Everyday Economics: Fiscal reality meets Central Bank caution

(The Center Square) – At Davos, Citadel CEO Ken Griffin pointed to Japan's bond selloff – where super-long yields surged and 40-year yields hit record highs – as an "explicit warning" about what happens when investors start to doubt a government's fiscal trajectory. His message was blunt: when a country's "fiscal house is not in order," "bond vigilantes" can "extract their price." That is not political rhetoric. It is bond arithmetic. Long-term yields can be thought of as a bundle of (1) expected real short rates, (2) expected inflation, and (3) risk premia – especially the term premium and inflation-risk premium. The fiscal channel matters because persistent deficits affect yields through multiple mechanisms simultaneously: More issuance increases the compensation investors demand. When governments run larger deficits, they supply more duration risk to the market that must be absorbed by private balance sheets. A large economics literature finds that higher deficits and higher debt ar