inflation target of 2%. Inflation targeting tries to influence medium to long-term inflation expectations, and the aggressive policy stance of the Abe government and the current Bank of Japan brings credibility to the intention, and if inflation begins to creep up, inflation expectations may rise up near to the 2% target. A crucial question is how do inflation expectations influence long-term interest rates? If investors really believe that inflation will reach about 2% in the long term, then long-term interest rates (say, on 10-year JGBs) should rise near to the expected inflation rate. This will imply a substantial upward jump in interest rates compared to their current levels, and may then lead to many of the negative symptoms of a public debt crisis that were well explained in Hoshi and Ito's (2013) Section 8. So the crisis may be initiated not by the need to rely on foreign investors to finance JGBs, but by domestic investors whose inflation expectations have been changed through aggressive monetary policy.

In fact, Hoshi and Ito are a little vague on the link between interest rates and fiscal sustainability. On the one hand, in the discussion about the reinvestment of interest income in Hoshi and Ito's (2013) Section 4.3, it was pointed out that a rise in the interest rate increases interest income and the amount of private financial assets that can be potentially used to buy JGBs, and, thereby, improve the fiscal sustainability position. On the other hand, a significant increase in the interest rate from the need to rely on foreign purchases of JGBs is also viewed as the trigger for a fiscal crisis, and this is the rationale for the definition of the sustainability ceiling. So it is not clear what will be the impact on fiscal sustainability of a jump in the interest rate (from whatever reason).

Finally, how will the intention of the Bank of Japan to buy up massive amounts of JGBs in order to try to achieve the 2% inflation target affect the likelihood of a public debt crisis? The Bank of Japan can buy up more and more long-term JGBs from the secondary market, thereby increasing the liquidity of financial institutions which they can then use to buy up newly issued JGBs. This could keep interest rates on JGBs low for a long time and may help to maintain fiscal sustainability. What would be the likely outcome in such as case, and what would be the limit?