Despite unfavorable fiscal conditions, some argue that the situation in Japan is not a problem given the abundant domestic savings and little need to rely on foreign investors. Having said this, no government can keep expanding its liabilities forever. The current stable low level of the government bond yields reflects market participants’ confidence that Japan ultimately has the ability to work on fiscal consolidation.
As I will get into later, confidence in fiscal sustainability is the most fundamental prerequisite for stability in prices and the financial system. Once damaged, it will adversely affect the economy.