First and foremost, optimism is not warranted when discussing Japan’s public finances. With the current shift in monetary policy, long-term interest rates, or the yields on long-term Japanese government bonds (JGBs), are trending upward. Japan has returned from the zero-interest rate regime to “a world with positive interest rates.” At the end of October 2025, the yield on the 10-year JGB was 1.66%, and the yield on the 40-year JGB exceeded 3%. In response to the upsurge in the ultra-long-term JGBs, the Ministry of Finance was forced to revise the JGB issuance plan by reducing the issuance of JGBs with a maturity of 20 years or longer and increase the issuance of short-term JGBs, known as Treasury Bills (TBs). The harsh situation surrounding JGBs is expected to continue.
At a time when the Bank of Japan (BOJ) is reducing its JGB holdings, the capacity for banks to purchase JGBs is limited because of financial regulations. It seems inevitable that the dependence on foreign investors purchasing JGBs is likely to grow. In fact, as of June 2025, the share of the total amount of JGBs held by foreign investors was around 12%, double the level seen 10 years ago.
The era when JGBs could be absorbed domestically at low yields in a stable manner has come to an end. On the other hand, the BOJ has decided to leave its target for short-term interest rates (the policy rate) unchanged at 0.5%. The need to examine the effects of the tariff hikes imposed by U.S. President Trump is one reason cited for the decision, but the wait-and-see stance is also indicative of the central bank’s political consideration toward the Takaichi administration.
However, the market shows no such regard. Against the backdrop of the interest rate differential between Japan and the United States, the yen has continued to weaken. Rising import prices are an additional inflationary factor. Even if expansionary public fiscal policy is supported by the public, skepticism in the JGB and foreign exchange markets could lead to higher interest rates and yen depreciation, resulting in price increases and negative effects on the economy.
So what should be done? If the proactive public finance policy is to be managed wisely, well-prioritized budget allocation is essential. The government should scale back on low-priority budget areas while increasing budgets in high-priority areas. For example, one possible option is to reconsider the current corporate support programs, including research and development tax breaks.
If new spending can be financed by curbing existing expenditures, it is possible to limit the budget deficit caused by any spending explosion. This could also provide an opportunity to reform the government’s rigid spending structure that is rooted in vested interests. At the same time, project progress should be monitored for budget-financed projects, and if results are not expected, fiscal support should be promptly withdrawn. If the expansionary public finance policy is to be truly responsible and strategic, such wise spending is indispensable.
>> Original text in Japanese
* Translated by RIETI.
December 6, 2025 Weekly Toyo Keizai
