Does QE reduce the public debt burden?
By Scott Sumner
Bill directed me to an article that suggests the answer is yes:
Japan for years has been renowned for having the world’s largest government debt load. No longer.
That’s if you consider how the effective public borrowing burden is plunging — by one estimate as much as the equivalent of 15 percentage points of gross domestic product a year, putting it on track toward a more manageable level.
Accounting for the Bank of Japan’s unprecedented government bond buying from private investors, which some economists call “monetization” of the debt, alters the picture. Though the bond liabilities remain on the government’s balance sheet, because they aren’t held by the private sector any more they’re effectively irrelevant, according to a number of analysts looking at the shift.
“Japan is the country where public debt in private hands is falling the fastest anywhere,” said Martin Schulz, a senior economist at Fujitsu Research Institute in Tokyo.
While Japan’s estimated gross government debt is now over twice the size of the economy, according to Schulz’s calculations using BOJ data, the shuffle of holdings from private actors like banks and households to the central bank is having a big impact. It means debt in private hands will fall to about 100 percent of GDP in two to three years, from 177 percent just before Prime Minister Shinzo Abe took power in late 2012, he estimates.
It’s possible to make a good argument that Japan’s debt burden is falling, but I don’t believe this is because the BOJ holds lots of Japanese Government Bonds (JGBs). Rather they are benefiting from very low interest rates, and a strong likelihood that rates will stay low for the foreseeable future.
Consider four possible cases:
1. Japanese interest rates stay low indefinitely.
2. Japanese interest rate eventually rise above zero, and the BOJ continues to pay market interest rates on bank reserves.
3. Japanese interest rates eventually rise above zero, and the BOJ stops paying IOR. They sell off most of their stock of debt to prevent hyperinflation.
4. Japanese interest rates eventually rise above zero, and the BOJ stops paying IOR. They hold on to their stocks of JGBs bonds, leading to hyperinflation.
In case 1, the Japanese government benefits from the near zero rates, but they’d benefit regardless of whether the BOJ held the bonds, or whether the private sector held the bonds. It’s the near zero rates that benefit the Japanese government, not the fact that QE occurred.
In cases 2 and 3 it may seem that BOJ debt monetization offers a way to reduce the debt burden. But I think that’s misleading. In case 2, the BOJ must continue to pay interest on the reserves that are backed by the debt it has purchased. Since the BOJ is part of the Japanese government, that’s still a debt burden. In case 3 the stock of bonds is eventually sold off, so the burden of the debt is still there in the long run.
Case 4 seems to offers the greatest prospect for reducing the burden on the debt. If market rates rise above zero, however, and IOR stays at zero, then the BOJ must sell off its huge stock of debt or face hyperinflation. Obviously if they hold onto the JGBs and there is hyperinflation then the burden of the debt falls sharply. But there is no indication that the BOJ plans to allow hyperinflation in the foreseeable future. So I view case 4 as very unlikely.
Bottom line: If something seems too good to be true, it usually is. That’s not to say governments are not seeing any benefits from low rates. If interest rates average only 1% over the next 100 years (which doesn’t seem that much of a stretch for a country like Japan), then even a debt of 200% of GDP implies an annual interest cost of only 2% of GDP.
Countries with their own currencies, such as the US, Britain, and Japan, are facing pretty modest debt burdens at current interest rates, and indeed the same is even true for countries without their own currency, but with a credible commitment to service their debt, such as Germany. Even Greece’s debt burden would be easily manageable at German, Japanese or American interest rates. If Greece could get Germany, Japan or the US to co-sign their government loans, then the Greek government could easily service its debt. However, if they actually did find someone gullible enough to co-sign their loans, then Greece would default on the debt, as Greece is especially susceptible to the moral hazard and time inconsistency problems.
Greece has in fact been in default on its external financing for fully 50% of its time as an independent country.