Secular Stagnation and Low Interest Rates under the Fear of a Government Debt Crisis

By using a model incorporating a crisis risk triggered by the accumulation of government debt, we provide a new perspective to explain the driving forces behind secular stagnation associated with a persistent decrease in interest rates. According to the model, the fear of the imposition of a large-scale capital levy in the face of a crisis helps explain Japans decades of persistent stagnation by almost one quarter. As government debt accumulates, not only the level but also the growth rate of output declines persistently, while the government bond yield decreases. We then discuss the possible mechanisms that induce people to share the expectation of a capital levy at the time of a government debt crisis from the historical, theoretical, and political points of view. The model also shows that a permanent increase in consumption tax, which prevents a government debt crisis from occurring, increases social welfare.