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

In this study, we explain the driving forces behind the secular stagnation associated with a persistent decrease in interest rates. To do so, we employ a model that incorporates a crisis risk triggered by an accumulation of government debt. The model shows that the fear of large-scale taxation on capital and misallocations of capital in future debt crises explains almost half the economic slowdown in Japan over the past two decades. Over the same period, the government bond yield decreases, because the uncertainty in returns on capital makes investing in government bonds becomes less risky than investing in capital.