Imf working Paper

 
Redistribution of Wealth from Debtor to Creditor 
Sustained unanticipated deflation has implied a substantial transfer of resources from debtors 
to creditors in Japan in recent years.
19
Following Bernanke (2000), a simple exercise is 
carried out below to illustrate the impact of unanticipated deflation on the borrowers. Assume 
that a borrower took a ten-year loan in 1997 at the interest rate of 2.1 percent, which was the 
yield on long-term government bonds during that period.
20
It would be reasonable to assume 
that the borrower’s expectation of future price increases would have been in the range of 
about 1.1 percent inflation per year, which was the average of the previous decade. 
Subsequent deflationary developments would have however led to a significant increase in 
the borrower’s real debt burden. Through 2003, the borrower’s real obligations would have 
been 12 percent higher than anticipated. Even allowing for a trend decline in deflation in the 
19
A comparable magnitude of disinflation and deflation could have similar impact on the 
debt burden of borrowers. Hence this section does not exclusively deal with deflation’s cost.
20
The year 1997 has been chosen for this example as it is the last year before CPI deflation 
materialized in Japan. 
0
25,000
50,000
75,000
100,000
125,000
150,000
1997
1998
1999
2000
2001
2002
2003
1/ Source: Bloomberg.
Figure 11. Japan: Average Open Interest Positions: 
10-year JGB Futures Market 1/ 

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- 19 - 
coming years, it is estimated that by the time the loan matures in 2007, the real debt burden 
would be about 20 percent higher. Relaxing the assumptions, refinancing the loan in 2000 as 
interest rates come down and deflation set in, the borrower would have still found his debt 
burden to be about 7 percent higher by 2003 than anticipated at the beginning of the loan. 
Thus even the mild deflation seen in Japan in recent years has had a punitive impact on 
borrowers, possibly contributing to rising bankruptcies, and affecting spending and 
investment decisions. 
The transfer of wealth from the borrower to the creditor is not frictionless owing to the value 
of collateral. In the post-bubble era, creditors have had difficulties recovering the value of 
defaulted loans owing to sharp declines in collateral value (especially land and stock). The 
borrower in the above illustration, if using land as collateral and expecting the asset to at 
least maintain its real value over the time path of the loan, would have found its real value to 
be 34 percent lower than anticipated through 2003.
21
 
A combination of the increase in real debt burden and decrease in collateral value has been 
deleterious for financial intermediaries in Japan. Indebted households and corporates, faced 
with debt-service difficulties, curtailed spending and investment, and in some cases have 
entered bankruptcy, leaving banks in the aftermath saddled with bad loans with substantially 
lower recovery value.