Currency risk and debt sustainability in Japan’s public sector
Yili Chien, Wenxin Du, and Hanno Lustig, in this paper, argue that Japan’s public sector is running a very large, implicit currency carry trade, which is crucial to understanding why high debt has remained sustainable and why the system is vulnerable.
The authors build a consolidated, market‑value balance sheet for Japan’s entire public sector (central and local governments, public pension funds, public financial institutions, and the Bank of Japan) expressed as percentages of GDP over 1997–2024. They classify major asset and liability categories (deposits, loans, domestic equities, foreign securities, bonds, bills, bank reserves, postal‑fund deposits) and track how their composition changes over time. To capture currency risk, they measure the net foreign‑currency exposure of the public sector, focusing on largely unhedged foreign holdings by pension funds and other entities, and simulate valuation effects of yen appreciation.
Findings
- Japan’s government, taken as a consolidated public sector (central and local government, public pension funds, public financial institutions, and the Bank of Japan), borrows predominantly in yen at very low, short‑term rates and invests heavily in unhedged foreign‑currency assets.
- Over the past decades, the yen’s sizable real depreciation combined with higher foreign yields has generated large valuation and income gains on this foreign portfolio, contributing several percentage points of GDP per year in excess returns and helping to keep net public liabilities contained despite persistent primary deficits.
- However, the public sector’s currency exposure is very asymmetric: because foreign holdings are largely unhedged, a yen appreciation leads to immediate mark‑to‑market losses on the order of multiple percentage points of GDP (for example, a 10 percent appreciation implies losses of roughly 6 percent of GDP on foreign assets).
- Rising Japanese interest rates would simultaneously: Reduce the attractiveness of borrowing in yen (weakening the carry trade), and raise the probability of a sharp yen appreciation as global carry positions are unwound.
Japan’s Debt Puzzle: Sovereign Wealth Fund from Borrowed Money
Authors: Yili Chien, Wenxin Du, Hanno Lustig
From: Federal Reserve Bank of St. Louis, Harvard University, Stanford University
Exchange rate effects of BoJ unconventional monetary policy
In this paper, Yan Carriere Swallow, Gene Kindberg Hanlon, and Danila Smirnov use high‑frequency financial data to identify Bank of Japan unconventional policy shocks and then trace their effects on Japanese macro variables, the yen, and foreign bond yields, with a strong emphasis on exchange‑rate and cross‑border transmission.
The authors measure minute‑by‑minute changes in JGB yields, short‑term rates, and the dollar/yen rate in a narrow window around each BoJ policy announcement to isolate unexpected policy news. They extract two structural shocks from these moves: a large‑scale asset purchase (LSAP) shock that mainly affects long‑term JGB yields, and a forward‑guidance (FG) shock that mainly affects shorter maturities.
Findings
- Domestically, both expansionary LSAP and forward‑guidance shocks are “theory‑consistent”: they lower longer‑term JGB yields, depreciate the yen (higher JPY per USD), raise stock prices, increase industrial production, and reduce unemployment; LSAP shocks have a somewhat stronger and more persistent effect on the exchange rate and prices than FG shocks.
- The exchange‑rate dimension is central: by lowering long‑term yen yields and compressing term premia, BoJ LSAP shocks make yen funding cheaper, encourage capital outflows, and weaken the yen, while simultaneously easing financial conditions abroad via lower yields, effectively embedding Japan within the global “safe‑asset and funding‑currency” architecture.
- The authors conclude that BoJ’s unconventional policies have meaningful global spillovers despite relatively low volatility of JGB yields; yen‑centric LSAP shocks can move foreign term premia and bond markets in ways quantitatively similar to Fed actions, especially where Japanese investors are deeply involved.
Macroeconomic Effects and Spillovers from Bank of Japan Unconventional Monetary Policy
Authors: Yan Carriere Swallow, Gene Kindberg Hanlon, Danila Smirnov
From: IMF
