With government debt over 200 percent of Gross Domestic Product (GDP), Japan forged a path that other Western governments, like the United States, have followed. Now, as Japan’s macroeconomic problems become acute, it is no longer just a cautionary tale for Americans, but part of our developing debt crisis, too.
Bust, Deficits, and Debt
In 1990, Japan’s stock market collapsed and its economy tanked. The Bank of Japan pioneered “Quantitative easing,” flooding the financial system with liquidity, but this failed to stimulate lending, borrowing, and GDP growth. With monetary policy seemingly impotent, the government turned to fiscal policy and began running budget deficits. Economists YiLi Chien and Ashley H. Stewart write that “Japan’s general government (which comprises the central and local governments) has consistently run a significant primary fiscal deficit, averaging 5.1 percent of GDP since 1998.”
These deficits were greater than the rate of economic growth, so government debt grew as a share of GDP. Between 1997 and its peak in 2022, Japan’s government debt grew from 63.7 percent of GDP to 214.8 percent, comfortably the biggest increase among the G7 countries and nearly 60 percent greater than second-placed Italy.
Debt Crisis
Japan could afford these deficits and this debt when interest rates were low. In July 1997, the rate on the Japanese government’s 10-year bonds fell below 2.5 percent and stayed there; the biggest deficits and debt in the G7 were accompanied by some of the lowest borrowing costs.
But in late 2021, yields on Japanese government debt began to rise. Not as steeply as elsewhere in the G7, but, in April, the rate on the Japanese government’s 10-year government bonds rose above 2.5 percent for the first time in 29 years. The era of cheap finance is over.
These might not seem like big numbers, but they are when servicing a debt the size of Japan’s. In February, the Finance Ministry forecast that interest payments would rise from the current year’s budgeted ¥10.5 trillion to ¥21.6 trillion ($139 billion) in the year starting April 2029. Overall debt-servicing costs are projected to rise by about 46 percent during the same period and would account for about 30 percent of total projected spending in fiscal 2029, more than will be spent on social security. Japan’s debt will devour its budget.
Bond Markets
Bond yields are rising because bond prices are falling.
When a government borrows money, its treasury essentially prints a piece of paper — the bond — promising to pay the holder, say, ¥1 million in 10 years. The treasury sells this piece of paper for cash, but generally not for ¥1 million. Why not? Consider the question from the buyer’s perspective. You have ¥1 million, and the treasury is offering to take that and return it to you in 10 years: Where is the benefit to you? To incentivize the buyer to part with their cash, the treasury sells the bond for, say, ¥900,000. Now, the buyer hands over ¥900,000 and gets ¥1 million back 10 years from now. The yield, or interest rate, is ¥100,000 — or 1.1 percent annually. It follows that when the bond’s price goes up, the yield goes down, and vice versa.
Like any other price, bond prices are driven by supply and demand. If there are no buyers for a bond at a given price its price will fall, which is to say that yields — interest rates — will rise; this is the situation Japan now faces.
Currency Crisis
There is another option. As the “monetary sovereign” of MMTers’ dreams, borrowing in a currency it issues, the Japanese government can always declare a maximum yield it will pay. If yields rise above it, the central bank can step in to purchase the bonds at whatever price the government decrees, printing whatever money is necessary.
Indeed, at its May meeting, Prime Minister Sanae Takaichi is reported to have urged Gov. Kazuo Ueda of the Bank of Japan to buy Japanese government bonds to curb rising long-term interest rates. Whatever concerns this raises about its independence, the Bank of Japan is already the biggest holder of government debt, with 52 percent of the total outstanding in December.
But the currency creation this requires may fuel inflation; there is a big difference between handing newly printed money to financial institutions to rebuild ravaged balance sheets, as in the 1990s, and handing it to government to finance current spending. Consumer price inflation in Japan has been above 2.5 percent annually in each of the last four years, the first time since 1981 the rate has been so high for so long. To fight this, Bank of Japan has hiked its main interest rate to a level not seen since 1995: one percent. This, of course, pushes yields higher and makes the debt situation worse.
The central bank is stuck; it prints money to keep government interest rates down, or it hikes interest rates to get inflation down. This is the choice all heavily indebted Western countries, like the United States, will eventually face; a debt crisis resolved with “austerity” or an inflationary currency crisis which will be remedied by “austerity” in any event. At some point, even government has to live within its means.
Exchange Rates
Now, Japan’s problems threaten to hasten the United States’ journey down the path to crisis.
Inflation is the loss of money’s value relative to other things. One manifestation of this is a falling exchange rate, which is just the price of one currency expressed in terms of another. As recently as January 2021, $1 US bought ¥104 (¥100 bought 96 cents); in July, $1 US bought ¥162 (¥100 bought 62 cents), the fewest in 40 years. Japanese buyers must pay more yen for goods, like energy, which are traded in foreign currencies, like dollars.
To ease this squeeze, Japan’s authorities have tried to boost the yen against the dollar. Like any other price, currency prices are driven by supply and demand so, to boost the yen’s exchange rate against the dollar, Japan needs to have fewer yen chasing dollars and/or more dollars chasing yen. Tighter monetary policy is required to accomplish the former — though that makes debt financing more challenging — and to accomplish the latter, the Japanese have been selling US bonds in return for dollars which they then use to purchase yen.
But this increase in the supply of Treasury bills on the market lowers their price and boosts their yields, another factor contributing to the alarming spike in the federal government’s borrowing costs. In summer 2026, the 30-year US Treasury yield hit a 19-year high of 5.238 percent.
Recognizing this, the US Treasury has stepped in to buy yen with dollars, but this is only a temporary fix. The underlying problem remains, as Robin Brooks notes: Japan’s bond yields are still not high enough to reflect its true fiscal situation, but Japan cannot afford for them to rise any higher.
Japan has borrowed itself into a corner. Many other countries, including the United States, are on track to join it.
