The yield on France’s 10-year government bond is approaching 5%, and the yield spread against German government bonds has temporarily widened to 1.5 percentage points. The yield on the U.S. 10-year government bond is also in the 5% range, and in Japan, the 30-year government bond yield has exceeded 4%. Fiscal deficits and the increase in government bond issuance in various countries are attracting attention in the bond market.
However, the background to rising interest rates differs by country. In the United States, in addition to the fiscal deficit, investment in AI-related equipment and power infrastructure is creating huge demand for funds. In Europe, political turmoil in France and distrust in its fiscal management have led to the selling of government bonds. In Japan, changes in the price and interest rate environment accompanying the exit from deflation and the normalization of the Bank of Japan’s monetary policy are progressing.
What they have in common is that the price of government bonds cannot be explained by the size of government debt alone.
Why are French government bonds being sold now?
France’s fiscal problem is not new. The government debt-to-GDP ratio is about 120%, and the fiscal deficit is also around 5%. Political conflict over pension reform and spending cuts has also continued. Even so, the market has held French government bonds at a yield somewhat higher than that of German government bonds.
What has changed this time is not so much the fiscal figures themselves, but the assessment of whether the government can turn its fiscal management around. The political turmoil surrounding the 2027 budget has prompted a reassessment of the credit risk that had been tolerated until now. The unwinding of hedge fund positions and a decline in market liquidity also appear to have amplified price fluctuations.
However, it is not appropriate to equate this with the European debt crisis of the 2010s. At that time, capital inflows within the region supported the current account deficits of Southern European countries, and their reversal triggered a banking crisis and a government bond crisis. The current Eurozone does not have as large a current account imbalance as it did then, and the ECB has a system to curb market fragmentation.
The problem is not whether France will immediately become unable to raise funds. It is at what yield the market will absorb the large amount of government bonds that will continue to be issued.
In that sense, the ECB’s response will also be important.
First, it will not rush to raise interest rates further and will assess the sustainability of inflation. The next thing to be considered is the suspension of quantitative tightening (QT). If the ECB does not reinvest the redemption of government bonds, private investors will have to absorb not only the new issues from each government but also the reduction in the ECB’s holdings.
Suspending QT will not solve France’s fiscal problems, but it will have the effect of improving supply and demand in the government bond market as a whole. Although the TPI (Transmission Protection Instrument) is an option if the market of a specific country is in disorderly turmoil, this is not a system that unconditionally supports fiscal deficits.
The ECB needs to consider both fiscal discipline and market stability. This is because allowing fiscal risk to be reflected in prices and ensuring that monetary policy itself does not amplify market turmoil are separate issues.
A new fiscal theory called the government bond bubble
In this situation, what is interesting is the government bond bubble theory introduced in the October 12th issue of the Nikkei Shimbun’s “Economic Classroom.”
In conventional fiscal theory, the value of government debt is backed by future primary balance (PB) surpluses. If the current debt balance is large, a future fiscal surplus commensurate with it is required. For Japan, there are estimates that if this way of thinking is strictly applied, tax increases and spending cuts that are politically difficult to realize would be necessary. However, in reality, many major countries have maintained their government bond markets while continuing to run PB deficits for many years.
Research by Brunnermeier and others focuses on the value of government bonds as safe assets. Government bonds are government debt, but at the same time, they are liquid assets for financial institutions, collateral for financial markets, and a means of savings and investment for households and institutional investors. This convenience creates government bond value that cannot be explained by future fiscal surpluses alone.
The “bubble” referred to here does not mean speculative price surges. It is a theoretical concept that demand for safety and liquidity supports government bond prices. Based on this way of thinking, there is a possibility that the value of government bonds can be maintained even if the government does not realize a huge PB surplus every year. However, this is not a theory that justifies unlimited fiscal deficits. There is a limit to the demand for government bonds, and the trust that the government can adjust its finances when necessary is also essential. What is important is that actually accumulating a huge surplus and the market believing that the government can turn its finances around if necessary are not necessarily the same thing.
How should Japan’s fiscal policy be evaluated?
Japan’s government debt-to-GDP ratio is outstanding among major countries. However, looking back at the trends in the PB of the national and local governments, the fiscal deficit has not continued to expand in one direction.
In the 1980s, the fiscal balance improved, and a PB surplus was recorded during the bubble period. Since then, although the deficit has expanded due to the collapse of the bubble, the global financial crisis, and the COVID-19 pandemic, it has been improving in recent years against the backdrop of increased tax revenue.
Moreover, this improvement was not achieved through massive tax hikes, such as raising the consumption tax to 25%.
When considering the sustainability of government debt, it is necessary to look not only at the primary balance (PB) but also at the relationship between the nominal growth rate and the average interest rate on government debt. If the nominal growth rate exceeds the average interest rate, the debt-to-GDP ratio can remain stable even if the PB is in a slight deficit.
Conversely, if interest rates continue to exceed the growth rate, a balanced PB alone may not be enough to stabilize the debt ratio.
It is not appropriate to evaluate Japan’s fiscal situation solely based on the outstanding government debt balance, nor is it appropriate to assume that the problem is solved just by improving the PB. It is necessary to make judgments by considering growth rates, interest payment burdens, tax revenues, and the supply and demand for government bonds together.
How to think about ‘responsible proactive fiscal policy’
This point also connects to the current debate surrounding ‘responsible proactive fiscal policy’.
The Nikkei and other media outlets view it as problematic that the funding sources for these policies are unclear and that specific measures in the policy speech are left for future consideration. If permanent expenditures or tax cuts are to be implemented, their funding sources and future burdens must be disclosed. The cost-effectiveness of these policies must also be verified.
On the other hand, such discussions must also fully take into account the changes in the Japanese economy.
Japan is moving away from long-standing deflation and transitioning to an economy where prices and wages are rising. If nominal GDP expands, tax revenue will increase even without raising tax rates. Increases in corporate profits will boost corporate tax revenue, wage increases will boost income tax revenue, and the expansion of nominal consumption will boost consumption tax revenue.
During the deflationary period, nominal GDP did not grow, and it was difficult for tax revenue to increase. Improving the government debt-to-GDP ratio was not easy. However, if sustained price and wage increases take hold, the conditions for fiscal management will change.
Japan is finally returning to a normal economy where prices, wages, and interest rates all move.
Of course, inflation is not all beneficial for the government. Expenditures will increase, and as the refinancing of government bonds progresses, the burden of interest payments will also rise. Increased tax revenue does not automatically translate into fiscal leeway.
Even so, simply applying the fiscal perspective of the deflationary period and assuming that permanent funding sources like tax hikes are immediately necessary for increased spending may lead to an underestimation of the tax revenue gains from growth.
In particular, expenditures on capital investment, research and development, human resource development, and social infrastructure that enhance productivity have the potential to increase future income and tax revenue. It is necessary to evaluate not just the amount of expenditure, but its effects over a time horizon.
However, if future tax revenue from growth is to be anticipated, the assumptions must be clearly stated. A response is also necessary in case the growth rate falls below expectations. If future growth is overestimated, the sustainability of proactive fiscal policy will be undermined.
The evaluation of a responsible proactive fiscal policy cannot be completed solely by looking at the single-year PB or individual funding arrangements. It should be verified up to how the policy contributes to the nominal growth rate and tax revenue, and as a result, stabilizes the government debt-to-GDP ratio.
Is the credibility of the government bond market being maintained?
We should also carefully assess the market’s confidence in Japanese government bonds.
The yield on Japan’s 30-year government bonds has risen to the 4% range. It is one-sided to view this solely as a sign of distrust in fiscal policy.
For domestic life insurance companies and pension funds, the appeal of Japanese government bonds has increased as an investment target that can secure long-term yields in yen.
Foreign government bonds carry currency risk and hedging costs. In the case of French government bonds, one must also consider the widening of credit spreads. If a reasonable yield can be obtained from Japanese government bonds, the necessity of holding foreign bonds becomes smaller than before.
Whether a large-scale repatriation of funds from foreign bonds to Japanese government bonds is actually occurring requires confirmation through statistics. However, even a change in the marginal judgment of investors affects the supply and demand of government bonds.
Japanese government bonds continue to play a role in supporting the financial market as a yen-denominated safe asset. However, credibility is not guaranteed simply by the fact that they are traded in the market. It is necessary to continuously monitor the status of government bond auctions, long-term interest rates, expected inflation rates, and investor demand.
The turmoil in France has shown that if confidence in a government’s fiscal management wavers, even previously known fiscal problems can suddenly be reflected in prices.
Japan is no exception to this.
What is the purpose of fiscal discipline?
In this week’s bond market, I would like to focus on U.S. price indicators, the yield spread between French and German government bonds, the ECB’s monetary policy, and the supply and demand for Japan’s super-long-term government bonds.
However, if we think on a longer time axis, what is being questioned is the meaning of fiscal discipline itself.
Government bonds are not only government debt but also important financial assets for the private sector. Their value is supported not only by future primary balance surpluses but also by safety, liquidity, their function as collateral, and confidence in the government.
Therefore, it is not necessary to seek fiscal consolidation solely through the realization of a massive primary balance surplus.
On the other hand, one cannot rely on the value of government bonds as a safe asset and ignore fiscal discipline.
Japan is in the midst of a long-awaited change: escaping from deflation. In an economy where nominal GDP and tax revenue are increasing, the conditions for considering the sustainability of government debt also change.
What is needed for a responsible proactive fiscal policy is not to omit explanations of funding sources, but to present a future vision of fiscal policy, including the effects of growth and increased tax revenue.
The purpose of fiscal discipline is not to repay all government bonds or to produce a massive surplus every year. It is to stabilize government debt and maintain the credibility of the government bond market without undermining economic growth.
Now that Japan is finally about to emerge from deflation, the discussion on fiscal policy also needs to emerge from the deflationary era.
Reference Materials
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Nikkei ‘Economic Classroom’ article on government bond bubbles and fiscal discipline (October 2026)
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Ministry of Finance, ‘Materials Related to Japan’s Fiscal Situation’ (April 2026)
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Cabinet Office, ‘Projections for the Medium to Long Term Economy and Public Finance’
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Markus K. Brunnermeier, Sebastian Merkel, Yuliy Sannikov, Safe Assets, Journal of Political Economy, 2024
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Brunnermeier, Merkel, Sannikov, The Fiscal Theory of the Price Level with a Bubble
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European Central Bank, official documents regarding APP, PEPP, and TPI