Japan Was Never a Convincing Case for U.S. Debt

For more than a decade, defenders of ever-higher U.S. public debt leaned on what they believed was a simple rebuttal to fiscal skeptics: Look at Japan. Japan’s debt-to-GDP ratio exceeded 200% and interest rates were near zero, yet there was no obvious crisis. If Japan could do it, why not the United States?

I have long argued, alongside my colleague Veronique de Rugy, that this was a deeply misleading comparison. Japan was never a clean counterexample to concerns about high and rising public debt. It was a unique case with institutional, demographic and financial features that the U.S. does not share. And now, even that flawed comparison is beginning to collapse under the weight of reality.

Back in July 2020, when economists and commentators were cheering on trillions in additional borrowing because interest rates were low, Vero and I warned that the “Japan is fine” argument ignored crucial facts. Yes, Japan had avoided hyperinflation and default. But it had done so at enormous cost: decades of anemic growth, stagnant wages, repeated tax hikes and a government forced into ever more extreme forms of financial repression. Low interest rates did not mean debt was costless; they merely obscured the bill.

The same argument resurfaced in even louder form in early 2021, as another $2 trillion in stimulus spending was pushed through an already overheating U.S. economy. Again, critics of fiscal restraint waved away concerns by invoking Japan, and again, the comparison failed on even the most basic grounds.

Japan’s debt dynamics are fundamentally different from those of the United States. Japan has traditionally had an exceptionally high household saving rate, around one-third of GDP, while the U.S. saving rate is roughly half that. About 90% of Japanese government debt is held domestically, insulating it from shifts in global capital flows. Japan is the world’s largest creditor nation. The U.S. is the world’s largest debtor.

These differences explain why Japan could sustain much higher debt levels without triggering immediate market discipline. They also demonstrate why Japan’s experience was never a green light for the U.S. to follow the same path. Even with ultra-low interest rates, Japan has been devoting a staggering share of its national income to servicing debt—around 4% to 5% of GDP, and close to a quarter of all government spending.

More broadly, Japan illustrates what the empirical literature has been telling us for years. High public debt crowds out investment and drags down long-run growth. Since 2000, Japan has averaged real annual growth of just 0.7%. The U.S., despite its own policy mistakes, has averaged roughly three times that. Wage stagnation in Japan is not a mystery, but a predictable result of decades of weak productivity growth in a heavily indebted economy.

None of this was controversial in the academic literature. It was controversial only in policy debates, where Japan’s low interest rates were mistaken for proof that debt no longer mattered.

Importantly, even economic models that are generous to deficit financing impose limits. Overlapping-generations (OLG) models, which explicitly account for intergenerational transfers and capital accumulation, consistently find that advanced economies face debt tolerance thresholds well below Japan’s current levels. Depending on a particular model’s assumptions, those thresholds typically fall somewhere between 120% 180% of GDP for a country like the United States. Beyond that range, welfare losses accelerate rapidly as debt service crowds out private capital and future tax burdens rise.

As the Penn Wharton Budget Model has noted, Japan’s extreme debt levels are not informative for the United States precisely because Japan’s household saving rate “more than absorbs” the government’s borrowing. The U.S. does not have that buffer. Its debt-to-GDP ratio becomes far more sensitive to bond market volatility at much lower levels.

And now comes the part that should finally put this debate to rest: Even Japan is starting to feel the strain.

As Allison Schrager recently wrote in Bloomberg, Japan’s long-suppressed bond market is stirring. Long-term yields are rising as the yen depreciates, exposing the tradeoff that had been postponed for years. To fight inflation, rates must rise, driving up debt service costs. To keep rates low, the currency weakens and inflation pressures mount. There is no painless option once debt reaches this scale.

In its FY2025 budget, Japan spent roughly 33 cents of every tax dollar just servicing its debt. That was before yields on 10-year bonds roughly doubled to more recent levels, as the figure below illustrates. In upcoming budgets, that figure is likely to creep toward 40 cents on the dollar. This is a remarkable constraint on fiscal policy for a country that supposedly “proved” debt doesn’t matter.

Japan is not in a full-blown crisis, yet. It still has substantial assets and institutional credibility, but that is precisely the point. Even with every advantage, even with decades of financial repression and central bank monetization, debt eventually reasserts itself. Markets will not allow governments to suppress risk indefinitely.

The broader lesson for the United States should be obvious. You can sometimes build an economy on a fiscal fault line and avoid disaster for a long time, but that does not make it wise. High debt makes countries more vulnerable to inflation shocks, bond market volatility and policy mistakes. And when the reckoning comes, it usually arrives when fiscal flexibility is needed most.

Japan was never a comforting counterexample to concerns about U.S. debt. The fact that even Japan is now testing the limits of debt tolerance should finally end the fantasy that advanced economies can borrow without consequence forever.

Low interest rates were not proof that debt was harmless. They were a temporary condition, and like all temporary conditions, they eventually changed.