Government Debt: Lessons from Japan

The global public debt to GDP ratio will worsen by 9 percentage points on the previous year in 2020, and many countries are now following Japan’s lead in introducing zero and negative interest rates as monetary policy. Kojima Akira analyzes the situation in Japan, where even before the COVID-19 pandemic, government debt exceeded 200% of GDP. 

COVID-19 has brought the global economy into the worst recession since the Second World War. The policies implemented by countries in response to this have been expanded public spending and further monetary easing. According to the IMF’s October 2020 World Economy Outlook, public spending to counter COVID-19 worldwide has reached 12% of GDP (gross domestic product). As a result, the global public debt to GDP ratio will worsen by 9 percentage points on the previous year in 2020. The deficit growth is especially striking in advanced countries. As monetary easing proceeds further, we see soaring private (corporate, household) debt and face an unprecedented situation where global government debt exceeds the whole world’s GDP.

Even before the COVID-19 pandemic, Japanese government debt exceeded 200% of GDP, the most striking indebtedness among the major nations. Japan was also a pioneer in terms of introducing zero and negative interest rates as monetary policy. However, other countries have also seen rapid indebtedness and shifted to a policy course of zero and negative interest rates. The IMF is warning that this cumulative debt increase will become an uncertainty factor for the economy in the future, but due to COVID-19, countries have no choice but to continue expanding public spending and maintaining a negative interest rate policy for the time being. Experts are discussing the Japanification of fiscal and monetary policy as well as economic performance.

We frequently hear the expression “the death of interest rates.” Even when a country’s central bank slashes all interest rates, buys large amounts of government bonds, and expands the public deficit, interest rates may not increase and the function of interest rates in economic management is lost. This is what the expression means.

One survey reported that the 10-year yield for 62 principal countries in the world was less than 1% in 30 countries, or 48% of the 62 countries, negative in 10 countries, and around 0% in 20 countries, as of June 2020. Compared to the end of last year, the number of countries facing this “death of interest rates” has increased by 6, including the United States and Canada.

Fukui Toshihiko, former Governor of the Bank of Japan, points out that “1% is the minimal level for an interest rate to function.”

It was in April 2013 that the Bank of Japan introduced its unprecedented monetary easing policy, termed “different dimension easing” and “non-traditional monetary easing.” This is known in Japan and abroad as quantitative and qualitative easing (QQE). The reason that the Bank of Japan set out on this path of super easing was to get out of the deflation and economic stagnation that has lasted since 1998. When doing this, the Bank of Japan set a price increase rate target (inflation rate target) of increasing the then annual rate of increase for consumer prices from about 0% to about 2% in around two years. However, they found it difficult to reach the 2% target, so the Bank of Japan decided to embark on negative interest rates in 2016. This was applied to the current accounts of financial institutions in the Bank of Japan. The negative interest rate is applied when the financial institutions keep their funds in the Bank of Japan without investing them, so the policy was expected to increase financing that secures interest revenue. The funds deposited at the Bank of Japan by this financial institution are funds that can be mobilized for financing by the financial institution at any time, and so it may be termed a “capital reservoir.”

However, the 2% price target has yet to be reached even eight years after introducing the “different dimension easing.”

Commodity prices are like the body temperature of economic activities. A price increase of 10% or 15% means the economy is “overheating” and a bubble is created. However, if the opposite happens and prices keep dropping, active production and investment activities will be suppressed as companies find it difficult to get returns. Just like the body temperature of a healthy person, commodity prices should ideally have a moderate increase rate. Most countries’ central banks operate their financial policies to keep the price increase rate moderate at about 2%.

Since the 2% commodity price increase rate target appears difficult to achieve, the Bank of Japan is steering the government bond interest rate to nearly 0% not just short-term but also long-term. The Bank of Japan does this by buying government bonds on a large scale from the market at a low interest that is nearly 0%. It is because of this policy that government bond prices do not crash despite government debt exceeding 200% and still increasing. In April 2020, the Bank of Japan decided on a policy of unrestricted buying of government bonds when needed. The government bond market is becoming one controlled by the Bank of Japan.

The Bank of Japan is also purchasing large amounts of stock on the stock market in order to boost stock prices. Of course, the Bank of Japan does not directly buy stocks in individual companies, but rather buys them indirectly through purchases of exchange traded funds (ETFs). As a result, the Bank of Japan is becoming a major stockholder. 

For example, the Bank of Japan owns 24% of Adventest stock, more than 20% in Fast Retailing, and exceeds the foreigner shareholder ratio of 19.3%, making the Bank of Japan the biggest shareholder. Foreign shareholders were the biggest in the market for a while, but there are currently more than 300 companies where the Bank of Japan exceeds the foreign shareholding.

Despite these policies of the Bank of Japan, the 2% price increase target has not been achieved. Some are even saying that it would be better to give up on the 2% target. There are also growing concerns about the side effects of super easing. No matter how great the public deficit, there is no end in sight for the swelling of public finances as the Bank of Japan continues to buy deficit government bonds and the government bond interest rate remains low. The government can safely expand public spending and politicians are seduced into going after easy public spending policies. The worry is that we will see what could be called a moral hazard in public finance and that fiscal moderation will be lost.

There must be a limit to how much government bonds and stock the Bank of Japan can buy. What will happen to the market and economic activities when they hit that limit? Countries leaning toward Japanification are having to face the same problems. That’s why some now say GDP stands for “Gross Debt Product,” or the “Global Debt Problem.”

KOJIMA Akira is a member of the Board of Trustees and professor of the National Graduate Institute for Policy Studies.

Note: This article first appeared in the November/December issue of the Japan Journal.

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