The Bank of Japan has absorbed half that country’s national debt, creating huge liabilities and leaving the nation at a monetary fork in the road.
by Peter C. Earle
The Daily Economy
Over the past three decades, Japan’s monetary policy has been characterized by near-zero interest rates and significant quantitative easing (QE), aimed at countering persistent deflation and stimulating economic growth. The outcome of decades of accommodative policies has resulted in the Bank of Japan (BOJ) accumulating a balance sheet equivalent to 125 percent of Japan’s GDP — a ratio that surpasses any other major central bank. Japanese government bonds (JGBs) dominate the balance sheet, accounting for over three-quarters of the total; more than half of Japan’s outstanding government debt is held on the BOJ’s balance sheet.
That extraordinary accumulation has created an acute vulnerability. As interest rates rise, the value of JGBs could plummet due to heightened inflation and duration risks (bonds with longer maturities decline more sharply as rates rise). Moreover, the yen, a liability of the BOJ, is inherently tied to the proportion of “hard” assets on the bank’s balance sheet. A significant selloff in JGBs could erode the yen’s value, triggering broader financial instability. In consequence, the dual vulnerability of Japanese Government Bonds (JGBs) and the yen to a protracted selloff could have significant repercussions for global markets.