High Fiscal Deficits Don’t Automatically Require Higher Interest Rates —
What Truly Matters Is Building a Healthy Capital Circulation System
In public debates, it’s common to hear claims like:
“The government is running large fiscal deficits, so interest rates must rise.”
But fiscal deficits and interest rate policy are not mechanically linked.
The deeper issue is whether the domestic economy has a functioning circulation of capital—a system that allows money, credit, and investment to flow smoothly.
This article explains why strengthening capital circulation matters more than simply arguing for or against rate hikes.
It also clarifies how the size of public debt interacts with interest rates and fiscal pressures.
■ 1. Fiscal Deficits and Interest Rates Are Not Directly Connected
A key distinction:
- Fiscal deficits are about government revenue and spending.
- Interest rates are tools of monetary policy aimed at managing credit and currency conditions.
Interest rate hikes are usually implemented to:
- Curb inflation
- Maintain currency stability
- Manage capital inflows and outflows
In other words, rate decisions respond to monetary conditions, not to the size of the fiscal deficit alone.
There is no simple rule that “higher deficits require higher rates.”
■ 1-2. Debt Size Matters: High Interest Rates Affect Large Debtors Differently
Here is the important nuance.
When a country’s total government debt is relatively small, even a higher interest rate environment may not be a major fiscal problem—as long as there is a credible repayment or reduction plan and the debt remains proportionate to economic capacity.
However, when government debt is large, high interest rates have a very different consequence:
- The cost of servicing debt grows rapidly
- This pushes fiscal pressure forward into future years
- And effectively builds up long-term pressure for future tax increases
In this sense, prolonged high interest rates in a high-debt country act like a mechanism that steadily accumulates future tax burdens.
Historically, this pattern aligns closely with periods that eventually forced governments to raise taxes.
This is why interest rate discussions can’t be separated from the scale of public debt.
■ 2. The Real Problem: Domestic Money Isn’t Circulating
Before even debating interest rates, Japan (and many other economies) face a more fundamental issue:
Capital is not flowing through the economy.
For example:
- Corporations accumulate internal reserves instead of investing
- Households save excessively due to future uncertainty
- Capital concentrates in major cities instead of reaching local regions
- Venture firms and emerging industries struggle to access risk capital
With this structural stagnation, monetary policy alone cannot revitalize real economic activity.
■ 3. What’s Needed: Structural Reforms That Support Credit Flow
A sustainable economy requires more than liquidity—it requires pathways for capital to move.
This means reforms such as:
- Tax and regulatory structures that encourage productive investment
- Systems that support labor mobility and skill transition
- Better allocation of capital across regions and industries
- Infrastructure for risk capital (start-up finance, pension fund investment reforms, etc.)
- Mechanisms that enhance credit creation for SMEs and new ventures
Without these structural adjustments, increasing the money supply or raising/lowering interest rates will have limited real impact.
■ 4. When Credit Channels Don’t Match the Economic Structure, Circulation Breaks
Modern economies run on credit creation.
If the institutional pathways don’t align with how credit moves:
- Excess funds remain idle
- The real economy becomes undernourished
- Growth slows
- Fiscal deficits worsen
The issue is not merely the amount of money, but whether the system allows money to flow effectively.
■ Conclusion: The Priority Is Capital Circulation, Not Rate Hikes
Rate decisions should depend on inflation, growth trends, and monetary conditions.
But the more urgent priority—especially for economies with large public debt—is:
Rebuilding a domestic circulation system where capital flows rather than stagnates.
High debt combined with high interest rates creates a long-term buildup of fiscal pressure, analogous to accumulating future tax burdens.
This makes structural reform—not rate adjustment—the real key to fiscal and economic sustainability.
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