NBER WORKING PAPER SERIES

WHAT ABOUT JAPAN?
Yi-Li Chien
Harold L. Cole
Hanno Lustig
Working Paper 31850
http://www.nber.org/papers/w31850

NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
November 2023

We would like to thank Manuel Amador, Ben Hebert, Arvind Krishnamurthy, Peter DeMarzo,
Bengt Holmstrom, Jonathan Payne and other participants of the Stanford Finance lunch, St. LouisFed Brown-Bag seminar, Academia Sinica seminar, GRIPS seminar, and the SITE session on
fiscal sustainability. The views expressed here are those of individual authors and do notnecessarily reflect the official positions of the Federal Reserve Bank or the National Bureau of
Economic Research.
NBER working papers are circulated for discussion and comment purposes. They have not been
peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies
official NBER publications.
© 2023 by Yi-Li Chien, Harold L. Cole, and Hanno Lustig. All rights reserved. Short sections oftext, not to exceed two paragraphs, may be quoted without explicit permission provided that fullcredit, including © notice, is given to the source.

What about Japan?
Yi-Li Chien, Harold L. Cole, and Hanno Lustig
NBER Working Paper No. 31850
November 2023
JEL No. E63,F30
ABSTRACTAs a result of the BoJ’s large-scale asset purchases, the consolidated Japanese government
borrows mostly at the floating rate from households and invests in longer-duration risky assets toearn an extra 3% of GDP. We quantify the impact of Japan’s low-rate policies on its governmentand households. Because of the duration mismatch on the government balance sheet, thegovernment’s fiscal space expands when real rates decline, allowing the government to keep its
promises to older Japanese households. A typical younger Japanese household does not haveenough duration in its portfolio to continue to finance its spending plan and will be worse off.
Low-rate policies tax younger, poorer and less financially sophisticated households.

Yi-Li Chien
Research Division
Federal Reserve Bank of St. Louis
P.O. Box 442
St. Louis, MO 63166-0442
yilichien@gmail.com
Harold L. Cole
Economics Department
University of Pennsylvania
3718 Locust Walk
160 McNeil Building
Philadelphia, PA 19104
and NBER
colehl@sas.upenn.edu

Hanno Lustig
Stanford Graduate School of Business
655 Knight Way
Stanford, CA 94305
and NBER
hlustig@stanford.edu

1Introduction

In many developed countries the population is currently aging and shrinking. As the rate of economic growth declines, these countries confront the prospect of sustained deficits. Japan has beenat the leading edge of this development. Japan’s central government runs large deficits mostly
driven by a secular increase in social security spending as a result of Japan’s aging population.
Some economists have argued that governments may be able to run deficits indefinitely provided that the real growth rate of their economy always exceeds the real return on government
debt (Blanchard, 2019; Mehrotra and Sergeyev, 2021). In spite of its low interest rates, Japan is
not in the fiscal goldilocks region. Since 1997, the real return on Japanese government debt has
exceeded the growth rate by 1.2%. The local and central government’s debt has grown from 93%
in 1997 to more than 241% of GDP (gross domestic product) in 2021.1
By consolidating the government with the Bank of Japan, we show that Japan’s government
has engineered a sizeable duration mismatch on its consolidated balance sheet. The government
borrows from Japanese households through the banking sector mostly at floating rates, and theninvests in longer duration, risky assets to harvest risk premia, leading to a duration mismatch on
the government balance sheet. As a result of the duration mismatch, the government’s fiscal space
expands significantly as real rates decline. All else equal, the Japanese government can increasespending as rates decline, but a typical Japanese household will have to cut spending, because
it does not have enough duration in its portfolio. Conversely, when rates increase, the Japanese
government’s fiscal capacity is quickly eroded.
To manage this fiscal challenge, the public sector in Japan has deployed a levered investment
technology that households and financial intermediaries cannot deploy. Through the public pension funds, the public sector takes on large quantities of unhedged duration risk and currency
risk. The Japanese government implements a sizeable carry trade, and it earns high realized asset returns while its borrowing rates decline. Japan’s government has realized an ex post excess
return of about 2.13% per annum above its funding cost by going long in long-duration risky assets, financed with mostly short-duration funding in the form of bank reserves, T-bills and bonds.
This investment strategy has allowed the government to earn more than 3% of GDP from its risky
investments. As a result, the net debt, liabilities minus assets, of the entire public sector has onlygrown from 49% to 117% over the same period.
From an ex ante perspective, the government’s investment strategy delivers excess returns
above its funding costs only if the expected return on its debt does not fully reflect the riskinessof its investments. As the government invests in riskier assets, the required return on government
debt should increase commensurately unless government surpluses absorb this extra risk by becoming safer (Jiang et al., 2019a, 2020). We find no evidence of this, as this would entail cutting
1 The government debt includes T-bills, government bonds and loans

2payouts to pensioners and/or raising taxes in bad times.2 If the Japanese government is engaged
in financial repression, then government debt may be overpriced. To quantify the effect of financial repression, we conservatively assume that government surpluses as a fraction of GDP are
a-cyclical, and we infer a financial repression wedge of -1.96% for Japanese government debt, implying that the government debt return should be at least 1.96% higher. This wedge is ultimately
a tax on depositors.
First, we discuss the interest rate risk exposure on the government balance sheet. The Japanese
government has engineered a sizable duration mismatch on its consolidated balance sheet. Japan’s
government engages in risky maturity transformation on a large scale by borrowing at floating
rates and investing in long-duration assets. At the end of 2021, the consolidated government,
including the central and local governments, the FILF (fiscal investment and loan fund), the pension fund, and the BoJ (Bank of Japan), had liabilities of more than 3 times GDP. Almost 1/2 haveno duration: 101% of GDP in reserves held at BoJ, another 23% of GDP in cash. Finally, there
is another 144% in Bonds and T-bills. QE (quantitative easing) has added a floating-for fixed interest rate swap of 1 GDP to the government’s balance sheet, further shortening the duration of
the Japanese government’s liabilities. On the other hand, the government’s risky assets, totalingaround 200% of GDP, have much higher duration. The Japanese government invests one-thirdof GDP in domestic equities, more than half of GDP in foreign securities including equities andanother 14% in domestic bonds.
To be fully hedged against interest rates, the duration of its net debt, liabilities minus assets,
would have to equal the duration of its primary surpluses, which accrue in the distant future.
Think of the government issuing zero coupon bonds that match the expected surpluses period by
period. Instead, the duration of its debt is short, as a result of QE, and further reinforced by its longposition in high-duration risky assets. As a result of this duration mismatch on its consolidatedbalance sheet, a decrease in real rates creates extra fiscal capacity, because its net debt position has
negative duration, but its future surpluses have long duration.3
Second, we analyze currency risk. The consolidated government sector in Japan is engaged ina global currency carry trade, borrowing at the short rate in Yen, a typical carry trade funding currency, and investing more than 50% of GDP in risky foreign assets, without hedging currency risk.
The currency exposure adds to the duration risk, because the Yen depreciates in real terms when
the Japanese long rate declines if long-run U.I.P holds. The financial sector in Japan cannot replicate this currency carry trade, because financial intermediaries need to hedge currency risk. The
CIP (covered interest parity) deviations reduce the currency-hedged returns earned by Japanese
investors abroad (Du et al., 2018a), effectively taxing currency-hedged capital outflows. The fi2 There is a risk mismatch because the government is backing risk-free promises to bondholders and safe promises

to pensioners with risky cash flows from its tax revenue and its increasingly risky investments.
3 The duration of its net debt is actually negative, because the duration of its asset position far exceeds the durationof its liability position.

3

nancial sector in Japan starts with a large Yen depositor base, which they seek to deploy abroadto earn higher returns. This creates demand for synthetic borrowing in dollars, which increases
the synthetic dollar rate above the cash dollar rate (Borio et al., 2016). Between 2011 and 2023, thenegative spread of CIP deviation is especially large, which can be viewed as direct evidence offinancial repression due to the QE and YCC policies of BoJ.
If the main objective is to keep its promises to older Japanese households, then the Japanese
government has a strong incentive to promote low-rate policies. A decline in real rates creates
substantial extra fiscal capacity because of the short duration of the government’s liabilities andthe longer duration of its investments and projected budget surpluses, while a rise in rates would
remove fiscal capacity.
We explore the welfare consequences of the lower real rates for Japanese household, many ofwhich have little duration in their holdings of financial assets. The Japanese government is set
to benefit from lower real rates, but most households are not. The stand-in Japanese household’sbalance sheet does not have enough duration on its balance sheet.
As a result of quantitative easing, the consolidated Japanese government is borrowing fromJapanese households at floating rates: Japanese households have invested around 2 GDP in shortduration bank deposits, but only 38% of GDP in equities and 98% of GDP in private pension andinsurance products. On the liability side, the Japanese households have 63% of GDP in loans.
Given the low duration of the stand-in Japanese household’s wealth, the majority of younger
households is worse off as a result of a decline in long term real rates induced by financial repression. As the BoJ has stepped up its large-scale asset purchases, it further reduces the household’s
net duration and increases the welfare costs.
Moreover, the median young Japanese household does not participate in financial markets andhence has little or no duration in its financial holdings, but still has to finance its future consumption upon retirement out of savings. We use the metrics developed by Greenwald et al. (2022)
and Fagereng et al. (2022) to analyze the welfare consequences of financial repression. The welfare effects of lower real rates depend on the duration of the household’s financial wealth relative
to the duration of its excess consumption plan, where excess consumption is defined as the partof the household’s consumption to be financed out of its financial investments. For the medianyoung Japanese household, the duration of financial wealth falls short of its excess consumption
duration, and the lower real rates induced by financial repression will shrink the household’s
consumption possibility set (Greenwald et al., 2022).4 This is not the case for more financially sophisticated households who participate in financial markets. In that sense, Japan’s low rate policies transfers wealth from the young, less financially sophisticated to the older, more financiallysophisticated Japanese households.
The demographic transition in advanced economies (Auclert et al., 2021), in addition to the
4 These households are net buyers of financial assets, which will appreciate in value (Fagereng et al., 2022).

4

slowdown (Eggertsson et al., 2016) and the increase in inequality (Mian et al., 2020), have allcontributed to the secular decline in real interest rates. However, given the duration mismatchin Japan, the government has a strong incentive to implement low-rate policies because lower
real rates can substantially amplify the government’s fiscal space. Low real rates are not just a
symptom of the transition, but they’re also a policy outcome favored by governments of countries
in transition. Conversely, a rise in real rate would have serious fiscal repercussions.

2

Related Literature

When governments take measures to allow themselves to borrow at below-market rates, this is
usually referred to as financial repression (see Reinhart et al., 2011; Chari et al., 2020). During theGreat Financial Crisis, banks were persuaded by governments to load up on sovereign debt of
their countries (Acharya and Steffen, 2015; De Marco and Macchiavelli, 2016; Ongena et al., 2019).
This was widely interpreted as a manifestation of financial repression. However, since the Great
Financial Crisis, central banks in advanced economies have dramatically increased the size of theirbalance sheets relative to the size of their economies. These central banks have mostly used theirbalance sheet capacity to purchase government bonds.
Japan was a front-runner in this regard. The recent expansion of central bank balance sheets
can best be interpreted as a new wave of financial repression (see Hall and Sargent, 2022, for acomparison of the pandemic and two World Wars).5 We reinterpret the Bank of Japan’s large
scale asset purchases and yield curve control experiment through the lens of financial repression.
After the capital market liberalization, the Japanese government used large scale asset purchases
to substitute bank reserves held at the BoJ for cheap post bank deposits and pension reserves asa cheap source of funding. We believe our paper is the first to formally measure this financial
repression wedge. To do so, we rely on the approach to government debt valuation developed in
Jiang et al. (2019a).
Our paper contributes to the literature on fiscal sustainability in low rate environments (seeBlanchard, 2019; Mehrotra and Sergeyev, 2021; Ball and Mankiw, 2021; Aguiar et al., 2021; Mianet al., 2021). Even though the real rate of return on its debt exceeds its growth rate, Japan keeps
rolling over deficits by investing in riskier assets and collecting risk premia, much like the U.S.
has been running current account deficits, while investing in risky assets abroad (Gourinchas andRey, 2007). The Japanese government is levering up, not unlike underfunded pension funds in
the U.S who gamble for resurrection (see Myers, 2018; Giesecke et al., 2022; Giesecke and Rauh,
5 Moreover, financial repression could come in various forms, including macro-prudential regulation that favors
government bonds, direct lending to the government by domestic pension funds and banks, moral suasion used toincrease domestic bank holdings of government bonds (see Acharya and Steffen, 2015; De Marco and Macchiavelli,
2016; Ongena et al., 2019, for examples from Europe during the GFC). Chari et al. (2020) derive conditions under which
forcing banks to hold government debt may be optimal, because it acts as a commitment device.

52022). In the long run, the Japanese low-rate approach is not sustainable. The Japanese government has made risk-free promises to pensioners and to bondholders, but it is funded by risky tax
revenue and risky investments. This risk mismatch is not apparent, because the bond portfolio,
the promises to pensioners, have not been fully marked to market.
We make contact with the growing literature on CIP deviations in currency markets. Regulators may play a key role in keeping arbitrageurs from closing the gap by imposing capitalrequirements on financial institutions (Du et al., 2018a). In the case of Japan, we show that CIP
deviations directly help the government’s low rate policies by reducing the hedged return gap between foreign and domestic investments. Hébert (2020) analyzes CIP and other law of one pricedeviations as the footprint of interventions by regulators who address externalities. We show thatgovernments can use financial regulation to deliver CIP deviations as a tool of financial repression.
We argue that the Japanese government is engaged in a massive global currency carry tradeby borrowing at below-market rates in Yen and investing in high interest rate currencies abroad.
In historical data the currency carry trade breaks down at longer maturities. Shorting longer
maturity bonds of low interest currencies to go long in bonds of high interest rate currencies does
not produce excess returns over longer samples, because the low (high) currency risk premia areoffset by large (small) local currency term premia in low (high) interest rate countries (see Lustig etal., 2019).6 However, since the GFC, when central banks have started large scale asset purchases,
currency carry trade profits have turned positive at longer maturities, since central banks havecompressed the local currency term premia in low interest rate currencies (Andrews et al., 2020).
This is consistent with financial repression.
There is a growing literature that studies the effects of monetary policy on the distribution of
wealth. Auclert (2019a)’s work studies the effects of transitory, nominal interest rate shocks on
the balance sheet of households and the distribution of wealth. In their seminal paper, Doepke
and Schneider (2006) examine the redistributive effects of inflation in an overlapping generations
model. Our work is closer to Greenwald et al. (2022) and Fagereng et al. (2022) who study theeffects of permanent shocks to real rates on household consumption and welfare. Piazzesi andSchneider (2010) measure the interest rate risk exposure of different sectors of the U.S. economy.
We use a different approach to measure the interest rate risk exposure of the household and government sector in the Japanese economy. We also explore the welfare implications of low rate
policies using this apparatus. While there is a large literature on financial repression, there is lessanalysis of its welfare implications.
Our paper is organized as follows. Section 3 briefly discuss the example events of financial
repression in the past few decades. We then consolidate the balance sheet of Japanese central
government with local government, central bank, government-owned banks (FILF) and social security. Section 4 describes the dynamics of the debt-to-output ratio of the Japanese government
6 This finding is consistent with long-run U.I.P.

6

and the net debt-to-output ratio of the consolidated government as a function of past returns, past
deficits and past growth rates. Section 5 develops a novel measure of financial repression. In section 6, we document the large duration mismatch on the consolidated government’s balance sheet,largely as a result of QE. The large duration mismatch implies that a lower borrowing cost causedby financial repression could expand the fiscal capacity government greatly. Section 7 analyzes
the household balance sheet. We measure interest rate risk exposure on households’ balance sheet
and analyze the welfare consequences of low rate policies for the Japanese households. Section 8
concludes our study.

3

The Japanese Government’s Carry Trade

Japan’s post-war economy was heavily bank-dependent. The government tightly controlled thebanking sector. Until the 90s, Japanese capital markets were undeveloped and capital market
transactions were prohibitively costly for Japanese households. Direct participation in the stock
market was expensive even in the late 90s. Commissions on trades were fixed and regulated.
Until the late 90s, US-style mutual funds were not allowed. Investment trusts typically underperformed, because they had an incentive to generate fee income for the parent companies by trading(Hoshi and Kashyap, 1999). Japanese household savers were effectively trapped in the banking
sector. Even today, participation rates in asset markets are quite low: only 23% of Japanese households own bonds, stocks or mutual funds.
At the time, the postal savings bank was the largest deposit-taking institution in the world. Before 2001, the deposits of households at Japan Post, the postal savings bank as well as the pension
reserves were required to fully fund Japan’s FILP, the Fiscal Investment and Loan Program, a large
government-run lending program. Its loan portfolio exceeded 100% of GDP in 2001. During the
80s and 90s, a number of measures were taken to gradually increase options for savers. Interest
rate ceilings on deposits were gradually removed by 1994. By 1999, commissions for stock trading
had been liberalized and households obtained cheaper access to the stock market. In 2001 Japanabolished the FILP funding requirement imposed on the postal bank and the pension reserves.
Instead, the FILP started to tap the bond market directly.
After the capital markets liberalization, the Japanese government effectively replaced the cheap
funding it had obtained through the postal savings bank prior to the capital markets liberalization with bank reserves held at the Bank of Japan. Japan had been stuck in a low-growth regime
since the mid-1990s. In April 1999, the BoJ committed to holding short-term rates at zero until
the deflationary concerns were dispelled. In 2001, the BoJ shifted gears and started large scaleasset purchases to try and stimulate the economy. The BoJ coined the phrase quantitative easing
to describe this policy. Its main stated objective was to increase bank reserves. The underlying

7

Figure 1: Annual purchases of Japanese government Bonds (excluding T-bills)

Source: Japan’s Flow of Funds.

assumption was that the banks would deploy these reserves in lending to firms and households.7
Since 2012, the BoJ has stepped up its large-scale asset purchases as part of the Abenomics ambitious government spending program.
In 2016, the BoJ shifted to a policy of explicit yield curve control (YCC). The BoJ capped longterm yields explicitly. It set a target for the 10-year yield at zero percent. The BoJ was ready topurchase the necessary bonds to implement this cap, effectively putting a floor on the price ofbonds.8 Figure 1 plots the purchases of long-dated bonds. Over the past decade, the BoJ has
crowded out private investors, including banks and the non-financial sector, in the market for
long-dated Japanese government bonds by buying more than the government’s issuance of bonds
each year. Figure 2 plots the bond holdings in levels. By the end of 2021, the BoJ owned well over
500 trillion Yen in government bonds (excluding T-bills), more than half of outstanding bonds.
While the government had removed all of the interest rate ceilings as part of the capital market
liberalization, the government had effectively imposed a new cap on interest rates through YCC.
To understand the impact of these policies on public finances, we construct the consolidated
government balance sheet. We consolidate the Bank of Japan, the FILF, and the general government which includes the central government, the local government and the public pension funds.
7 Later, Federal Reserve Chair Bernanke sought to use the term credit easing to describe large scale asset purchasesin the U.S., but the term never caught on (Bernanke, 2022, pp.144).
8 The BoJ was hopeful that it would not have to buy as many bonds by sending this signal to the bond markets, i.e.
that the market would produce the target yield. That scenario has not materialized.

8

Figure 2: Japanese Government Bond Holdings (excluding T-bills)

Source: Japan’s Flow of Funds.

3.1

Consolidating the Government Balance Sheet

In 2021, the consolidated government invested 101 % of GDP in risky securities, while borrowing
311% of GDP. The consolidated government, shown in Table 1, takes a long position of 54% of GDP
in foreign securities and 33% of GDP in domestic equities. To fund its operations the consolidated
government issues T-bills and bonds (144% of GDP) as well as bank reserves (102% of GDP).
Table 2 shows the balance sheet of the BoJ, which has purchased about 1 GDP of bonds andissued reserves. The BoJ has entered into an interest rate swap, paying floating on bank reserves
and receiving fixed on the bonds it has purchased. The underlying notional is one GDP. Thishas dramatically shortened the duration of the Japanese government’s consolidated liabilities. In
doing so, the Japanese government set the stage to reap the full benefits of financial repression.
These floating rate payments are ultimately passed onto depositors. In this sense, the BoJ has
massively reduced the duration on the balance sheet of Japanese households, who mostly holddeposits, as we are about to show.
The investments in the risky assets are mostly undertaken by the Japanese government pension funds. These risky long positions (including domestic bonds and equity as well as foreign
securities), shown in the General Government balance sheet in Table 3 have grown from 24% of
GDP in 1997 to 98% of GDP in 2021. In 2013, a government panel recommended a major realloca-

9Table 1: Consolidated Government Balance Sheet

December 1997
AssetsCurrency and Deposits
Domestic Loans
Other Domestic Securities
Domestic Equities
Foreign Securities

6.00%
102.83%11.15%
13.85%
6.75%

Liabilities
Currency
10.77%
Bank Reserves
0.73%
Bonds & T-Bills 50.43%
Loans
52.10%
Deposits FILF
75.43%

Sum

140.57%

Sum

189.46%

Net Debt

48.89%

December 2021
AssetsCurrency and Deposits
Domestic Loans
Other Domestic Securities
Domestic Equities
Foreign Securities

19.28%
73.37%
14.00%
33.20%
53.94%

Liabilities
Currency
23.01%
Bank Reserves
101.57%
Bonds & T-Bills 143.94%
Loans
38.06%
Deposits FILF
4.61%

Sum

193.78%Sum

311.19%Net Debt

117.41%

Unit: % of GDP. Source: Japan’s Flow of Funds.

tion into risky assets for all of the government-run pension funds (Hoshi and Yasuda, 2015).9 The
government has increased its exposure to equities by 260%, and it has increased its exposure toforeign risky assets eightfold.
Figure 3 shows the quarterly evolution on the liability side of the consolidated balance sheet
from 1997 to 2021. The evolution of government funding exactly reflects the phases of financial
repression discussed in the beginning of this section. In 1997, around 75% of GDP in funding
came from deposits with the FILP through the postal bank and the public pension reserves. As
this source of funding gradually dried up in the wake of the 2001 reform, the Japanese government
issued more Japanese government bonds and other fix income securities instead, but eventually,
after 2012, the government replaced these deposits with bank reserves held at the BoJ –throughlarge scale asset purchases–as a source of funding. These reserves currently make up about 100%of GDP.
9 The public pension funds include the Government Pension Investment Fund (GPIF), the National Public Service

Personnel Mutual Aid Fund, the Local Service Personnel Mutual Aid Fund and the Private School Personnel Mutual
Aid Fund.

10

Table 2: BoJ Balance Sheet

December 1997
AssetsCurrency and Deposits
Domestic Loans
Bonds & T-Bills

0.00%
4.16%
9.58%

Liabilities
Currency
10.77%
Bank Reserves
0.73%

December 2021
AssetsCurrency and Deposits
Domestic Loans
Bonds & T-Bills

0.50%
26.67%
97.94%

Liabilities
Currency
23.01%
Bank Reserves 101.57%

Unit: % of GDP. Source: Japan’s Flow of Funds.

Table 3: General Government Balance Sheet

December 1997
AssetsCurrency and Deposits
Domestic Loans
Other Domestic Securities
Domestic Equities
Foreign Securities

Liabilities
5.68%
6.48%
5.70%
11.65%
6.75%

Loans
Bonds & T-Bills

25.22%
67.80%

December 2021
AssetsCurrency and Deposits
Domestic Loans
Other Domestic Securities
Domestic Equities
Foreign Securities

Liabilities
17.24%
3.40%
13.75%
30.28%
53.94%

Unit: % of GDP. Source: Japan’s Flow of Funds.

11

Loans
Bonds & T-Bills

27.13%
213.77%

Figure 3: Liabilities of the Consolidated Japanese Government Balance Sheet

Unit: % of GDP. Source: Japan’s Flow of Funds.

4

Accounting for Japan’s Debt-to-Output Dynamics

Next, we move on to accounting for the dynamics of net debt on the consolidated government’sbalance sheet. During our sample periods, we find that the government has earned an additional
3.26% of GDP on its investments.

4.1

Japan is Not in the Goldilocks Region

The debt-to-output ratio is a valuation ratio for the entire portfolio of outstanding Treasuries. Following Hall and Sargent (2011), we can decompose variation in the debt-to-output ratio in termsof variation in returns and variation in primary surpluses. Let Gt denote nominal government
spending before interest expenses on the debt, Tt denote nominal government tax revenue. We
start from the static central government budget constraint,
Gt − Tt + Dt−1 Rt = Dt ,(1)

where Rt denotes the gross return on the entire portfolio of marketable debt Dt . By iterating backwards, we obtain the following expression for the debt-to-output ratio. We can impute variationin the debt-to-output ratio of a country to its history of output growth, inflation and interest rates.

12

Proposition 4.1. The debt-to-output ratio can be stated today as a function of cumulative past returns
Rt− j,t , past nominal growth Xt− j,t , as well as past primary deficit/output ratios
t
Dt
=∑
Yt
j =0
j



Gt− j − Tt− j
Yt− j



Gt− j − Tt− j:
Yt− j

Rt− j,tD+ R0,t −1 ,Xt− j,tY−1jwhere Rt− j,t = ∏k=1 Rt− j+k and Xt− j,t = ∏k=1 Xt− j+k .
High deficits, high returns, and low nominal output growth in the past all contribute to a highdebt-to-output ratio today.10 We start by considering a deterministic environment. If the real
growth rate of the economy, denoted by x, is higher than the bond returns, denoted by r, then thedebt-to-output ratio will not explode even when the government runs permanent deficits. Whenthe r < x, the government can roll over its debt in perpetuity and run steady-state deficits (G > T)with a constant debt/GDP ratio:
D
Y

=

G−T
Y
x −r .
1+ x(2)

Recently, Blanchard (2019); Mehrotra and Sergeyev (2021) study these dynamics of the debt-tooutput ratio in a low interest rate environment, and evaluate the implications of low rates forgovernment debt sustainability. In this environment, it appears as if there may be no fiscal cost to
debt. In dynamically inefficient economies characterized by r < x, governments may have a freelunch. Ball and Mankiw (2021); Aguiar et al. (2021) study the effect of government debt on capital
accumulation and efficiency in dynamically inefficient economies that are not subject to aggregate
risk. Furman and Summers (2020) also study debt dynamics in a low rate environment. They
advertise the government’s interest cost as a fraction of GDP as a sufficient statistic to gauge fiscal
sustainability.
Over the past two decades, Japan has not been operating in the goldilocks r < x region described by Blanchard (2019) and Mehrotra and Sergeyev (2021). Bond returns were low, but GDP
growth was even lower. Table 4 reports the returns on the outstanding portfolio of Japanese government bonds and T-bills, Japanese inflation and Japanese GDP growth. The top panel reports
the nominal bond returns (r n ) and nominal GDP growth rates (x n ). Between 1997 and 2022, the average nominal growth rate and the average nominal inflation rate were close to zero. The averagenominal return on Japanese bonds and T-bills is 1.32% per annum. The middle panel reports real
returns. The real return on the portfolio of Japanese bonds and T-bills is 1.12% per annum, muchhigher than the real growth rate of -0.13% per annum. The bottom panel shows the gap between
10 Hall and Sargent (2011) decompose the U.S. post-war debt-to-output dynamics over longer horizons into components due to the nominal returns on Treasuries, U.S. output growth and U.S. inflation. They emphasize the role ofhigher-than-average output growth and inflation after the world war II in bringing the debt-to-output ratio back down.

13

real returns real growth. Over the whole sample, this r − x gap was 1.26%. The gap decreased from
2.30% in the 2000-2009 to 0.73% between 2010 and 2019, as real bond returns decreased while real
growth increased.
Table 4: Bond Returns, Inflation and Growth

1997-2022
2000-20092010-20192020-2022
1997-2022
2000-20092010-20192020-2022

xn
0.07%-0.63%
0.96%-0.14%
x = xn − π-0.13%-0.40%
0.39%-0.41%

1997-2022
2000-20092010-20192020-2022

π
0.20%-0.22%
0.57%
0.27%

rn
1.32%
1.67%
1.69%
-1.93%
r = rn − π
1.12%
1.90%
1.11%
-2.20%
r−x
1.26%
2.30%
0.73%
-1.79%

Source: Bond Returns are from BofA Ice Japan Government Bond Index Fund (excluding T-bills). Nominal GDP
growth and CPI inflation from Cabinet Office of Japan. Top Panel reports nominal returns, inflation and nominal
growth. Middle panel reports real return and real growth. The bottom panel reports the gap between real returns andreal growth.

4.2

Consolidated Government Debt Dynamics Accounting

One missing piece in the government budget constraint shown in equation (1) is the asset positionof government. This is obviously a shortcoming at least in Japan’s case since the consolidatedbalance sheet of Japanese government exhibits a large asset position. We then arguments thegovernment budget constraint by including the asset term, At and defining net debt, NDt , as thedebt minus the asset position:
Gt − Tt + Dt−1 RtD − At−1 RtA = Dt − At ≡ NDt(3)

where RtA denotes the gross return on the portfolio of assets. Given this government budget
constraint, Proposition 4.1 can be modified as the following:
Proposition 4.2. The net debt-to-output ratio NDt /Yt can be stated as a function of cumulative past debt
returns Rt− j,t , past nominal growth Xt− j , as well as past primary deficit/output ratios
14

Gt− j − Tt− j, as well as
Yt− jpast cumulative excess returns between RtA and Rt :
t
NDt
=∑
Yt
j =0



Gt− j − Tt− j
Yt− j



R A − R0,t A−1
Rt− j,tND−1− 0,t+ R0,t,Xt− j,t
X0,t
Y−1
Y−1

A =
where R0,t∏tk=1 RkA . The net debt-to-output ratio depends on past cumulative government bond returns,

past cumulative growth rates and past excess returns on the assets.
The above proportion then implies that even if the growth rate is lower than the rate of return,r > x, and the government is running deficits, the consolidated government’s net debt may bestable as a fraction of output. In other words, the government can roll over its debt in perpetuity
and run steady-state deficits (G > T) with a constant debt/GDP ratio provided that the returns
on its asset position r A as well as asset position itself A are both large enough:r A −xT −G
D+x A= r−Y x + 1r−
x Y.
Y
1+ x
1+ x

Table 5 reports the past returns on the Japanese government’s consolidated balance sheet over
our sample periods. The consolidated Japanese government earns an excess return of 2.13% perannum on its risky long position above the cost of its funding position. This average excess return
has increased since 2000. The average return on the asset position of the consolidated balance sheet
is 2.87%. The average return on the liability position is 0.74%. By taking on risks, the government
earns a spread of 2.13% on its consolidated balance sheet.11 The size of the balance sheet in 2021
is 194% of GDP in asset and 311% in liability. (see Table 1). As a result, the government earns anadditional 3.26% (= 1.94 × 2.87% − 3.11 × 0.74%) of GDP on its risky asset position. The Japanese
government therefore can generate positive steady-state fiscal capacity.
The government expenditure excluding interest payment and social security payment is around
15% of GDP in 2021. The net social security and welfare payment is around 8.5% of GDP. Total tax
revenue is around 20% of GDP in 2019. Therefore, the average fiscal surplus required to fulfill government spending without increasing tax burden is around 3.5% of GDP. This simple accounting
exercise indicates that the current financial leverage as well as tax policy chosen by the Japanese
government is likely to balance its budget even in the long run. This could be a possible explanation that why there is no debt crisis nor inflation even if its debt-to-output ratio exceeds 200% of
GDP.
Table 5 indicates that the spreads really started to increase during the period 2010 to 2019. Thisis the time when the BoJ resumed its large scale asset purchases in 2010 on a much larger scale,essentially crowding out private investors, as shown in Figure 1. This is also the time when the
11 Please refer to Appendix A.1 for more details on the calculation of the consolidated balance sheet returns reported
on Table 5

15

public pension funds started to reduce its government bond holdings and increase the foreign
risky asset positions. Between 2000 and 2009, the spread was only 53 bps. It increased to 3.66% in
the next decade, after the start of large scale asset purchases.
Table 5: Returns on Consolidated Balance Sheet

1997-2022
2000-20092010-20192020-2022

Liabilities
Government Consolidated
(1)
(2)
1.32%
0.74%
1.67%
0.88%
1.69%
1.08%
-1.93%-0.91%

AssetsConsolidated
(3)
2.87%
1.41%
4.74%
1.07%

Difference
(4)
2.13%
0.53%
3.66%
1.97%

See Appendix A.1 for details.

5

Financial Repression

To earn this spread, the Japanese government has increasingly taken on aggregate risk in foreignand domestic equity and bond markets. In the absence of financial frictions, this risk should bereflected in the pricing of the government debt, unless the government’s surpluses absorb the risk.
As the government takes on more risk, this risk should be reflected in the pricing of debt, unlessthe government renders the tax revenue safer or the transfer spending riskier.
Since 2010, the BoJ has been purchasing a significant fraction of the issuance of bonds. Since
2014, the BoJ has been buying more than the total issuance, completely crowding out private
investors who have been net sellers. Without these purchases lowering bond yields, it is not clear
the Japanese government could earn these spreads, because the required return on debt would
increase as the government levers up.
We find evidence that the risk is not priced into debt. The debt may be overpriced. Financial
repression was common in advanced economies prior to the 1980s. The history of government
debt financing is partly a history of financial repression.12
12 There is a large literature documenting financial repression in emerging market economies (see McKinnon, 1973).
U.S. financial history is replete with examples of financial repression. During the Civil War, the Union passed the
National Bank Act in 1863, authorizing national banks to issue banknotes provided the notes were partly backed by
U.S. Treasurys. During WW-I , the Federal Reserve helped the Treasury by buying short-term bonds. In addition, theFederal Reserve encouraged private investors to buy Liberty loans by borrowing from private banks. To do so, theFederal Reserve allowed banks to discount loans secured by Liberty loans at preferential discount rates. After WWI, a number of European countries, most notably Italy and France, engaged in financial repression to keep interest
rates low (see Sargent et al., 2019, for detailed discussions of the U.K., U.S. French and Italian experiences during theinterbellum.). During and after WW-II, the Federal Reserve engaged in yield curve control by pegging short terminterest rates. This lasted until the Federal Reserve Treasury Accord in 1951. In addition, there were explicit ceilings on
nominal interest rates in place (Regulation Q). According to Reinhart and Rogoff (2009); Acalin and Ball (2022), thesemeasures played a key role in reducing the debt/GDP ratio after WW-II.

16

5.1

Mispricing of Government Bonds

To see this idea more clearly, we start by analyzing the case in which the debt is priced accurately.
We use PtT to denote the cum-dividend price of the tax claim and PtG to denote the price of the
spending claim. If the TVC (transversality condition) is satisfied, then the value of debt is fully
backed by the present value of future surpluses and the value of the assets: PtT − PtG + At = Dt .
Moreover, governments cannot make risk disappear. The government debt portfolio’s expectedexcess return is the expected return on a portfolio that goes long in the tax claim and short in
the spending claim, and long in the risky assets A, given by (see Jiang et al., 2019b, for a fullderivation):i PG − Ghi Ahi
PtT − Tt h T
f
f
f
t
t
Et R t +1 − R t − t
Et RtG+1 − Rt +Et RtA+1 − Rt .
Dt
Dt
Dt

h
i
f
Et RtD+1 − Rt=

The risk of the tax, spending claims and the asset position have to be reflected in the riskinessof the government debt. Consider the simplest case in which spending and taxes have the samerisk. Then the return on the government debt portfolio is given by a weighted average of the risk
premium on a claim to surpluses and the risk premium on the risky portfolio:
i A
h
h
i
h
i
At
f
f
f
t
Et RtD+1 − Rt
= (1 − )Et RSt+1 − Rt + Et RtA+1 − Rt .
Dt
Dtvar ( M

(4))

Denote the pricing kernel as: Mt+1 . Define the return alpha as: αt = Et t( M t+1) , and the returnt +1−covt ( Mt+1 ,Rit+1 )ibeta of an asset i as: β t =. By the investor’s Euler equation, βit αt determines thevart ( M )t +1

conditional risk premium of this asset:
Ethf
Rit+1 − Rti
−covt Mt+1 , Rit+1 vart ( Mt+1 )== βit αt .
vart ( Mt+1 )E t ( Mt + 1 )The beta of the debt is a weighted average of the beta of the sovereign wealth fund and the betaof the surpluses:βD= (1 −t

At S At A
)β +
β .
Dt t
Dt t

(5)

As the consolidated government takes on more risk by leveraging up and by investing in riskier
assets, the riskiness of its debt will increase proportionately, unless the government makes thesurpluses correspondingly less risky.
In addition, by rearranging equation (4), we can obtain an expression for the expected excess
return on assets minus liabilities:
h
i
h
i
At
Et RtA+1 − RtD+1 = (1 −)Et RtA+1 − RSt+1 .
Dt
17

(6)

The Japanese government can only deliver a positive expected excess return on its investment
strategy if the return spread between the asset is riskier than the surplus. We can then calculate thereturn spread between the asset and the surplus. The 2021 asset-to-debt ratio of the consolidated
government is 0.62 = 194%311% . The excess return of the consolidated balance sheet is 2.13% according
to Table 5. Hence, the implied spread between the sovereign wealth fund and the surplus ishihi
Et RtA+1 − RSt+1 = Et RtA+1 − RtD+1 ×

2.13%
1
=
= 5.65%.
1 − 0.62
0.38

A 5.65% implied excess return then suggests that, if the debt is priced correctly, then the implied
risk premium on the surplus claim is -2.78% (= 2.87% − 5.65%). The surpluses would have to bea hedge, i.e. counter-cyclical. But in reality, Japanese surpluses are strongly pro-cyclical. This is
an indication that the government bonds might be mispriced as a result of financial repression. In
other words, the government cannot just back risk-free promises to bondholders and safe promises
to pensioners with risky cash flows from the tax revenue and the risky investments.

5.2

Quantifying Financial Repression

We then consider the possibility that the government debt is mispriced and hence the equation (4)might not holds.
Definition 1. Given the assumption of constant surplus/output ratios, the financial repression wedge, ωt ,is defined as the difference between the expected return on government debts and the predicted return basedon risk exposure in the balance sheet:ωt = Ethf
RtD+1 − Rt

i



At A
At
β
− (1 − ) βYt +
Dt
Dt t




vart Mt+1 , Rit+1.
E t ( Mt + 1 )(7)Moreover, ωt can also be seen as the Euler equation wedge or the pricing error.
The next step is to quantify the financial repression wedge defined in equation (7). First, consider the case that government debt portfolio has zero beta. Then all of the risk in the risky portfolio has to be offset by the insurance offered by the surpluses:
βSt = −At
Dt
At
(1 − D)t

β tA .

(8)

Given that surpluses are co-integrated with output, this would require strongly counter-cyclicalsurpluses, which is again counterfactual. As the consolidated Japanese government takes on moreleverage and more risk in its sovereign wealth fund, the beta of the surpluses has to decrease tocompletely insulate the government debt.

18

A more realistic approach is to consider the case in which both taxes and spending are constantfractions of output. Then the surpluses are as risky as a claim to output, or, equivalently, unlevered
equity.
βD= (1 −t

At Y At A
)β +
β .
Dt t
Dt t

(9)

Given that surpluses are actually pro-cyclical, this produces a lower bound on the financial repression wedge.
We then quantify the financial repression wedge in 2021 below. In 2022, the unlevered beta ofequity in Japan is 0.45. The ratio of assets to debt in 2021 is 0.62 as mentioned earlier.
βD= (1 − 0.62)0.45β Et + 0.62β tA .
t

(10)

The current expected excess return on equities in Japan is 5.1%13 We then calculate the returnbeta of the asset portfolio in the consolidated balance sheet by the following equation:ihf
Et RtA+1 − Rt
2.87% − 0.1%hi × β Et ≈× β Et = 0.55β Et ,β tA =
f
5.1%
−
0.1%
E
Et R t +1 − R twhere the expected return for the asset portfolio is obtained directly from Table 5 and the risk free
return is approximated by the average return of bank reserve in our sample period, which is 0.1%.
We end up with an asset beta that is equal to 0.55 of the stock market or levered equity beta.

βD= (1 − 0.62)0.45β Et + 0.62 × 0.55β Et ≈ 0.51β Et .
t

(11)

The implied expected excess return on the government’s liabilities would then be equal to 2.6%
(5.1% × 0.51). From Table 5, we then approximate the expected access return of the overall liability
as 0.64% (0.74% − 0.1%). Hence, the implied finance repression wedge is 1.96% if we assume thatsurpluses are expected to be a-cyclical in the future.
ωt = −2.6% + 0.64% = −1.96%.
This back-of-the-envelope calculation suggests that Japanese earns returns that are much too low.
In other words, Japanese debt is overpriced. In our view, the overpricing is a result of financial repression. Appendix A.2 uses the past returns to measure this financial repression wedge and findthat the wedge is slightly larger at 2.24%. We believe that we are the first one to quantify this financial repression wedge. This wedge is ultimately a tax on depositors and financial intermediaries
13 see AQR Capital Market Assumptions.

19

who hold bonds (e.g. insurance companies).

5.3

CIP Deviations as Evidence of Financial Repression

In order to circumvent financial repression at home, the Japanese financial sector could increase
returns by investing abroad, but these financial institutions, unlike the government, would be
expected or required to hedge their currency risk at least partially. If CIP holds, the hedging cost
is exactly equal to the interest rate difference between domestic and foreign assets. The hedging
requirement for currency risk imposed on the domestic financial institutions can then effectively
reduce their hedged returns on foreign investments. As a result, these hedging requirements
enable financial repression by trapping the assets of financial intermediaries in Japan (see, e.g.,
Setser, 2023).
To make this idea concrete, consider the CIP formula between USD and Japanese Yen. Let St
denote Yen per dollar. The USD/Yen LIBOR basis is defined as the difference between the cash
LIBOR rate for borrowing in USD and the synthetic USD LIBOR rate constructed from Yen LIBOR
rates and hedged back into USD:$,LiborLibor
xt,t+n = rt,t+n − (rt,t+n − ρt,t+n ),where ρt,t+n = (1/n)( f tn − st ) denotes the n-period forward premium (in logs) obtained from theforward f tn and spot st exchange rates. Du et al. (2018b) document large deviations from Covered
Interest Rate Parity in LIBOR markets during the crisis. These CIP deviations have not completely
disappeared. Figure 4 plots the LIBOR CIP deviations for maturities ranging from 1-month to 12
months. Between 2010-2019, the average basis was -41bps at the 1M horizon, -31 bps. at the 3M,-28 bps at the 6M, -27 bps at the 12 M. Du et al. (2018b) document even larger CIP deviations at
longer maturities of 5 years. Figure 5 computes the CIP deviations at maturities in excess of one
year, computed from cross-currency swaps. Between 2011 and 2023, the average basis is -55 bps.
at the 5Y horizon, -57 bps. at the 10Y, -43 bps. at the 20 Y, and -35. at the 30Y.
The large and consistent CIP deviations in the USD/Yen market provide strong evidence insupporting our view that the financial assets are effectively trapped in Japan. The large negativebasis in the USD/Yen market, which are determined by the size of international capital flows,
reduce the hedged returns on foreign investments even further for the Japanese private financial
institutions.
According to the flow of fund data, financial intermediaries in Japan have to intermediate
about 3× GDP in bank deposits, insurance and pensions. However, they cannot replicate thegovernment’s strategy of foreign investments because of the hedging requirement. When they
invest abroad, the Japanese banks have to hedge at least part of the currency risk. The banks havea large Yen depositor base of 2× GDP, and they seek dollar investments abroad to earn higher
20

Figure 4: LIBOR CIP Deviations

Source: Bloomberg and authors’ calculation

Figure 5: LIBOR CIP Deviations –Longer Maturities

Source: Bloomberg and authors’ calculation

21

returns. To hedge the currency risk exposure, the banks will demand synthetic dollars, creating
upward pressure on the synthetic USD LIBOR rate. This creates downward pressure on the basis.
This is a general pattern documented by Du et al. (2018b) . Low interest rate currencies tend tohave more negative bases against the USD, as investors seek higher returns abroad.
In addition, the BoJ’s Quantitative and Qualitative Monetary Easing (QQE) announcements,
starting in 2014, as well as its move to negative policy rates causes a widening of the USD/JPY
basis (Borio et al., 2016). As the BoJ further depresses the term premium in Japan, this induces
financial intermediaries to seek higher bond returns abroad, thus causing the CIP basis to widen.
We view this as direct evidence of financial repression.

6

Interest Rate Risk Exposure on the Government Balance Sheet

Does the rate reduction induced by the financial repression help the government to relax its budget
constraint? If so, how much? These are the questions we intend to shed a light on in this section.

6.1

Duration Mismatch and the Government’s Fiscal SpaceWe first consider the implications of a permanent decline in interest rates on the fiscal space of thegovernment. We begin by deriving the standard link between an asset’s cash flow duration andits exposure to interest rates.
∞
s−t z .
Proposition 6.1. In period t, consider a sequence of cash flows {zs }∞ss=t and its valuation, Zt = ∑s=t R

The revaluation of asset Zt due to a change in R is given by:∂ log Zt∑∞ Rs−t zs × ( s − t )= s=t≡ − D,∂ log R
Zt
where D is the asset’s duration.
Proof. Please refer to Appendix A.4
If we iterate forward on the flow government budget constraint, then we can obtain the following expression for its period-t net debt:∞

NDt = ∑ Rt−s ( Ts − Gs ),

(12)

s=t

which simply states that government’s net debt is equal to the present value of future primary
surpluses, defined as tax revenue minus spending. With this identity in hand and together with
Proposition 6.1, the effect of a decline in rates on the government’s spending possibility set depends on the duration of its balance sheet as well as the duration of its future spending plans.
22This theoretical insight regarding the link between interest rates and the government’s spending
possibility set is stated below:
Corollary 1. The effect of real rate declines on the government’s spending possibilities set depends on therelative duration of its net debt and surpluses:(a) If D ND < D T −G then the government’s spending possibilities expand when the interest rate falls,(b) if D ND > D T −G the government’s spending possibilities contract.
Equivalently, the effect of real rate declines on the government’s spending possibilities set from the depends
on the relative of its net financial assets and deficits:(a) If D N A > D G−T then the government’s spending possibilities expand when the interest rate falls,(b) if D N A < D G−T the government’s spending possibilities contract.
When the duration of net assets exceeds the duration of the deficits, then a real rate expands
fiscal capacity. The capital gain on its net assets exceeds the increase in the NPV of future deficits,
and the government has extra fiscal capacity to increase G or reduce T in the future. Or, equivalently, when the duration of its net debt is smaller than the duration of future surpluses, then the
resulting increase in the market value of debt is smaller than the increase in the NPV of its futuresurpluses, thus increasing the government’s fiscal capacity. As we are about to show, this turns
out to be the empirically relevant case for Japan. By contrast, to fully hedge against shocks to real
rates, the government should set its balance sheet portfolio in a way such that the duration of net
debt matches the duration of future surpluses.

6.2

Measuring Duration Mismatch on the Government Balance Sheet

Next, we measure the net duration of the government’s net financial assets. We start on the asset
side. We infer the duration of equities from the price/dividend ratio using the Gordon growthmodel.14 We use the Jorda-Schularick-Taylor Macro-history database (Jordà et al., 2019) for the
price/dividend ratio on Japanese stocks. The average duration for Japanese stocks over this period is 75.6 years. This high number reflects the high valuation ratios for Japanese stocks overthis period. For bonds, we use the ICE-BofA Japan Government index’s effective duration. The
average duration over this period is 7.19 years. For all of the loans on the government’s balance
sheet, we used a duration of 3 years. The duration of deposits (cash and bank reserves) is 1 year
(0 years). For foreign securities, we used a weighted average of the duration of bonds and U.S.
stocks (59 years). The weights are 50/50.
14 In the Gordon growth model, duration is given by D = 1+r = pd × (1 + r ) where r denotes the expected returnr− g

and g denotes the expected growth rate.

23

Long-lived assets denominated in foreign currency are exposed to the domestic real discountrate as a result of long-run U.I.P, which equalizes the long-run holding period returns on real
bonds denominated in domestic and foreign currency.
According to the portfolio reported on Table 1, we can then calculate the duration of the consolidated balance sheet. In 2021, the duration of its risky asset position is around 23 years. The
high duration is mostly due to the equity position. The duration of its liabilities is only 3.7 years.
The net duration is the weighted average of asset and liability duration. The consolidated government has a negative net financial asset position of about 117% of GDP in 2021, the net result of adebt position of 311% of GDP and an asset position of 193% of GDP. As a result, the smaller asset
position contributes more positive duration than the negative duration contributed by its larger
debt. This means that the duration of the government’s net asset position is positive and large (seeFigure 10 in the Appendix). In 2021, the net duration is 29 years, up from 13 years in 2010. The
Japanese government has dramatically increased the duration of its net asset position in the past
decade or so. Put differently, the Japanese government has a negative duration of 29 years for its
net debt, because the value of its net debt actually decreases when rates decline, as a result of thelong position in high-duration risky assets.
At the same time, its surpluses accrue in the distant future, because Japan is expected to run
deficits for now. We follow the procedure developed by Jiang et al. (2022) to measure the duration of government surpluses using budget projections. In the baseline projection of the JapaneseCabinet15 , the combined local and central government is projected to run primary deficits until
2032, the end of the projection range. The projected bond-to-GDP ratio in 2032 is 216%, which isroughly unchanged compared to the 214% bond-to-GDP ratio in 2021 (See table 3).
We assume that the economy is in the steady-state starting in 2032 and the net debt-to-GDP
ratio remain unchanged at 117%. If the transversality condition holds, then the net debt positionin 2032 is fully backed by surpluses. The government will need to run a steady-state surplus YS of
2.11% of GDP:


ND
Y



= pdY ×
2032

S
1
1
= Y
=
× 2.11%,Y(0.3% + 2% − (0.5%))r −gwhere pdY denotes the steady-state price/dividend ratio for a claim to GDP, g denotes the steadystate growth rate of the economy, rY denotes the discount rate for a claim to GDP.16 We use a reallong-term rate of 0.3% and a GDP risk premium of 2%. When we compute the duration of theentire projected surplus starting in 2022, we end up with a duration of 64 years for the surplus
15 The Japanese Cabinet’s fiscal projections are available at this web site.
16 The steady-state price/dividend ratio of a claim to GDP determines the fiscal capacity as a fraction of GDP per %of primary surplus (Jiang et al., 2022).

24

claim:
T −G
D2021
≊

−t
∑∞
t=0 R t × ( T2021+t − G2021+t )= 64.
∞∑t=0 R−t ( T2021+t − G2021+t )If the government wanted to be fully hedged against interest rates, it would have had to issue zero
coupon debt equal to the projected surplus for each maturity. In that case, its debt would have aduration of 64 years. Instead, the government borrows at a much shorter duration. As a result,the increase in the NPV of surpluses exceeds the increase in the market value of the net debt inresponse to a real interest rate decline:∞∆ E0 ∑ R ( Tt − Gt )!

−t

> ∆NDt .

t =0More specifically, the left hand side of equation above, the PDV of future surpluses, increases by
64% in response to a permanent decrease in real rates of 100 bps. The right hand side decreases
by 29%, because the net debt has negative duration. Japan can increase government spendingor reduce taxes while still satisfying its intertemporal budget constraint. So, when real rates decline, the fiscal space of Japanese government expands significantly. In contrast, a permanent rateincrease destroys fiscal capacity.

7

Interest Rate Risk Exposure on the Household Balance Sheet

Through financial repression, we have shown that it is possible for Japanese government to sustain its high debt with fiscal deficits even in the long run. In this section, we study the welfare
consequence of the financial repression on Japanese households.

7.1

Stand-in Japanese Household Balance Sheet

For the household sector in Japan, The deposit-to-GDP ratio has been historically high since the80s (Hoshi and Kashyap (1999)). In 1997, the ratio of deposit-to-GDP was still quite elevated,
at 129%. Even then, Japan was an outlier. U.S. households held only deposits worth 42% of
GDP (Table 12). The banking sector remained large in the late 90s partly because Japanese savers
kept supplying deposits to the banking system, even when on the demand side the commercial
borrowers were tapping into capital markets directly as a result of financial market liberalization.
Just as Japan completed the liberalization of its capital markets, the central bank embarked on abold new path.
Table 6 compares the Japanese household balance sheet in 2021 to the one in 1997. In 2021,
Japanese households held around 200% of GDP in deposits, compared to 40% of GDP in equities.
About another 1 GDP are invested in insurance policies and pensions. Household demand deposits are up around 70% of GDP since 1997 despite the nominal deposit rate declining to zero25

during this period. In sum, 3X GDP of household wealth is intermediated through the banking
and insurance sector. In contrast, as reported in Table 12, U.S. households only held currency anddeposits, including money market mutual fund shares worth 70% of GDP. U.S households held
191% of GDP in equities, and 35% in debt (Treasuries, corporate bonds etc.).
In spite of the more than doubling of equity holdings as a fraction of GDP between 1997 and
2021, the duration of the Japanese stand-in household’s net asset position has not increased significantly. It has hovered between 15 and 20 years. Figure 12 in the Appendix plots the durationof the household balance sheet. This stagnation of the stand-in household’s duration is largely
driven by the sizeable increase in the ratio of deposits to GDP which largely offsets the effect of
the increase in household equity holdings.
Table 6: Japanese Household Balance Sheet

December 1997
AssetsCurrency and Deposits 127.65%
Other Securities
16.41%
Equities
15.75%
Insurance & Pension
63.15%
December 2021
AssetsCurrency and Deposits 197.74%
Other Securities
4.64%
Equities
38.32%
Insurance & Pension
97.82%

Liabilities
Loans 64.90%

Liabilities
Loans 63.35%

Unit: % of GDP. Source: Japan’s Flow of Funds.

7.2

The Cross-section of Japanese Households

We then turn to the cross-section distribution of Japanese households. Our analysis utilizes the
National Survey of Family Income, Consumption and Wealth data conducted in year 2019.17 Thissurvey data collects consumption, income and assets data for a sizeable number of households
around 90,000.
First, for financial assets other than deposits, participation rates by Japanese households arelow. Table 7 reports the participation rate for different financial assets for all households as wellas across income quartiles. The average participation rate (for all households) of demand deposits
and time deposits are 76.3% and 57.3%, respectively. Participation for other financial assets is
17 The survey results are available at this web site.

26

more limited. For example, the overall participation rate for direct stock holdings is only 16%. The
stock participation rate does increase in income but peaks at 28% among the top-quartile-income
households. The participation rates for trusts, investment vehicles akin to mutual funds, are evenlower. The overall participation rate for securities, which include stock, bond and open-end trust,reaches only 23%. This empirical fact indicates that a large fraction of Japanese households hold
mostly short duration assets, such as deposits, in their portfolios.
Table 7: Asset Market Participation Rates (%) across Income Quartile

Income Quintile

1st

2nd

3rd

4th

5th

Avg

Financial Assets
Demand Deposits
Time Deposits
Securities (stocks, bonds and trust)
StocksUnit & Open-end Trust

80
65
46
12
7
6

88
74
55
19
12
10

91
76
58
22
15
10

94
81
59
26
18
13

97
86
70
37
28
18

90
76
57
23
16
12

Source: National Survey of Family Income, Consumption and Wealth 2019 Report: Table 4-20.

Second, downsizing homes is not a popular option even among the senior retired Japanesehouseholds. Table 8 provides the supporting evidence. In general, the value of housing assets
increases in age and income. More importantly, the value of housing owned does not decrease
even after age 65 conditional on the income decile. This suggests that the idea of home downsizing
to finance consumption is not prevalent even among the aged and retired households.
Table 8: Estimated Value of Houses and Residential Land across Age and Income Groups

Income Decile

under 35

35 to 44

45 to 54

55 to 64

64 to 74

75 & above

1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th

1, 596
1, 4402, 4842, 8185, 555
6, 1398, 1799, 03515, 631
15, 858

6, 9354, 32418, 527
8, 08812, 10711, 32215, 731
18, 877
21, 795
38, 896

13, 638
11, 2449, 02317, 627
15, 161
17, 518
16, 860
19, 252
22, 932
34, 350

17, 327
16, 60313, 973
14, 611
16, 51622, 256
21, 101
23, 404
26, 697
38, 960

14, 90717, 145
20, 022
21, 78120, 691
23, 04227, 72227, 90631, 275
50, 069

17, 687
18, 168
20, 192
21, 437
25, 94128, 91639, 377
40, 358
50, 868
71, 938

Units: Thousand Yen. Source: National Survey of Family Income, Consumption and Wealth 2019 Report.

Third, the net worth of net financial assets remains large even for the aged households. Table
9 reports the net financial wealth conditional on income. Compared the level of financial asset to27

the housing value reported in Table 8, the size of their financial asset is not trivial. The average
financial wealth to housing wealth ratio reaches 56% for the age group 74 and above. This empirical fact indicates that households have a strong precautionary saving motive for near end of life
and/or strong bequest motives.
Table 9: Net Financial Asset for Aged Households across Income Groups

Income Decile

64 to 74

75 and above

1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th

7, 67410, 232
13, 04218, 647
16, 394
17, 169
16, 989
19, 489
21, 74130, 968

6, 6208, 91212, 266
15, 186
17, 754
19, 165
19, 630
26, 129
27, 130
31, 811

Units: Thousand Yen. Source: National Survey of Family Income 2019 Report.

In the following three subsections, we use a sufficient statistics approach to assess the welfare
effects based on recent work by Auclert (2019b); Greenwald et al. (2022); Fagereng et al. (2022).
This approach allows us to gauge the welfare effects of a decrease in real rates on the cross-sectionof Japanese households. The welfare effect depends on the duration of the household’s wealthportfolio versus the duration of the household’s excess consumption plan.

7.3

Duration Mismatch and Household Spending

We first consider the implications of a permanent decline in interest rates on household’s consumption possibility set. Consider a household who lives from age 0 to age J and is given a streamof income denoted by {ys }sJ=0 . By iterating forward on the flow household budget constraint, thenet asset position of a household at age j, denoted by θ j , can be expressed as the present value of
future excess consumption, which is defined as the consumption minus income plan {cs − ys }sJ= j :J

θ j = ∑ R s − j ( c s − y s ),

(13)

s= j

which together with Proposition 6.1 implies that the effect of a decline in rates on the household’s
spending possibility set depends on the duration of its net asset holding as well as the durationof its future excess consumption plans. For notation, let D θ to be the duration of the household’s
portfolio of financial assets, and let D c−y be the duration of the household’s excess consumption
28

claim. We have the following corollary:
Corollary 2. The effect of real rate declines on the household’s consumption possibility set depends on therelative duration of its net wealth and excess consumption (Greenwald et al., 2022):(a) If D θ > D c−y then the household’s consumption possibilities expand when the interest rate falls,(b) if D θ < D c−y the household’s consumption possibilities contract.
Whether changes in interest rates expand or contract a household’s consumption possibilities
depends on how that duration compares to the duration of that household’s lifetime excess consumption. While financial wealth is always equal to present value of future excess consumption
by the budget identity (13), the two can be differentially exposed to the same interest rate shock,much like a bank with a maturity mismatch of assets and liabilities. As a result, even if a household gains financial wealth from a decline in rates, it can still see its consumption possibilities
contract if the present value of its pre-shock excess consumption plan rises by more than its financial wealth. Intuitively, a decline in interest rates increases the cost of a given consumption plan.
Thus, if the value of the household’s human and financial wealth has not risen sufficiently at thesame time, its former consumption plan may no longer be affordable.
The young will typically have high duration of excess consumption, because they keep consuming when they are retired. Of course, this depends on the replacement ratio of the pensions
provided by the Japanese governments. These are included in our definition of y.

7.4

Measuring Duration Mismatch in the Cross-section of Households

We then measure the duration mismatch in the cross-section of Households in the data. The income data we employed is the pre-tax income net of interests and dividends, which includes thesocial security taxes for young cohorts and the social security payment for the old cohorts.
Given the empirical observation that households do not downsize their house for consumption, we exclude housing related consumption, imputed rent, as well as housing related assets,
mortgage and house, to compute the excess consumption and asset duration. Moreover, the endof life net financial asset is included in the end of life consumption in order to take the strong
bequest and/or precautionary saving motives into consideration. In addition, we simply assume
that the data observed as an outcome of a stationary economies. Namely, the consumption andincome profiles observed in the data are the expected consumption and income profiles over life
cycle.
According to the analysis in Subsection 6.2, the average durations of stocks and bonds are 76
and 7 years, respectively. On the other hand, the durations of demand and time deposits are short,
0 and 1 year, respectively. As a result, the determination of asset duration among households
critically depends on participation in the security market. Therefore, for the welfare analysis, it29

is critical to classify the households according to their asset market participation. We consider
three types of households described below. The first type of households only holds deposits but
does not hold any securities. They are called non-participants. The second type holds all typesof financial assets seen in the data. They are called participants. The third type of households
does not hold any financial assets and hence are called hand-to-mouth households. Table 7 thendirectly implies that the percentage of hand-to-mouth households and participants are 10% and
23% of total households. The majority of households are non-participants, which account for 67%
of the total population.
Figure 6 plots the asset duration for participants and non-participants across income and age
groups. As we expected, participation in the security market is the key determination of asset duration among households. The asset durations of participants are at least one order of magnitude
higher that of non-participants conditional on income and age. In addition, the asset duration of
non-participants are low regardless of incomes and ages since their assets are either in demand
deposits, which have zero duration, or in time deposits, which have one year duration. Our
welfare analysis ignores hand-to-mouth households since both of their asset duration and excess
consumption duration must be zero by construction. The interest rate change does not affect thewelfare of hand-to-mouth households.
We then turn to the excess consumption duration. Figure 7 plots the excess consumption duration for participants and non-participants across income and age groups. The excess consumption durations of participants are higher than that of non-participants after controlling incomes
and ages while the duration gap of excess consumption between these two type of households ismuch smaller than the gap of asset duration. As a result, the non-participants are exposed heavily to downside risks of interest rates and participants are the opposite. In short, By compared
the durations of asset and excess consumption among different type of households as shown in
Figure 6 and 7, we conclude that the non-participants, which are the majority of households, areexposed heavily to the downside risks of interest rates since their asset durations are far less thanthe excess consumption duration. Finally, the fraction of participants is increasing in income andage and hence our duration analysis implies that the younger and lower income households havea larger exposure to the downside risks of interest rates. Instead, the higher income and moresenior households tend to have enough asset duration to hedge against to lower interest rate risk.

7.5

The Welfare Impact of a 1% Decline in Interest Rate

To further link the consumption possibility set with welfare of households, we rely on the Euler
equation derived from a household utility maximization problem. We then define a money-metric30

Figure 6: Household Asset Durations across Income and Age

measure of welfare gain for a household at age j:
J

Welfare gain = ∑ βs− j
s= j

31

uc,s
dcs
uc,j

Figure 7: Household Excess Consumption Durations across Income and Age

where β is the utility discount rate and uc,s denotes the marginal utility of consumption at periods.
With the household Euler equation in hand, we can further state the welfare effect of changing
real rate:
Proposition 7.1. In response to the change in rates, the welfare gain for a household can be approximated32

by the following equation (Greenwald et al., 2022; Fagereng et al., 2022):
Welfare gain ≈ D c−y − D θ × θ × d log R,(14)which depends on the net duration between excess consumption and net asset as well as the level of asset, θ.
Proof. Please refer to Appendix A.5
We are now ready to measure the welfare costs of financial repression. Consider a scenario
where the interest rate decline permanently by 100 bps. By using Proposition 7.1 (or equation(14)), Figure 8 plots the estimated welfare costs (as percentage of households’ current wealth) for
participants and non-participants across income and age groups. A decline of 100 bps in the real
rate induces significant welfare losses for non-participant, especially among younger households.
For age groups between 35 to 64, the welfare cost of non-participants range from 5% to more than
10% of their wealth except for the highest income decile.
The case of participants is quite different. These households have a considerable amount of
duration in their portfolio. For almost all income and age groups, participants experience a large
welfare gain (negative in cost) especially among senior households older than 55. Their welfare
gain of 1% reduction in real rate is around or above 15% of their wealth even for the lower income households. For participants aged younger than 55, the welfare gain is significantly reduced
for middle income groups. In short, the financial repression induces a high welfare cost to nonparticipants, who are the majority of households (67% of total households). At the same time, italso benefits participants, who tend to be higher income and richer, tremendously. The welfare
effects of financial repression are then regressive.

33

Figure 8: Welfare Cost of 1% Decline in R across Income and Age34

8Conclusion

By consolidating the balance sheet of the Japanese government and the Bank of Japan, we document that the Japanese government has engineered a massive duration mismatch on its balance
sheet. As a result of this duration mismatch, the government has earned significant excess returns
that help to explain why the Japanese government can sustain a high amount of debt, more than
200% of GDP, and run consistent fiscal deficits.
In order to do this, the government has to issue overpriced securities. We quantify the size offinancial repression, which almost reaches 2%. In other words, without financial repression, thereturns of government liability would be 2% higher.
Due to the large duration mismatch, its fiscal capacity is greatly boosted by a lower real rates.
On the household side, the duration mismatch is quite heterogeneous. The more financially sophisticated households who hold a significant amount of long duration assets benefit from a lower
interest rate, while the less financial sophisticated ones suffer a large welfare loss. Given that sophisticated households tend to be older and income richer and that unsophisticated ones tend
to be younger and income poorer, our welfare analysis indicates that a low interest rate policy
induces a regressive distribution effect between income rich and income poor as well as an intergenerational transfer from young to old.
Japan is at the forefront of the demographic transition. In fact, aging society, secular decline ingrowth, and high debt-to-GDP are common theme either already faced or about to happen among
many countries. Our study cautions that low rate policies might expand the government’s fiscal
space but could come with a large welfare cost.
In the long run, the Japanese low-rate approach is not sustainable. The Japanese government
has made risk-free promises to pensioners and to bondholders, but it is funded by risky tax revenue and risky investments. This risk mismatch is not apparent, because the bond portfolio, thepromises to pensioners, have not been fully marked to market.

35

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A

Appendix

A.1

Consolidated Balance Sheet Return Calculation

The consolidated balance sheet returns are calculated in quarterly frequency. The data range fromthe first quarter of 1998 to the last quarter of 2022. The composition of financial assets and liabilities is directly obtained from Japan’s Flow of Funds. On the asset sides, asset data can be38

classified into the following major types of financial instruments: currency and deposits, loans,
domestic equities, other domestic assets, foreign reserves and foreign securities. In the flow offunds data, there is no detail decomposition of foreign securities. However, we know that these
foreign securities are exclusively held by social security funds. To further classify the foreign securities portfolio, we then turn to the quarterly reports of the GPIF (Government Pension InvestmentFund), the major public pension fund in Japan. According to the GPIF report data, foreign securities can be decomposed into two subcategories: foreign equities and foreign bonds. The portfolio
share of equity out of total foreign investment is fixed at 50% since 2020, and it varied between
50% and 64% before 2013 to 2020. We simply assumed the portfolio share before 2013 was thesame as that in 2013, which is 56%.
The following return data are assigned to be the return on the categories of assets listed above:
interest on reserves at BoJ for currency and deposits, return on BofA (Bank of America) Ice Japan
government bond index for loans and other domestic assets, return on the BofA 10 Year US Treasury Index for foreign reserves, the return on MSCI Japan index for domestic equities, the returnon the MSCI world index excluding Japan for foreign equities, and the return on FTSE world
government bond index excluding Japan for foreign bonds.
The liability side of the consolidated balance sheet includes the following major types of financial instruments: cash, T-bills, government bonds, bank reserves, loans and FILF (Fiscal investment and Loan Fund) deposits. We use the following as their returns: zero for cash, T-bill returnfor T-bills, loans and FILF deposits, interest on reserves at BoJ for reserves, and the return on BoFAICE Japan government bond index for government bonds.
We also check the accuracy of our return choices by comparing them to GPIF asset returns,
which are available in four major categories of assets: domestic bonds, domestic equities, foreign
bonds and foreign equities. As indicated by Figure 9, our choices of returns matches the returns
reported by the GPIF quite well.
In addition, Table 10 reports the nominal returns for domestic equity, domestic bond, foreign
equity and foreign bond in Japanese Yen or in U.S. dollars. The top panels reports equity returns
for the Japan and ROW (rest of the world) in USD and JPY, as well as the difference between them.
Over the entire sample, there is a 5.4% spread in ROW vs. Japan returns expressed in JPY. This gap
reflects an additional 1.2% due to the depreciation of the JPY against the USD. The bottom panels
reports bond returns for Japan and the ROW in USD and JPY, as well as the difference them. Overthe entire sample, there is a 2.8% spread ROW vs. Japanese bond returns expressed in JPY.

A.2

An Alternative Measure of Financial Repression

We provide an alternative measure of financial repression assuming the expected return of each
asset in 2021 is its past average return during our sample period (1997 to 2022). Table 11 reports

39

Figure 9: Returns Comparison

the asset and liability positions of each type of financial instrument in 2021 as well as their returns
in sample average.
The 2021 assets to debt ratio of the consolidated government is 0.62 = 194%/311% . Table 11
reports the weighted asset and liability returns are 3.53% and 0.72% respectively. By keeping thesame assumption that return on the surplus claim is equal to the return of GDP claim, which canbe approximated by the unlevered return of domestic equity claim. In 2021, the unlevered ratio is
about 0.45. Then we can quantify the financial repression wedge in 2021 by the following equation
below:
ωtAlt


At
At
Et RYt+1 +Et RtA+1 − Et RtD+1
≈
1−
Dt
Dt
= (1 − 0.62) × 0.45 × 4.55% + 0.62 × 3.52% − 0.72%
= 2.24%.
This alternative financial repression calculation gives a slightly higher financial repression wedge
compared to our benchmark case at 2.02%.

40

Table 10: Equity and Bond Returns
Country
Currency
1997-2022
2000-20092010-20192020-2022
1997-2022
2000-20092010-20192020-2022JP
ROW ROW ROW-JP
JPY
USD
JPY
Nominal Equity Returns
4.7%
8.9% 10.2%
5.4%-2.4% 3.5%
3.3%
5.6%
10.0% 10.2% 12.5%
2.5%
9.0%
8.4% 17.0%
8.0%
Nominal Bond Returns
2.0%
3.9%
4.8%
2.8%
1.9%
8.2%
7.3%
5.5%
2.2%
2.5%
4.3%
2.1%
-1.0% -4.9% 4.0%
5.0%

Table 11: 2021 Balance Sheet Portfolio and Past Returns
Asset Position
Currency and Deposits
Domestic Loans
Domestic Bonds
Domestic Equities
Foreign Equities
Foreign Reserve
Foreign Bonds% of GDP in 2021

Average Past Return

19%
73%
14%
33%
12%
29%
12%

0.1%
1.74%
1.74%
4.55%
9.85%
6.59%
4.51%

Weighted Asset Return

3.52%

Liability Position% of GDP in 2021

Average Past Return

Currency
Bank Reserves
T-BillsGov Bonds
Domestic Loans
Deposits FILF

23%
102%
23%
121%
38%
5%

0%
0.09%
0.07%
1.74%
0.07%
0.09%

Weighted Liability Return

0.72%

41

A.3

U.S. Household Balance Sheet

For the comparison to the Japanese household balance reported on Table 6, Table 12 reports the
US household balance sheet by the end of 1997 and 2021.
Table 12: US Household Balance Sheet

December 1997
AssetsCurrency and Deposits
41.96%
Other Securities
130.86%Equities
91.47%
Debt
34.87%
December 2021
AssetsCurrency and Deposits
71.64%
Other Securities
155.83%Equities
191.83%
Debt
34.99%

Liabilities
Loans 59.73%

Liabilities
Loans 69.13%

Units: % of GDP. Source: Federal Reserve Board of Governors, Flow of Funds Table B.101e.

A.4

Proof of Proposition 6.1

The proof is straightforward by taking derivative of ln Zt on ln R. First, rewrite ln Zt as(
ln Zt = ln∞

∑ exp ((s − t) × ln R) zs

)
,

s=t

and then take the partial derivative:∂ ln Zt∂ ln R

(

=
= −

∞

∑ exp ((s − t) × ln R) zs

s=t
s−t z × ( s − t )
∑∞
s
s=t R

Zt

) −1 (,

which is the definition of D.

42∞∑ (s − t) exp ((s − t) × ln R) zt

s=t

)

A.5

Proof of Proposition 7.1

Consider a maximization problem of a household at age j with asset θ :J

Vj = max ∑ βs− j u(cs ){cs }sJ= j s= j

subject toJθ − ∑ R−s ( cs − ys ) ≥ 0
s= j

The Lagrangian associated with the household problem is
J

J

s= j

s= j

!

L j = ∑ βs− j u ( cs ) + λ θ − ∑ R j−s ( cs − ys ) ,and the first order condition with respect to cs is
βs− j uc,s = λR j−s for all s = j, .., J.
The Envelop condition together with the first order condition with respect to c j imply thatJ−s ( c − y )
R
d
∑
s
s
dVj
dL j
s= j
dθ
.
=
= uc,j −d ln Rd ln Rd ln Rd ln R

From Proposition 6.1 and binding budget constraint θ = ∑sJ= j R−s (cs − ys ), we know thatdθ
= − Dθ θd ln Rand thatd ∑sJ= j R−s (cs − ys )d ln R

Then we have:

= −D

J

∑R

c−y

!
−s

(cs − ys )= − D c−y θ.

s =0



dVj
= uc,j D c−y − D θ θ.
d ln R

Hence, the welfare gain of a change in interest rate can be approximated byJ

Welfare Gain =uc,s dcs∑ βs− j uc,j

s= j

=



dVj
≃ D c−y − D θ × θ × d ln R,
uc,j

43

(15)

Figure 10: Duration of Japanese Government’s Balance Sheet

Source: Jorda-Schularick-Taylor Macro-history database, Japan flow of funds and authors’ calculation.

where the last equality utilizes equation (15).

A.6

Additional Figures

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Figure 11: Projected Surpluses

Note: Based on Japanese fiscal projections. The projected debt in 2032 is fully backed by a steady-state surplus.

Figure 12: Duration of Japanese Household’s Balance Sheet

Source: Jorda-Schularick-Taylor Macro-history database, Japan flow of funds and authors’ calculation.

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