The 28th of October marked a significant occasion in Japan as its central bank made a pivotal announcement, deciding to keep its policy interest rate at a striking -0.1%. This monetary policy choice is consistent with Japan's objective to maintain a yield target of approximately 0% for 10-year Japanese government bondsIn stark contrast to the monetary tightening trends observed in many parts of the world, Japan remains resolute in its ultra-loose monetary strategy, reminiscent of a lone warrior standing firm amid a tide of financial contraction globally.

Simultaneously, a notable shift in the value of the Japanese yen occurred, with the US dollar climbing from around 110 at the beginning of the year to a staggering 150. This depreciation of more than 40% demonstrates the challenges faced by the yen against other currencies

Advertisements

Recognizing the economic pressures on consumers and businesses alike due to rising prices, Japanese Prime Minister Fumio Kishida revealed an ambitious economic stimulus plan amounting to a staggering 71.6 trillion yen—or approximately 490 billion dollarsThis initiative aims to alleviate the burden of inflation and foster economic growth, showcasing a proactive government approach to combat economic stagnation.

The Bank of Japan (BOJ) reaffirmed its commitment to sustaining highly accommodative policies in the foreseeable future, reiterating that interest rates will not be hiked any time soon and that the central bank will not withdraw its stimulus measuresThis decision stands in stark contrast to the recent political turmoil witnessed in other nations, such as the United Kingdom, where an economic expansionary agenda led to quick political fallout for the former Prime Minister, who lasted barely 40 days in office.

Given Japan's economic landscape, one cannot help but ponder certain enigmatic factors

Advertisements

Notably, the monetary easing approach has been ongoing for more than two decadesSince the year 2000, the basic benchmark interest rates have hovered around the 0% mark, and Japan has even adopted a negative interest rate policy since 2016. Historical context reveals that even when the interest rates did rise between 2005 and 2007, they peaked at a mere 1.5%—a modest hike that offers little remedy for the contemporary economic malaise.

Contrasting the persistent low interest rates, Japan's inflation rate remained low for an extended periodEven amidst surging global energy prices, domestic inflation only recently crested to around 3%. This prompts a fundamental query: Why has Japan's low interest rate environment not precipitated surging inflation?

The answer lies in the dynamics of economic vitality—Japan's economy has suffered from chronic lack of demand and weakened consumer motivation over time.

Inflation, often perceived as a fearsome economic beast, can also be regarded as a product of economic engagement

Advertisements

In economic theory, moderate levels of inflation are typically considered beneficial, indicating active domestic economic activityWhen an economy is stricken by tight conditions, investment dwindles; conversely, inflation compels spending and investments, potentially stimulating growthThis was evident during the periods of elevated energy prices between 2011 and 2014, where major global economies grappled with inflation, while Japan maintained its inflation rate near zero—a stark reflection of deep-rooted economic vulnerability.

In modern monetary theory, a consensus has emerged that a measured amount of inflation can be advantageous for economic healthWhereas many nations fear rising inflation, in Japan's case, it is desired—it embodies what policymakers dream of as a spark to rekindle economic dynamism.

Notably, inflation is fundamentally rooted in a balance, or lack thereof, between supply and demand

• Mercedes-Benz: Embracing a New Era
• Intel Shares Surge 9.5%
• China-U.S. Treasury Yield Differential Holds Steady
• The UK Bond Market May Continue to Suffer
• How High Will U.S. Treasury Yields Soar?

When both supply and demand are weak, with demand trailing behind supply, inflation struggles to gain tractionJapan's long-term economic lethargy—exacerbated by demographic challenges such as an aging population—has led to tepid consumer demandOver the last two decades, consumption growth has remained soberingly stagnant.

Two critical factors have largely contributed to Japan's enduring economic stagnation: the aging population, which has resulted in labor shortages and innovation deficits, and the swift rise of emerging markets following the Cold WarNations such as China and India have rapidly positioned themselves as alternatives in various industries, presenting formidable competition to Japanese goods and services.

This dismal economic forecast compels Japanese citizens to refrain from spending, leaving them vulnerable to external inflationary pressures

The OECD reported in 2021 that the average annual income for Japanese residents stood at around 4.33 million yen, indicating a meager 4.4% growth in real wages over the past three decades—an almost nonexistent changeIn a society riddled with despair, inflation resembles driftwood adrift in the current.

The predicament of Japan’s investment-driven economy is pronounced.

Within the context of essential production resources—namely, labor, capital, and resources—Japan finds itself deficient in the first two categories; however, the wealth amassed during the 1980s and 1990s has afforded it significant capital advantagesPresently, Japan’s foreign exchange reserves rank amongst the highest globally, boasting a staggering figure of approximately 1 trillion dollars.

By the turn of the millennium, as domestic economic vitality wilted, Japan transitioned into a primarily investment-driven economy

As per data from the Ministry of Foreign Affairs, Japan's overseas net assets soared to 411 trillion yen (equating to about 2.78 trillion dollars, or as much as 3.67 trillion dollars considering end-of-year exchange rates) by 2021. In a span of just over two decades, these figures transformed radically, signaling a pronounced evolution in investment strategies.

Despite Japan's adeptness in fostering an investment-oriented economy, the nation has not successfully emerged from its protracted economic malaiseThis is largely due to the intrinsic limitations of investment opportunities globally, as barriers to trade persist, hindering market access.

In many sectors critical to national security and public welfare, governmental restrictions have stymied foreign investment opportunitiesJagged sectors—including energy resources like oil and coal, electricity, tobacco, and air travel—remain predominantly off-limits for foreign capital

In less sensitive sectors, the very act of investment nurtures potential rivals, as competitive dynamics amplify in industries defined by low trade barriers and high globalization, as evidenced by Japanese consumer electronics once dominating the Chinese market, now all but extinguished.

Furthermore, as the economies of the West continue to prosper, emerging markets vie in securing investment, with China usurping Japan’s former status as the largest investor in Africa, indicative of shifting global economic power.

With ongoing limited demand for the yen, despite ample domestic capital, genuinely viable investment opportunities are constrained, perpetuating the oversupply of currency and currency's value remaining suppressed.

The question remains: Why does Japan refrain from deliberately depreciating its currency?

Notwithstanding these challenges, Japan could potentially stimulate inflation via expansive monetary policy—a strategy previously employed by numerous countries

Increasing the money supply generates nominal demand since demand is ultimately measured in currency termsHistorical instances, such as the mid-1980s when the U.Sdollar plummeted from 160 to 80 on the dollar index, underscored how monetary depreciation reconstructed U.Sexport competitiveness by reclaiming market share from Japan.

However, statistics reveal that Japan's M2 money supply has only doubled over the past two decades, while the United States has seen a threefold increaseRemarkably, the yen-dollar exchange rate has remained consistent from 2000 to 2020, demonstrating Japan's cautious management of monetary policy.

Often, the refusal to actively depreciate the yen is mistakenly attributed to factors like the Plaza Accord; however, this perspective overlooks the fact that the yen's appreciation was intentionally driven by Japanese policy and has benefitted Japanese overseas investments.

Japan retains the capacity to influence its currency's value by means of monetary expansion, potentially generating greater inflationary pressures

Yet, the repercussions of depreciation entail the risk of imported inflation, thus necessitating higher interest rates to counteract the inflationary effectsSubsequently, elevated rates hinder domestic consumption, creating a vicious cycleFurthermore, as overseas investment assumes a crucial role in the Japanese economy, currency depreciation poses risks by elevating investment costs and reducing returns.

Thus, the labyrinth of historically low interest rates and inflation in Japan emerges primarily from inadequate economic dynamism and the inherent challenges of an investment-driven economy—a system where upward mobility falters while the descent is impeded.

Nevertheless, as the global landscape evolves, Japan's once-dominant capital advantages are beginning to dwindleThe intensifying competition in foreign investment realms signals that Japan may have to initiate currency depreciation to stimulate its stagnant domestic economy.

Finally, Japan confronts the broader societal issue of demographic aging