The Determinants of Long-Term Japanese Government Bonds’ (JGBs) Low Nominal Yields
The Determinants of Long-Term Japanese
Government Bonds’ (JGBs) Low Nominal Yields
Tanweer Akram (Voya Investment Management)
Anupam Das (Mount Royal University)
12th International Post Keynesian Conference (Sep 25-Sep 27, 2014)
University of Missouri Kansas City (UMKC)
Kansas City, Missouri, USA
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Japan’s Government Indebtedness Has Risen Sharply, But ...
… Long-term JGBs’ Nominal Yields Declined in the Mid
1990s and Since Then Have Stayed Remarkably Low
Motivation and the Main Research Question
The Japanese economy has been mired in slow growth that has
resulted in large and chronic fiscal deficits (net borrowing) leading
to elevated and rising government debt (financial liabilities) ratios.
But long-term JGBs’ nominal yields have stayed remarkably low
and declined over time.
The conventional wisdom holds that higher government deficits
and indebtedness will exert upward pressure on nominal yields
(Baldacci and Kumar 2010, Lam and Tokuoka 2011, Tokuoka 2012,
Gruber and Kamin 2012, and Poghosyan 2012).
Why have long term JGBs’ nominal yields stayed ultra low?
The Determinants of Long-term JGBs’ Low Nominal Yields
Low short-term interest rates
Low inflation and indeed persistent deflationary
Tepid economic activity
What is Monetary Sovereignty?
A government with monetary sovereignty has the
following characteristics (Wray 2012, p. 30):
Sets its own unit of account
Issues liability denominated in that unit of
A monopoly issuer of unconvertible financial
means of payment denominated in that unit of
The authority to tax and to determine what is
accepted in payment of taxes that it imposes
The Government of Japan Retains Monetary Sovereignty
The Government of Japan clearly:
sets yen as the country’s unit of account
issues liabilities only in yens
is the monopoly issuer of unconvertible
final means of payment denominated
solely in yens
has the authority to tax and accepts only
yens in payment of the taxes that it
Hence, it has monetary sovereignty.
JGBs Are Merely Promises to Deliver More of Its Own
Following Woodford (2001, p. 31), as cited in Tcherneva (2010, p.15), it can
be paraphrased that for any sovereign government that issues debts in its
own currency, such as Japan, its debt is merely a promise to deliver more
of its own liabilities in the future.
There are, hence, no operational barriers for the government of Japan to
service its debt. As such, Japanese authorities are theoretically free from
obsessing about fiscal consolidation. (In contrast the euro zone countries
and the state governments of the U.S. have no monetary sovereignty.)
The liabilities of governments that retain monetary sovereignty and are
currency issuers are fundamentally different from that of households,
businesses, and governments that do not possess sovereignty and hence
are currency users.
Nominal Debt Merely Promises Costless “Paper”
Christopher Sims (2013) has argued that the following:
“since nominal debt promises to pay only costless paper, it is never
necessary for it to default”
“a central bank with the fiscal backing from a Treasury that can
issue nominal debt is the most powerful form of a lender of last
“The effects of monetary policy actions depend on … fiscal policy
actions they stimulate …”
“Nominal and real government debt are quite different, as are
inflation and outright default.”
“Central bank ‘independence’ should not mean that all connections
between monetary and fiscal policy authorities are severed.”
Hypothesis: Low Short-term Interest Rates Have Kept
Long-term JBGs’ Nominal Yields Low
Low short-term interest rates, induced by the
monetary authorities, have been a key driver of
JGBs’ low nominal yields, while monetary
sovereignty implies that the Government of Japan
has the ability to always service its debt issued in its
Japan’s experience of JGBs’ low nominal yields
under extremely accommodative monetary policy
and ultra low policy rates vindicates Keynes’s (1930)
view that long-term interest rates primarily respond
to monetary policy which exerts its direct influence
on short-term interest rates.
Keynes’s Insights on LT Government Bonds’ Nominal
The central bank usually sets the overnight rates and various other
short-term policy rates. This was well understood by John Maynard
Keynes (1930), as cited in Kregel (2011).
Fundamental uncertainty about the future and the effect of short-term
realization on long-term expectations can keep long-term interest rates
largely in harmony with short-term interest rates.
Keynes’s (1930) conjectures, as cited in Kregel (2011), on long-term
interest rates were based on his interpretation of the empirical research
of Reifler (1930).
Short-term Interest Rates Follow the Bank of Japan’s
Persistent Deflationary Trend Since Early 1990s
Economic Activity Has Been Stagnant Since mid 1990s
The long-term government bond yield, rLT
The short-term interest rate, rST
The forward rate, fST,LT-ST
The future short-term interest rate, rF
The term premium, z
The expected rate of inflation, E, and the current rate of inflation,
The expected rate of economic activity, 풚 푬, and the current rate of
economic activity, 풚
The Yield of a LT Government Bond Depends on the ST
Interest Rate and the Appropriate Forward Rate
1 + 푟퐿푇
퐿푇 = (1 + 푟푆푇 )푆푇 (1 + 푓푆푇,퐿푇−푆푇 )퐿푇−푆푇
푟퐿푇 = ɸ 푟푆푇 , 푓푆푇,퐿푇−푆푇
푓푆푇,퐿푇−푆푇 = 휏 푟퐹, 푧 = 훾 휋퐸, 푦 퐸 = 훾 휆 휋 , 휅 푦
푟퐿푇 = ɸ 푟푆푇, 훾 휆 휋 , 휅 푦 = 휗 푟푆푇, 휋, 푦
ST Interest Rates and Current Conditions Affect LT
Government Bonds’ Nominal Yields
The short-term interest rate directly affects the long-term government bonds’
The forward rate depends on the future short-term interest rate and the term
premium, which depend on inflation expectations and growth expectations.
However, investors’ expectations of the rates of inflation and economic
activity are respectively influenced by the current of rate inflation and the
current rate of economic activity. The near term views almost always affect
investors’ long-term economic and investment outlook.
The short-term interest rate decisively determines the long-term government
bonds’ nominal yields.
Monthly and Quarterly Data
Short-term interest rates, %: Treasury Bills 3 month (TB3M), and Treasury
Bills 12 month (TB12M)
Inflation year over year, %: Inflation ex food & ex energy (CINF), Inflation
ex fresh food (CFINF), and General inflation (INF)
Industrial production, year over year, %: IP
Japanese Government Bonds’ (JGBs) nominal yields, %: JGB2YR, JGB3YR,
JGB5YR, JGB7YR, JGB10YR, and JGB20YR
Public finance variables as a share of nominal GDP, % (quarterly): Gross
financial liabilities (GROSSDEBT), Net financial liabilities (NETDEBT),
and Net borrowing/lending (BALANCE)
Data sources: Bank of Japan, Statistics Bureau of the Ministry of Internal
Affairs & Communication, Ministry of Economy, Trade, and Industry,
OECD, Reuters; Thomas Reuters EcoWin
However Debt Ratios & Deficit Ratios Are Not Stationary
Main Empirical Findings
The coefficients of short‐term interest rates, whether using T‐bills of 3 months or 12
months, are positive and always statistically significant. It implies that JGBs’ nominal
yields are extremely sensitive to short-term interest rates.
The coefficients of the rates of core inflation are positive and statistically significant but
moderate in magnitude. It implies that as core inflation picks up (decline) JGBs’
nominal yields rise (fall).
The coefficients of the growth of industrial production are positive but low and
statistically insignificant. This implies that JGBs’ nominal yields are fairly insensitive to
the pace of economic activity.
The Hansen (1982) J test for over identifying restrictions is used to check for the validity
and relevance of instruments. The Hansen’s J statistic is insignificant in most cases,
which means that the test does not reject the null hypothesis that the instruments are
uncorrelated with the error term.
Long-term JGBs’ nominal yields have stayed low because of low
overnight and shot-term interest rates, low observed inflation and
persistent deflationary pressures, muted inflationary expectations,
and tepid growth and Japan’s monetary sovereignty.
Low short-term interest rates, which are really the outcomes of
monetary policy, are the primary drivers of long-term government
bonds’ low nominal yields.
Monetary sovereignty entails that the government of Japan can
always service its yen denominated government bonds.
Highly accommodative monetary policy and ultra-low policy rates
have kept JGBs’ nominal yields low in spite of elevated
government debt ratios and chronically high fiscal deficit ratios.
This Presentation is Based on Recent Papers
Akram, Tanweer, and Das, Anupam (2014a). “Understanding the
Low Yields of the Long-Term Japanese Sovereign Debt,” Journal
of Economic Issues 48(2): 331-340.
Akram, Tanweer , and Das, Anupam (2014b). “The Determinants
of Long‐Term Japanese Government Bonds’ Low Nominal
Yields,” unpublished working paper.
Akram, Tanweer (2014). “The Economics of Japan’s Stagnation,”
Business Economics 49(3): 156–175.