Noah Smith on the Demand for Japanese Government Bonds →

In this post, Noah Smith argues that the price of Japanese government bonds (JGB’s) is still high (which is the same thing as saying the interest rate on Japanese government bonds is still low) despite the size of the Japanese government debt because people believe that the Japanese government will raise taxes in the future.  

Towards the end of his post, Noah raises the possibility of negative real interest rates as another way to deal with the debt. This seems quite possible to me. If confidence in the willingness of future Japanese governments to raise taxes falls, then the price of JGB’s will fall and their interest rates will rise significantly above zero. In that situation there would be more room for the Bank of Japan (BOJ) to push interest rates on JGB’s down toward zero again (and equivalently, push prices of JGB’s up) to stimulate the Japanese economy. If that stimulus raises inflation to the 2% per year rate that the Bank of Japan has said it wants, then real interest rates could easily be -2% (a nominal interest rate of 0 minus inflation of 2%) for quite some time.  

An important bit of background is that the Japanese government seems to be able to do quite a bit to twist the arms of insurance companies, regional banks and pension funds to get them to continue to hold JGB’s, as Noah argues in his earlier post “Financial Repression, Japanese Style.” And the pension funds in turn don’t give workers many choices about how to invest. That is the core of Noah’s answer to the obvious question of why anyone would ever put up with low real interest rates for JGB’s when higher real interest rates are available on foreign assets.