Article 03 · Japan · Refinancing Risk · Interest on Reserves
The Owe-It-To-Ourselves Myth
Why Higher Rates Still Crush the Japanese Government
There is a comforting story told about Japan’s ¥1,100 trillion of government debt: it doesn’t really count, because Japan owes it to itself. The Bank of Japan owns roughly half of it: the government pays interest to its own central bank, which remits the profit straight back to the treasury. A closed loop. Harmless. The story is arithmetically true for half the debt, and dangerously wrong about everything else.
The Myth
The Closed Loop That Isn’t Closed
The logic of the myth runs like this. Through a decade of , the BOJ bought roughly half of all outstanding JGBs. Interest the government pays on those bonds arrives at the BOJ as profit, and central bank profits are remitted to the government at year-end. Money leaves the treasury, circles through the central bank, and comes home. On this half of the debt, the interest burden is close to an accounting fiction, and that much is genuinely true.
The myth fails at two precise points: the other half of the debt, which is owned by investors who are very much not the government, and the mechanism by which rates are raised, which quietly breaks the loop on the BOJ’s own half too.
The Other Half
¥500 Trillion of Real Creditors
Set the BOJ’s holdings aside and roughly ¥500+ trillion of JGBs remain, a sum larger than the entire government debt of Germany and France combined. It sits with life insurers matching pension promises, with banks holding it as their core liquid asset, with pension funds, and with foreign investors. None of these holders is “ourselves.”
- They demand a market rate. When inflation runs at 3%, no insurer voluntarily rolls into a 0% bond: new issuance must offer whatever the market requires.
- They can leave. Insurers can buy US Treasuries instead; foreign holders can exit entirely. The government must keep this half continuously persuaded.
- They price every new auction. The rate on the private half sets the rate on all new debt, including the debt the government issues to refinance bonds the BOJ already owns.
Interest paid to this half does not circle home. It is a genuine fiscal outflow, at whatever rate the market sets. And the market’s rate has changed.
The Evidence
Three Decades Down, Then the Turn
The top panel is the price of the myth’s complacency: the ten-year JGB yield fell from near 7% in 1990 to essentially zero, and every year of decline made the debt feel more weightless. It now stands at 2.67%, a level Japan’s stock of debt has never had to pay. The lower panel shows who holds that debt: the BOJ’s half, and the half that expects to be paid.
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The Trap
The Refinancing Treadmill
Government bonds are almost never repaid; they are refinanced. When a ten-year bond matures, the treasury issues a new bond to pay off the old one. This is , and it is why higher rates are a delayed-action mechanism rather than an instant shock: the pain does not arrive when yields rise, but every year afterwards, as each vintage of 0% debt expires and is reborn at the market rate.
¥100T refinanced per year at 0% → ¥0 of interest
the world Japan lived in from 2016 to 2022
¥100T refinanced per year at 2.7% → ¥2.7T of new, permanent interest, every single year
each year of rollover adds another layer; the bill compounds vintage by vintage
Full stock: ¥1,100T × 1pp ≈ ¥11T per year, eventually
every percentage point, once it has worked through the whole stock, costs roughly ¥11 trillion annually
Total national tax revenue: ~¥75T per year
debt service already consumes ~24% of the budget, at 0% average rates
Run the treadmill forward at today’s 2.7% and the arithmetic converges on an interest bill in the tens of trillions of yen, against ¥75 trillion of total tax revenue, a quarter of which is already committed to debt service. Nothing dramatic happens on day one. The trap is that nothing needs to.
The Leak
How Raising Rates Breaks the Loop From Inside
The subtlest failure of the myth is mechanical: how does a central bank that has flooded the system with money actually raise rates? It cannot drain ¥500 trillion of liquidity overnight. Instead it pays banks not to lend: . No bank will lend at less than the risk-free rate the BOJ itself pays, so that rate becomes the floor for the whole economy.
But look at what that does to the loop. The reserves are the very money the BOJ created to buy its JGBs: roughly ¥500+ trillion sitting at the central bank. Each 1% of policy rate is therefore ~¥5 trillion per year paid out to commercial banks, while the BOJ’s own bond portfolio still earns the near-0% coupons it locked in during QE. Its remittances to the treasury shrink, then turn negative; push far enough and the BOJ itself slides toward negative equity. The interest the government “pays to itself” now leaks, at exactly the point where policy is executed, into the private banking system.
The Core Failure
Key Numbers
~¥500T
JGBs held outside the BOJ
Insurers, banks, pensions, foreigners: creditors who demand a market rate.
2.67%
10-year JGB yield today
A rate the full ¥1,100T stock has never had to pay. Each 1pp ≈ ¥11T/yr, eventually.
~24%
Of the budget already spent on debt service
Against ~¥75T of tax revenue, before the rollover treadmill reprices the stock.
~¥5T/yr
BOJ payout per 1% of interest on reserves
The cost of raising rates with ¥500T+ of reserves outstanding: the leak in the loop.