Fiscal Sustainability of Japan: A Crisis Avoided or a Crisis Delayed?

Abstract

Japan has the highest government debt in the world, and set a precedent for the developed world by running deficits since 1993. Although the large debt burden is widely regarded as posing a risk to fiscal sustainability, it has continued to increase with little repercussions. JGB yields remain relatively low, and the market seems unworried about a fiscal crisis in Japan. However, several papers in the early 2010s pointed to the danger of a fiscal crisis in Japan, including predictions of a debt crisis and spiking bond yields within the next 10-15 years. Now that these predictions have failed to materialize, we will examine how Japan has avoided a fiscal meltdown so far, and how we may assess the sustainability of the Japanese government debt going forward, given the consensus that Japan’s age of ultra-low interest rates is coming to an end. We find that many of the drivers behind Japan’s fiscal stability in the past 15 years are unlikely to be repeated, and debt sustainability concerns suggest that a fiscal consolidation will be needed sooner rather than later