Japan's Debt Conundrum: Balancing Inflation, Interest Rates, and Demographics

Japan's public debt has surpassed 230% of its GDP, the highest among advanced economies. Despite this, the country largely avoided a debt crisis for over three decades due to exceptionally low borrowing costs and inflation.

The Bank of Japan (BOJ) played a crucial role in maintaining these conditions through unprecedented monetary policy measures. The BOJ owns roughly half of all outstanding Japanese Government Bonds and its balance sheet has expanded to more than 100% of GDP.

However, with the return of inflation after 2022, the environment that allowed Japan to sustain high public debt at low borrowing costs has fundamentally altered. Headline inflation has remained above the BOJ's target, and yields on Japanese Government Bonds have risen to levels not seen for many years.

The country now confronts a policy dilemma, balancing three objectives: maintaining exceptionally low borrowing costs, preserving currency stability, and containing inflation. The BOJ finds itself in an 'impossible triangle,' where pursuing one objective inevitably complicates the others.