Will Growth Arrive in the Time Bought by Financial Repression?

Japan's long-end yields are pricing growing doubts about fiscal sustainability, while the policy rate sits far below where standard rules would place it: financial repression, buying time. The question is whether the growth needed to reduce the debt burden will arrive within that time, and what remains if it does not. History offers a precise warning: of the four exits from financial repression, only one is still open to Japan, and taking it requires financial firebreaks to be built before interest rates normalise, not after.

In the October issue of the monthly Bungeishunju I published a dialogue with Professor Emeritus Tsutomu Watanabe of the University of Tokyo on the Takaichi administration's expansionary fiscal policy. Let me state my central argument at the outset. What is missing is not primarily a source of funding, but a clear set of conditions specifying which expenditures should be stopped, and when, if the anticipated growth fails to materialise. In Professor Watanabe's words, what is missing is a Plan B.

The figures frame the problem. Japan's 10-year government bond yield stands at 3%, a level last seen roughly 30 years ago, while the 20-year yield has risen to 3.9%; the implied 10-year yield ten years forward is approximately 4.8%, still climbing. The Bank of Japan has raised its policy rate to 1.25%, yet the level suggested by the Taylor rule is slightly above 3%: a gap of nearly three percentage points, which is precisely what constitutes financial repression. The short end of the curve has not moved; the long end alone is pricing doubts about fiscal sustainability. Meanwhile dollar-yen has moved back above 158 despite coordinated intervention in July, and it is notable that the push for higher Japanese rates has come from Washington rather than from domestic debate. Intervention changed only when the destination would be reached, not where that destination lies.

To explore where this leads, I draw on a simulation exercise I have built, translating the decisions of Japan's finance ministers between 1936 and 1941 into a quantitative model in which oil prices, food prices, fiscal policy and yen depreciation determine inflation, which in turn shapes long-term rates. One lesson emerges immediately: when long-term rates are suppressed through central bank purchases, the pressure returns through currency depreciation and import prices, and inflation then erodes public support. A government that merely suppresses interest rates worsens its financial and its political position at the same time.

Against that background, the finance ministers of the era fall into four types. Korekiyo Takahashi began direct Bank of Japan underwriting of government bonds in 1932, but sold roughly 90% of those bonds back into the market and moved to reduce issuance; his economics were sound, and he was assassinated in 1936. His successor, Eiichi Baba, abandoned the reduction of issuance and expanded the budget while holding rates low; imports surged, and within a year Japan was forced to ration foreign exchange. Toyotaro Yuki attempted to reconcile the military and business communities, and his cabinet lasted four months. Okinori Kaya then imposed three binding principles, with the balance of payments as the constraint that prioritised all expenditure.

An administration that calls on the public pension fund to buy government bonds and on the central bank to expand purchases, while enlarging the budget, occupies Baba's position. I read the July coordinated intervention as the modern equivalent of the visible leakage Japan experienced through exchange controls in 1937.

Historically there have been four exits from financial repression. The first is victory in war and reparations; the modern equivalent is Japan's primary income surplus, roughly 40 trillion yen in 2024, most of which is reinvested abroad rather than repatriated into yen. Institutions can be designed to bring those earnings home, but there is no defeated counterparty to pay. The second is exporting inflation, available only to the issuer of a global reserve currency; Japan is instead importing the consequences of US financial repression through its exchange rate, and Washington's call for higher Japanese rates signals clearly that burden-shifting through yen depreciation will not be permitted. The third is favourable terms of trade, as in 1914-18 or the Korean War procurement boom; in the current conflict Japan is a purchaser of energy, not a supplier, and its 80 trillion yen investment commitment to the United States is the opposite of a wartime demand windfall. The fourth is technology and productivity, through AI and semiconductor investment. This exit remains open, but productivity gains take five to ten years to matter for inflation, and there is a contradiction at its heart: negative real rates keep low-productivity firms alive and channel deposits into government bonds, so the time bought through repression consumes the very resources needed to generate the growth that would justify it. The UK and the US reduced their debt burdens through repression after 1945, but behind capital controls and with decades of real growth. Japan today has open capital markets; failure to grow points toward the settlement of February 1946, when deposits were frozen, a capital levy reached 90%, and inflation did the rest.

From the simulation and the historical record, I have distilled ten principles that apply to the present. Interest rates are determined by where deposits flow, and depositors can now move money abroad online. When every minister maximises their own objectives, fiscal discipline collapses by fallacy of composition. Policy follows the distribution of veto power, which has shifted outside Japan, to bond auction bidders, rating agencies and the US Treasury. The correct answer may exist, but the person who chooses it may fall. Countries voluntarily take actions that reduce their own options. The best terms are always those available last month. A plan that requires every condition to succeed is not viable, while in a crisis any single event can start a feedback loop. Subsidies and price controls delay recognition of the problem by transferring it to the budget and the exchange rate. The true constraint is the ceiling imposed by logistics. And how a country loses determines the next round: Cyprus accepted painful adjustment in 2013 and now holds an A-category rating.

Underlying all ten is a historical pattern: major policy change in Japan has tended to arrive not from within the institutional system, but through external pressure.

If repression while waiting for growth is not a strategy, the task is to absorb the side effects of normalisation before raising rates. Most of the required measures cost little money; they cost political capital and careful sequencing. On the institutional side: a fiscal rule that automatically caps expenditure growth when nominal growth falls below the 10-year yield for two consecutive quarters, an independent fiscal institution to audit growth forecasts, and five-year ceilings by expenditure category, a modern version of Kaya's principles. On debt management: more inflation-linked and retail issuance, and automatic transfer of part of revenue windfalls to debt consolidation; Professor Watanabe estimates the inflation tax collected to date at roughly 180 trillion yen, around 90 trillion net of central bank losses, and specifying its use in advance by law would turn the funding debate into one about concrete numbers. On monetary policy: a prior agreement under which the government absorbs, under specified conditions, the negative carry the Bank of Japan will incur as rates rise on its roughly 530 trillion yen of holdings, removing one reason for hesitation, together with a joint statement on the destination of policy. On the financial system: expanded capital-injection frameworks for regional banks, refinancing of floating-rate mortgages into fixed, and pre-legislated reconstruction bond ceilings for a major Tokyo earthquake, because deposit outflows are what turn unrealised losses into realised ones.

The sequence is crucial: firebreaks first, fiscal rules and priorities with the next budget, only then faster rate increases, and capacity expansion over one to five years. Reversed, an otherwise appropriate rate increase can trigger runs on regional banks. This sequencing is precisely what Takahashi lacked: an institutional mechanism ensuring that those who implement sound policy do not fall for it.

Our baseline is the beta path: Baba-style expansion continues, with small rate increases and intervention buying time whenever external pressure intensifies. Under alpha, the administration announces clear expenditure priorities, restores the primary balance objective and accepts further rate increases; ultra-long forward rates decline and the yen firms gradually. Under gamma, selling pressure on government bonds forces rapid hikes, unrealised losses at regional banks become realised, and the unwinding of carry trades produces a sharp yen appreciation alongside a global equity decline. Three indicators will discriminate: whether a numerical funding plan accompanies any consumption tax reduction; whether discussion begins on the domestic bond share of the public pension portfolio; and how unrealised losses and deposits evolve in regional banks' interim statements. Concrete funding figures move the outlook toward alpha; a shifting pension allocation raises the probability of gamma.

More than a decade after its 2013 crisis, Cyprus has kept repaying, through tax increases and a higher pension age, and now holds a credit rating above Italy's, with growth of just under 4% last year. Its current prosperity rests on shipping and on regional demand for a secure base, and neither ships nor capital seek refuge in a country without credibility. The credibility regained through repayment has become the very qualification that allows it to attract the opportunities arising from instability elsewhere. In the simulation, participants initially choose Baba-style policies to protect approval ratings; several turns later, the pressures that escaped through the exchange rate and inflation return as political collapse. Only those who set the conditions for stopping in advance retain meaningful options. Rather than seeking a dramatic reversal, Japan should return to primary balance discipline. The clouds above the hill are visible only to those who continue the climb.