The Bank of Japan’s lifting of its zero-interest rate policy last week represents an end to an extraordinary policy that continued for five years and four months. With its decision, which marks a step toward normalization of the nation’s monetary policy, the central bank has signaled that the Japanese economy has finally freed itself from the persistent effects of the burst of the economic bubble in the early 1990s, including a deflationary spiral. At the same time, the BOJ is taking an especially cautious approach in deciding future interest rates. This is welcome because the BOJ should strive to keep interest rates at a level that won’t disrupt the economy.

The nine-member BOJ Policy Board, in a unanimous vote, increased the uncollateralized overnight call rate on short-term loans among banks from zero percent to 0.25 percent. The board voted 6-3 to raise the official discount rate, which the central bank charges ordinary banks for collateral-based borrowings, from 0.1 percent to 0.4 percent. This rate serves as the upper limit for short-term rates. To help prevent an increase in long-term interest rates, the BOJ will continue to buy national bonds worth 1.2 trillion yen every month on the market.

Behind the BOJ’s decision was its assessment that the interest rate increases will not send the economy back into deflation as the Japanese economy continues to expand, and that continuation of the zero-interest rate policy would threaten to cause the economy to overheat. The BOJ thus defied opinion within the government that deflationary pressure remains and that the zero-interest rate policy should stay in place.

The BOJ’s judgment was bolstered by several factors. Japan’s overall economic expansion has continued now since February 2002. Exports, especially to the United States, are a strong contributor. This economic boom is expected to exceed the length of the record boom from October 1965 to July 1970 — known as the “Izanagi Boom” after Izanagi no Mikoto, a male deity in Japanese mythology entrusted by heavenly deities with the task of creating the land. The year-on-year monthly consumer price index (excluding perishable foods) also showed an upward trend for seven consecutive months through May.

The BOJ’s June “tankan” business survey showed improved business confidence among major manufacturers for the April-June quarter and plans for stronger corporate capital spending for fiscal 2006. The business sentiment index for large manufacturers came to 21, compared with 20 in the previous survey. The index for major nonmanufacturers rose to 20 from 18 in the previous survey. The survey indicated that large corporations in all industries were planning to spend 11.6 percent more on plants and equipment in fiscal 2006 than in fiscal 2005, which would mark the highest growth since fiscal 1990.

Another factor behind the BOJ’s judgment is the fact that banks have almost finished disposing of their bad loans.

The central bank summed up the goal of its latest policy decision as that of contributing to price stability while achieving sustainable economic growth in the medium to long term. This should also be the hope of every enterprise, every market player and every household.

The latest decision by the central bank followed its decision in March to lift the quantitative easy-money policy introduced five years earlier. The March decision contributed to market players’ anticipating an end to the zero-interest rate policy, helping to prevent confusion in the market.

The BOJ had adopted a zero-interest rate policy in February 1999 before terminating it in August 2000. But as a U.S. slowdown impacted the Japanese economy, it was forced to go back to the zero-interest rate policy: The quantitative easy-money policy adopted in March 2001 flooded the banking system with excess liquidity while guiding the overnight call rate close to zero.

Hopefully, the BOJ has learned from this experience. The BOJ should be careful of factors such as domestic private consumption, which is not necessarily strong, and the U.S. economy, which is showing signs of inflation even as economic activities slow down. Possible overheating from capital spending and the effects of high oil prices also bear watching. In sum, the BOJ needs to carefully steer its monetary policy, avoiding sudden, steep changes in its direction.

Apart from the questions concerning the real economy, the latest policy decision by the BOJ comes amid public distrust of BOJ Gov. Toshihiko Fukui following his private investment in a fund managed by maverick Mr. Yoshiaki Murakami, who has been arrested on suspicion of insider trading. Mr. Fukui should not forget that this distrust persists.

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