1) The document analyzes the determinants of low nominal yields on long-term Japanese government bonds (JGBs), despite Japan's high government debt levels. 2) It argues that Japan's monetary sovereignty and ability to issue debt in yen allows it to always service yen-denominated debt. Low short-term interest rates, set by the Bank of Japan, are the main driver of low long-term JGB yields. 3) Persistent low inflation and deflationary pressures, as well as sluggish economic growth, have also contributed to keeping JGB nominal yields low, while high public debt ratios have not pushed yields up as conventional theories predict.

1. 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

2. Important Disclaimer
This commentary has been prepared by Voya Investment Management for informational purposes.
Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy
any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any
security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of
the statements contained herein are statements of future expectations and other forward-looking
statements that are based on management’s current views and assumptions and involve known and
unknown risks and uncertainties that could cause actual results, performance or events to differ
materially from those expressed or implied in such statements. Actual results, performance or events
may differ materially from those in such statements due to, without limitation, (1) general economic
conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan
defaults (5) changes in laws and regulations and (6) changes in the policies of governments and/or
regulatory authorities. The opinions, views and information expressed in this commentary regarding
holdings are subject to change without notice. The information provided regarding holdings is not a
recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change
based on market conditions and other factors. Past performance is no guarantee of future results.
Voya Compliance ID # 10535
2

3. Japan’s Government Indebtedness Has Risen Sharply, But ...
3

4. … Long-term JGBs’ Nominal Yields Declined in the Mid
1990s and Since Then Have Stayed Remarkably Low
4

5. 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?
5

6. The Determinants of Long-term JGBs’ Low Nominal Yields
 Monetary sovereignty
 Low short-term interest rates
 Low inflation and indeed persistent deflationary
pressures
 Tepid economic activity
6

7. 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
account
 A monopoly issuer of unconvertible financial
means of payment denominated in that unit of
account
 The authority to tax and to determine what is
accepted in payment of taxes that it imposes
7

8. 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
imposes.
 Hence, it has monetary sovereignty.
8

9. JGBs Are Merely Promises to Deliver More of Its Own
Liabilities!
 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.
9

10. Christopher Sims and “Paper Money”
10

11. 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
resort”
 “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.”
11

12. 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
own currency.
 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.
12

13. Keynes’s Insights on LT Government Bonds’ Nominal
Yields
 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).
13

14. Short-term Interest Rates Follow the Bank of Japan’s
Policy Rates
14

15. Persistent Deflationary Trend Since Early 1990s
15

16. Economic Activity Has Been Stagnant Since mid 1990s
16

17. Notations
 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
17

18. 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
18

19. ST Interest Rates and Current Conditions Affect LT
Government Bonds’ Nominal Yields
 The short-term interest rate directly affects the long-term government bonds’
nominal yield.
 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.
19

20. 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
20

21. Unit Root Tests: Stationary Variables
21

22. However Debt Ratios & Deficit Ratios Are Not Stationary
22

23. 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.
23

24. Results Using GMM, With 3 Month T-Bills
24

25. Results Using GMM, With 12 Month T-Bills
25

26. Results Using 2SLS, With 3 Month T-Bills
26

27. Results Using 2SLS, With 12 Month T-Bills
27

28. Conclusions
 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.
28

29. 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.
29