TOKYO — Prime Minister Sanae Takaichi’s party looks set to strengthen its hold on parliament in Sunday’s election, which, if so, will free her to pump new waves of stimulus into Japan’s underperforming economy.
Voters appear jazzed by the prospect of reopening those fiscal floodgates. Yet bond investors couldn’t be more worried about what’s to come, as evidenced by the highest Japanese government bond (JGB) yields since 1999.
A key reason Takaichi called the September 8 snap election is to harness high approval ratings to hit the stimulus accelerator anew. Things could get worse than that, though, if Takaichi’s Liberal Democratic Party (LDP) turns its sights on the Bank of Japan.
Given the LDP’s track record over the last 30 years, this seems less an “if” than a “when.” And a “how,” as markets wonder about the extent to which Team Takaichi might pressure the BOJ to abandon its onetary tightening cycle.
Of course, a lackluster performance by Takaichi’s LDP could be yen-positive. Investors might bet that Takaichi would have less latitude to push ahead with her fiscal profligacy and weak yen policy. That also could give the BOJ greater confidence to go its own way on interest rates.
BOJ Governor Kazuo Ueda and his board still argue that their tightening cycle remains intact. In December, for example, Ueda & Co hiked short-term rates to 0.75%, the highest level since 1995.
Yet with Japan skirting recession, real wages ending 2025 in negative territory and Takaichi likely newly emboldened by Sunday’s results, the BOJ’s latitude to hike rates is dwindling.
No one can say how big a spectacle a Takaichi-Ueda standoff might be. It’s worth exploring, though, how Takaichi’s economic team seems to have taken the wrong lessons from quantitative easing (QE) in both the 1990s and the 1930s — back in the days of Korekiyo Takahashi, who’s often referred to as “Japanese Keynes.”
True, modern QE is widely thought to have started in 2001. That year, the BOJ led by Masaru Hayami pioneered a strategy that Tokyo employed to combat deflation and paper over the cracks caused by a severe bad-loan crisis that deepened in the 1990s.
QE would later spread to Washington, London, Frankfurt, Sydney and beyond following the 2008 global financial crisis. While these QE dabblers normalized rates within a few years, Japan has yet to pull out the monetary intravenous tubes.
For all its quantitative tightening (QT) efforts, the BOJ still owns more than half of all outstanding JGBs and remains by far the largest holder of Tokyo stocks.
In 2025, Ueda got closer to extricating Japan from zero rates than Toshihiko Fukui, BOJ head from 2003 to 2008. Yet by 2009, rates were headed back to zero, and QE was back.
Ueda, of course, is trying to avoid the same fate. His biggest problem, arguably, is that the LDP essentially has one playbook: more stimulus. It has largely relied on fiscal and monetary expansion for seven decades. The party has ruled Japan with only two brief interruptions since 1955.
Now, even some senior LDP members admit that a quarter century of zero rates backfired. In this way, the plunge in the yen over the last decade is now coming back to haunt Tokyo.
The ways in which a weak yen deadened the urgency to level the playing field and increase competitiveness explain why Japan Inc today is watching with alarm as Chinese electric-vehicle maker BYD and artificial-intelligence upstart DeepSeek shake up their respective industries, in the way Japan might have in the 1980s.
Takaichi displays few signs that she might deviate from this formula. In this way, “Sanaenomics” is virtually indistinguishable from the strategy of Takaichi’s mentor Shinzo Abe.
Yet Abe took some of his inspiration from the earlier-mentioned Takahashi, the economist from the 1920s and 1930s who served as finance minister, BOJ governor and, eventually, prime minister.
Takahashi is best remembered for a hyper-aggressive mix of monetary easing and aggressive fiscal expansion, along with efforts that modern economists would call debt monetization. Central banks buying ginormous blocks of debt directly from the government is as radical as any industrialized nation can get.
Many would say Takahashi ran the 20th century’s most audacious experiment in so-called “Modern Monetary Theory.” All the debating over so-called MMT ignores that Takahashi effectively pioneered it. MMT holds that a country issuing debt in its own currency can borrow aggressively with little financial fallout or risk of default.
Ben Bernanke, the former US Federal Reserve chair, once told an audience that “Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies.” In 2013, then-Prime Minister Abe said the “example of my forerunner Takahashi has emboldened me” in the battle against deflation.
That same year, Abe empowered his BOJ Governor Haruhiko Kuroda to grow the BOJ’s balance sheet to a size bigger than Japan’s US$4.2 trillion economy. The Kuroda era pushed the BOJ so deeply into government debt and the stock market that it still effectively remains trapped.
When Ueda replaced Kuroda in 2023, it fell to him to begin QT and then put some rate hikes on the scoreboard. This normalization process is now in jeopardy as Takahashi resurrects “Abenomics” in ways that could backfire anew.
“Takaichi is running on an end to excessive fiscal austerity — that’s highly irresponsible,” says Robin Brooks, economist at the Brookings Institution.
“I’ve been flagging for a long time that we’re in the early stages of a global debt crisis. Long-term government bond yields have risen sharply everywhere,” Brooks said. “Markets are losing patience with governments that are chronically unable or unwilling to bring public debt down. This is no time to pretend Japan’s humongous debt isn’t a problem. Denial isn’t a plan.”
Hence, fears of a “Liz Truss moment” in Tokyo. In late 2022, then-UK Prime Minister Truss destabilized the debt market by attempting to sneak an unfunded tax cut past bond traders. The extreme market turmoil remains a cautionary tale for Takaichi as her party mulls tax cuts.
With a debt-to-GDP of 260% and a shrinking population, Takaichi needs to tread carefully. In May, Takaichi’s predecessor, Shigeru Ishiba, said Tokyo’s deteriorating finances are “worse than Greece.” The comment made global headlines for all the wrong reasons.
There are reasons why the often-predicted JGB crash never seems to arrive. For one thing, 90% of JGBs are held domestically. That significantly reduces the risk of large-scale capital flight.
There’s also the fact that banks, insurance companies, pension funds, endowments, the postal system and the growing ranks of retirees would suffer painful losses. So, the collective incentive is to hold onto debt issues rather than sell.
Also, the BOJ has the bond market’s back. On Wednesday, Reuters reported that Takaichi should not count on the BOJ’s help in taming sharp spikes in bond yields, given the huge cost of intervention. Still, it’s hard to see the BOJ sitting back and watching the market stumble.
“If bonds are being sold on speculative trading, the BOJ could see scope to intervene,” says former BOJ board member Takahide Kiuchi. “But it’s clear the recent rise in yields reflects market concern over Japan’s fiscal policy.”
Yet the bigger-picture worry is that Takaishi and the LDP took the wrong lessons from the QE of the 1990s and the extreme debt monetization of the 1930s. It’s that such monetary shock therapy may have its place, but it’s meant to be a short-term fix – not a permanent one.
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