Government Debt in Japan and Euro Area: Actions Speak Louder than Words

Government Debt in Japan and Euro Area: Actions Speak Louder than Words

photo: flickr

Fiscal Rules in Japan 

Fiscal rules, such as a quantitative debt limit, have been proposed to restrain the size of government debt. However, experience has shown that passing laws or issuing rules has little economic effect, unless they are enforced systematically and without delay. This point was illustrated last week by Kenichi Ueda of the University of Tokyo at a conference in Riga, Latvia , “Quo Vadis Europe: Growth in an Age of Debt”  organized by the Bank of Latvia. He explained how Japan became the world’s largest sovereign debtor, in spite of legislative attempts to limit debt. Paradoxically, Japan has accumulated debt in 2015 equal to 246% of GDP, in spite of a law that forbids the government from borrowing. Debt accumulated as a result of the Parliament voting to waive the law every year for more than 20 years.

Euro Area Rules 

The Euro Area has had a similar experience with fiscal rules on debt and budget deficits. The original Maastricht Treaty that created the Euro included a provision that limited debt ratios of Euro Area members to 60% of GDP. However, the rule was formulated in such a way that countries with public debt levels significantly exceeding the threshold could still be admitted to the Euro Area if their debt to GDP ratio was on a downward path. The most notable case was Italy, which had a debt ratio of near 120% in 1994. In fact, Italy managed to lower its debt ratio to 100% by 2004, but it rose after that.

The Stability and Growth Pact that was intended to enforce fiscal discipline after accession to the Euro Area lacked enforcement provisions, and violations of both the debt rule and accompanying budget deficit limit have been widespread. In October 2015, Greece had a debt ratio of 176%, even after debt restructuring in 2012, and Italy had a debt ratio of 132%. The two largest Euro Area members, Germany and France, continue to exceed the debt limit. Of the 19 Eurozone members, 13 clearly currently exceed the limit, with Finland hovering around the 60% threshold. In spite of widespread violations, no member country has been punished for excessive debt. Fines have been proposed, but not implemented. A radical proposal from Ivan Milos, former Slovakian Finance Minister, would be to expel a country from the currency union in the event of serious and persistent violations of commonly agreed rules.

Debt Overhang

Studies of debt overhang have verified the persistence of high debt for Japan, Greece, and Italy. A debt overhang is defined as an episode in which a country has a debt ratio of at least 90% of GDP for at least 5 consecutive years. Clearly the fiscal rules were not sufficient to prevent these countries from experiencing debt overhang. Fiscal deeds were stronger than fiscal words. The violations have been too long to be explained solely by the negative effect of recessions on tax revenue. Greek debt has exceeded 90% of GDP for 16 straight years, Japan for 21 straight years, and Italy for 27 straight years. These countries with persistently high debt are also among the slowest growing countries in recent decades.

Fiscal Deeds Can Follow Fiscal Words 

Japan and the Eurozone have tried using fiscal rules to restrain debt, but they have failed. The main effect has been to reduce the credibility of governments issuing the rules. Rules have little significance unless they are accompanied by economic and political institutions that enforce the rules. Fiscal rules supported by complementary economic and political institutions can succeed, as demonstrated by Sweden following a crisis in the 1990s. Sweden adopted and implemented a rule to approximately balance the budget (with a 1% surplus) over the business cycle that has worked rather well, in spite of the crisis of 2008. Sweden’s current debt ratio is around 40%, but whether the debt rule continues to be observed remains to be seen. The Left Party that supported a minority government in Sweden already called for loosening fiscal discipline (Bloomberg).

Achieving Fiscal Discipline without an Explicit Debt Rule 

Whether other members should offer another bailout of Greece was hotly debated by Euro Area countries last summer. In the end, a third bailout was agreed. A somewhat analogous problem is whether the United States federal government should bail out state governments, such as Illinois, that are having trouble repaying their debts. Since the founding of US fiscal institutions in 1790, the federal government has never bailed out state governments, in spite of defaults on state bonds in the 1840s and 1930s. Several cities, including Detroit, have resolved their debt problems in bankruptcy court, without resort to Federal bailouts. This practice of allowing states and cities to be responsible for their own debts has prevailed without any law or constitutional provision explicitly forbidding bailouts. Instead a set of complementary institutions has developed that reduces the likelihood of bailouts. All but one of the fifty states has voluntarily adopted some form of balanced budget requirement. The Federal Constitution forbids states from introducing their own currencies and inflating away debt. The Federal Constitution also contains a contract clause that prevents states from passing laws that interfere with the enforcement of contracts (Arellano et al). It is possible to develop fiscal institutions that generate certain kinds of fiscal discipline without an explicit debt threshold. Of course, protection against bailing out states, has not prevented the United States from developing its own debt overhang. The Euro Area differs from the United States in lacking a central fiscal authority.


Without economic and political institutions in place to implement and enforce limits on government debt, debt rules are merely scraps of paper. They are worse than no rules, because they reduce the credibility of government actions in areas other than debt limits. Furthermore, if they are enforced selectively, they generate resentment and complaints about discrimination in favor of the privileged few. Equal treatment is an important component of the rule of law.


Arellano, Cristina, Andrew Atkeson, and Mark Wright. 2015. “External and Public Debt Crises”. NBER Working Paper 21456, August.

Bloomberg. 2015. “Sweden’s Left Party Calls for Quick Changes to Surplus Rules.” March 9.