The very important question of Japan's monetary policy

Japan now has core inflation hovering around 4%, the result of both rapid wage growth and falling productivity. It is normal that population ageing leads to both tight labour markets and low productivity, so we can assume that Japan will experience fairly high inflation over the long term. Monetary policy consists of controlling 10-year interest rates (Yield Curve Control) which, although relaxed, currently keeps the 10-year interest rate between 0. 6 % and 0.9%, while the 10-year interest rate in 10 years' time is 1 . 7 %. Completely abandoning Yield Curve Control would ultimately (after more than eight years) increase the interest paid on public debt by 2.5 percentage points of GDP. But if inflation remains at around 4%, with a long-term interest rate of 2%, the fact that the real interest rate remains much lower than potential growth, even if it is zero, reduces the public debt ratio. So Japan’s public-finance problem does not seem very serious. We should be more concerned about the effect on bond markets, mainly in the euro zone and the United States, of abandoning Yield Curve Control. Japanese investors currently hold USD 2.5 trillion in foreign bonds, and a rise in long-term interest rates in Japan could trigger a repatriation of capital to Japan of such a size that the effect on long-term interest rates in the United States and the euro zone would be substantial.