This Week's Weekly: The
Bank of Japan and the Yen's Loss of Credibility is Bottomless
Monday, December 22, 2025
① How to Interpret the Nikkei
Editorial "The Bank of Japan Should Engage in Sufficient Dialogue on the
Path to Continued Interest Rate Hikes"
The Nikkei editorial dated
Saturday, December 20th, evaluated the Bank of Japan's decision to raise
interest rates to 0.75%, decided the previous day, as "appropriate"
and called for dialogue with the market toward future normalization.
While the argument is relatively
well-formed, it is by no means sufficient given the serious structural issues
facing the Japanese economy.
The Bank of Japan's decision on
Friday, the 19th, appears to be a nominal monetary normalization, but in
reality it remains accommodative and ineffective against structural
inflationary pressures.
1. The "Fourfold Woes" Surrounding the Japanese Economy and the Bank of
Japan's Delay
Japan is currently facing a
"fourfold woes":
• A declining birthrate
• Long-term consumption
stagnation
• A depreciating currency
• High inflation
Despite this, the Bank of Japan
is maintaining a de facto accommodative policy, citing its failure to achieve
its 2% inflation target.
However, raising the policy
interest rate into positive territory in real terms is essential to price
stability, a fundamental principle underpinned by the Taylor principle.
2. Optimism in Inflation Forecasts and Its Problems
The Bank of Japan repeatedly
forecasts that inflation will slow. However, given the following conditions:
• Fiscal stimulus and
monetary easing are proceeding simultaneously
• The yen's continued
depreciation
• Food prices remain
elevated
There is little basis for
expecting a slowdown in inflation.
In particular, the expectation of
disinflation in food prices is inconsistent with current data. Given the Bank
of Japan's poor track record of successful inflation forecasting, even greater
caution is warranted.
3. The Data Shows Reality: Inflation is Accelerating
Since April 2022, Japan's
inflation rate has exceeded 2% for 44 consecutive months. Incidentally, the
inflation rate surpassed 2% in April of that year, coinciding with the period
when the Federal Reserve, the U.S. central bank, was forced to implement significant
consecutive interest rate hikes due to its late recognition of rising
inflation.
On the other hand, it was only in
March of last year that the Bank of Japan finally moved to lift its negative
interest rates, which it had implemented in the name of escaping deflation.
In any case, the latest national
CPI (core) for November 2025, released last Friday, showed signs of
acceleration:
• +3.0% compared to the same
month last year
• +0.4% compared to the
previous month (annualized +4.9%)
Furthermore, rice prices have
soared:
• +37.1% compared to the
same month last year
• +1.9% compared to the
previous month (annualized +25.3%)
The Bank of Japan's forecast that
rice prices would "slow toward the end of the year" is no longer
realistic.
4. Deviation from the Neutral Interest Rate: The
Policy Interest Rate Is Still Too Low
Both the government and the Bank
of Japan estimate
• Price Stability Target: 2%
• Potential Growth Rate:
0.6%
Based on these estimates, the
authorities should be able to estimate a nominal neutral interest rate of
approximately 2.6%.
Meanwhile, the current policy
interest rate is 0.75%.
The difference from the neutral
interest rate is approximately 2%, still significantly accommodative.
Even if interest rates were
raised intermittently by 0.25% four times a year at each policy meeting
accompanied by an outlook report, it would still take approximately one and a
half years to normalize.
Furthermore, if interest rates
are limited to one to two hikes per year going forward, as the market consensus
predicts, prolonged excessive monetary easing could further exacerbate
inflation and a weaker yen.
5. The Combination with Fiscal Policy Exacerbates
the Crisis
This is compounded by
"Sanaenomics," which continues to expand fiscal spending by 3% of
GDP. A large-scale fiscal expansion under 3% inflation would synergistically
boost the economy and prices, making it extremely difficult to avoid overheating.
If this trend continues,
the risk of currency
depreciation, inflation, and asset bubbles reaching uncontrollable levels
increases.
6. What's Needed Is a Clear Policy Mix, Not
"Dialogue"
To revive the Japanese economy, a
policy mix is essential:
• A gradual increase in the
policy interest rate above the inflation rate
• A permanent reduction in
the consumption tax rate to 5% to offset the risks of rising interest rates and
a stronger yen.
Abstract phrases like
"dialogue" and "sound fiscal management" alone will not be
enough to avert one of the greatest crises in the postwar era.
7. The Limitations of the Nikkei Editorial
The Nikkei editorial is valid in
pointing out:
• The need for continued
interest rate hikes
• Dialogue with the market
• The importance of fiscal
discipline
However, it is difficult to say
that it fully captures the seriousness of the structural problems and the delay
in policy responses.
The risk facing the Japanese
economy is not simply a matter of the pace of interest rate hikes; it is a
structural crisis involving a complex intertwining of monetary, fiscal, and
foreign exchange rates.
8. Conclusion
What is needed now is:
• A clear path toward
normalization
• A policy interest rate
hike with an eye toward the neutral interest rate
• Consistency with fiscal
policy
• Realistic policy decisions
based on the premise that inflation will take hold
A concrete and effective policy
package (monetary policy normalization plus consumption tax abolition), rather
than abstract "dialogue," is essential to revitalizing the Japanese
economy.
② The "Disinflation
Mystery" Revealed in November's CPI Saves U.S. Financial Markets
By the way, the U.S. CPI released
in November 2025 clearly fell short of market expectations, once again
highlighting a clear trend toward slowing inflation (disinflation). However,
this figure does not simply mean that prices have stabilized.
Rather, it presents a strange
cooling in which the temperature of the real economy and the statistical
thermometer are at odds, presenting a challenge for both the market and
policymakers to interpret.
1. Unexpectedly Low Inflation
The U.S. CPI for November was up
2.7% year-on-year, and the core CPI was up 2.6%.
Both figures were below market
expectations (around +3%) and reached their lowest levels since 2021. While
these figures would normally be interpreted as "steady disinflation,"
the question is why they occurred at this time.
2. The Impact of the Government Shutdown Undermines
the Reliability of Statistics
This CPI was released despite
delays and missing data due to the government shutdown.
As a result, the data contains
"statistical noise," including:
• Insufficient samples in
some categories
• Reduced accuracy of
seasonal adjustments
• Possible delayed
reflection of price fluctuations
This unusual situation makes it
difficult to determine whether the figures are accurate or not. In fact,
November data was only collected after the 14th of that month.
As a result, the price data for
November 2025 corresponds to the mid-month period around Thanksgiving, when
many discount sales occur. Meanwhile, the November data from the previous year
was, of course, extracted from a sample covering the entire month. Therefore,
it cannot be denied that the November 2025 CPI may have been skewed downward.
3. The "Mystery" Created by the Gap with
the Real Economy
In any case, the US economy in
the second half of 2025 was actually experiencing increasing inflationary
pressures.
• The Trump Administration's
Tariff Intensification
• Sticky Service Prices
• Re-Acceleration of
Housing-Related Costs
• Resilient Demand Driven by
High Wages
Given these factors, inflation
was expected to trend upward. Despite this, November was "unusually
cool." This discrepancy is why it's referred to as the "Disinflation
Mystery."
4. An "Unexplainable Slowdown" Due to a
Confluence of Multiple Factors
The following explanations are
currently possible, but none of them are conclusive.
● Statistical Distortions
The most likely explanation is a
missing data point due to the government shutdown, but the extent of this
impact is unclear.
● Delayed Effects of Tariffs
The factors pushing up prices may
not have been fully reflected yet.
● High Interest Rates
Suppress Consumption
Slowing demand made it difficult
for companies to pass on the impact to prices.
● Temporary Stabilization of
Service Prices
Possible Temporary Easement of
Labor Market Distortions.
While each of these could be
"partially explained," no single factor can independently explain
November's sharp slowdown.
5. Implications for Monetary Policy: Rate Cut
Expectations Coexist with Caution
In response to these figures,
markets have strengthened expectations that the Fed will move to lower interest
rates soon.
However, the Fed faces three
uncertainties:
• The reliability of the
data is uncertain
• Inflationary pressures in
the real economy remain strong
• The impact of tariffs will
become more pronounced in the future
As a result, the Fed is unlikely
to act as optimistically as the market. In fact, last weekend, New York Fed
President William stated that, given the incomplete data, it would be
appropriate to continue patiently waiting for more accurate data on the end of
the government shutdown.
6. Summary: "Cooling" Numbers Do Not Mean
"Cooling" Economy
The November U.S. CPI is unusual
in that it is difficult to determine whether it represents a
"cooling" in the statistics or a "cooling" in the economy.
Rather, it should be viewed as
"difficult to explain disinflation," a combination of statistical
distortions and complex economic dynamics.
This "mystery" is
likely to become an unavoidable point of discussion when interpreting the US
economy and the Fed's policy decisions in 2026.
In any case, clean December US
employment statistics, based on data covering the entire monthly period, are
scheduled to be released on Friday, January 9th, and the December US CPI is
scheduled to be released on Tuesday, January 13th next year.
③ "Irresponsible Policy
Agreements" in a Multi-Party Era Will Lead Japan to Crisis
The Nikkei editorial dated
Friday, the 18th, "Irresponsible Policy Agreements in a Multi-Party Era
Are a Problem," makes seemingly plausible points. However, it fails to
delve into the core of the structural crisis Japan currently faces.
1. Large-scale Supplementary Budgets in an
Inflationary Environment are a Counterproductive Policy
At a time when 3% inflation is
becoming established, increasing the supplementary budget by 3% of GDP is a
typical example of procyclical fiscal policy. Snack-glubbing spending only has
a temporary effect and will instead boost aggregate demand, further exacerbating
price increases. This is not a "measure to combat rising prices," but
rather a policy that promotes inflation.
2. Price stability requires that
the policy interest rate exceed the inflation rate.
As the Taylor principle dictates,
price stability requires the policy interest rate to exceed the inflation rate.
Even with a 0.75% interest rate hike, real interest rates remain deeply
negative with 3% inflation, and financial conditions remain accommodative.
The Bank of Japan has been slow
to respond to the global interest rate hikes since 2022, allowing the yen to
weaken and inflation to continue. This is a classic example of "behind the
curve."
3. Public opinion expressed in this summer's House
of Councillors election shows a sense of crisis over the rising cost of living.
The public expressed their 1)
disgust with the collusion between politics and money and 2) a sense of urgent
crisis over the rising cost of living.
The consumption tax cut, which
the opposition parties unanimously called for, most directly reflected this
public opinion. Tax cuts that support people's lives were the policy the
sovereign people wanted.
4. The Only Policy Mix to Revive
the Japanese Economy
Price stability and a recovery in
growth require a combination of:
• A gradual increase in the
policy interest rate above the inflation rate
• A permanent reduction in
the consumption tax rate to 5%.
This policy mix is essential to easing the pressure for a stronger yen that
accompanies interest rate normalization while restoring real household income.
5. The Double Whammy of Sanaenomics' Handouts and
the Bank of Japan's Delay
Fiscal management that relies on
short-term handouts and monetary policy that lags far behind global trends.
These two policy mistakes have entrenched the current high prices and stagnant
growth.
6. Deteriorating Politics and Increasing
Geopolitical Risks
Politics, increasingly
hereditary, privileged, and vested interests, is losing its function as a
national compass. Furthermore, rising tensions, such as the idea that a
"Taiwan emergency is a Japan emergency," could intensify the new Cold
War between Japan and China, dealing a fatal blow to Japan.
7. The extraordinary Diet session closed without
addressing key issues.
The extraordinary Diet session
that closed on the 17th ended with a lack of responsibility to future
generations, including:
• The expansion of the
supplementary budget
• The postponement of
funding for the gasoline tax cut
• The unruly framework of
the bill to reduce the number of seats
• The postponement of
reforms to corporate and group donations
• Stagnation of social
security reform.
In this multi-party era, what is
needed is a sustainable policy agreement that transcends partisan interests.
However, in reality, politics is adrift, and the nation's course is
increasingly uncertain.
８. Japan is now facing its greatest crisis
since the war.
As we approach the 8th year of
Reiwa (2026), politics is spinning out of control, and the economy is deviating
from its path of price stability and growth.
Regrettably, we must say that
Japan is now facing its greatest crisis since the war.
④ Passage of the Supplementary
Budget—The Futility of Focusing Only on Bond Dependence
The Asahi Shimbun editorial dated
Wednesday, the 17th, "Supplementary Budget Passed: Don't Repeat Bond
Dependence," has some merit, but it fails to get to the heart of the
matter.
It's true that fiscal expansion
based on size and the expansion of government spending that only produces
temporary benefits are problematic. In particular, a significant increase in
government bond issuance could lead to a medium- to long-term debt crisis.
Interest rates have been kept
under control through zero interest rate policies and yield curve control, but
long-term interest rates have been rising sharply in December against the
backdrop of accelerating inflation.
If interest rates (r) exceed
nominal GDP growth rates (g) in the future, there is a high possibility that
debt will spiral out of control, contrary to the government's expectations.
This is exactly what the Domar model shows.
Furthermore, inflation above 2%
has been in effect for 44 consecutive months since April 2022, and the current
inflation rate has reached 3%.
Under these circumstances, fiscal
expansion through a supplementary budget of over 3% of GDP will inevitably
exacerbate rising prices rather than address them.
Bank of Japan President Ueda
decided to raise interest rates to 0.75% last weekend, but real interest rates
remain significantly negative, making it difficult to expect monetary policy to
curb inflation.
If fiscal and monetary policies
continue to stimulate aggregate demand simultaneously, the yen could weaken
further amid expectations of accelerating inflation, further amplifying the
vicious cycle of inflation, currency depreciation, and asset bubbles.
Fears of accelerating inflation
and increased government bond issuance push up risk premiums, and if an r >
g structure becomes entrenched, debt will inevitably spiral out of control.
Given this situation, Sanaenomics
and Uedanomics risk deviating significantly from their intended path of price
stability and sustainable growth. This is the biggest problem inherent in the
passage of this supplementary budget.
In short, while the government's
reliance on government bonds is certainly a significant debt issue, even more
serious are the "quadruple whammy" affecting the entire Japanese
economy: a declining birthrate, long-term stagnant consumption, inflation, and
a weak currency.
Temporary fiscal measures are
insufficient to resolve these quadruple whammy; a permanent fiscal policy such
as the abolition of the consumption tax is essential.
While short-term fiscal policies
only have temporary effects, permanent policies will shift the expectations of
economic actors, generate sustainable growth, and ultimately lead to the
resolution of government debt through increased tax revenue.
However, since the abolition of
the consumption tax has the potential to further push up prices, it is obvious
that achieving both price stability and growth will be difficult without a
gradual increase in the policy interest rate above the inflation rate.
In this light, the passage of
this supplementary budget could be the "fuse" that leads to a crisis
in the Japanese economy. Simply calling for an end to reliance on government
bonds, as the Asahi editorial did, falls short of addressing the root of the
problem.
⑤ The new fiscal year budget of
over ¥120 trillion is another final blow to Japan's collapse.
There is another cause for
concern on the fiscal side. According to reports in the December 19, 2025,
editions of the Nihon Keizai Shimbun and other publications, the government has
begun adjusting the general account total for the fiscal year 2026 (Reiwa 8)
budget to exceed ¥120 trillion.
The main points of the report are
summarized below.
________________________________________
Key Points of the FY2026 Budget
1. Largest Budget Ever
• Total Amount: Over ¥120
trillion (a significant increase from the initial fiscal year 2025 budget of
¥115.1978 trillion)
• Background: In addition to
the natural increase in social security costs due to the aging population,
expenses for the fundamental strengthening of defense capabilities are
significantly increasing.
2. Major Expenditure Items
• Social Security Expenses:
Due to the aging population, medical, nursing care, and pension benefits
continue to reach record highs.
• Defense Spending: Based on
the "Defense Buildup Plan," a period of intensive defense
reinforcement through fiscal year 2027 will see a large budget allocated for
this purpose.
• National Bond Expenses
(Interest Payments): Rising interest rates are driving up interest payments on
debt, which is another major factor pushing up the overall figure.
3. Notable New Investments
• AI-Related Investments:
Based on discussions at strategic meetings at the Prime Minister's Office, a
plan has been announced for investments of over 1 trillion yen toward the
domestic production of AI-based models and the utilization of government AI.
________________________________________
Fiscal Impact and Future Plans
While expenditures are expanding,
revenues (tax revenues) alone are insufficient to cover the costs, and the
government is expected to continue to rely on large amounts of new government
bond issuance. The government's draft budget is scheduled for cabinet approval
this week, and detailed breakdowns are attracting attention.
The tax revenue outlook and new
government bond issuance amounts for the fiscal year 2026 (Reiwa 8) budget
proposal are summarized below.
According to the government's
plan for a Cabinet decision this week, government expenditures are expected to
exceed ¥120 trillion, while tax revenues are expected to reach record highs.
However, the fiscal imbalance remains.
1. Tax Revenue Outlook: Continued at Record High
Levels
• Tax Revenue Outlook:
Approximately ¥75 trillion to ¥77 trillion (a significant increase from the
initial FY2025 forecast of ¥69.6 trillion)
• Background: * Corporate
tax growth driven by strong corporate profits.
• Increases in income tax
and consumption tax due to rising incomes due to inflation and wage increases.
• This reflects the fact
that tax revenues, which had previously been conservatively estimated, have
actually exceeded expectations.
2. New JGB Issuance: Maintained in the High ¥30
Trillion Range
• Planned Issuance Amount:
Approximately ¥30 Trillion to ¥35 Trillion
• Current Status: Expected
to remain at the same level as the initial FY2025 forecast (¥35.4 trillion) or
only slightly lower.
• Concerns: * While
expenditures are expected to increase by approximately 5 trillion yen, tax
revenues are also growing significantly, so at first glance the deficit does
not appear to be expanding dramatically.
However, the "crocodile's
mouth" remains open, with approximately 30% of the budget still dependent
on debt (government bonds), and the timing of achieving the goal of fiscal
consolidation (a primary balance surplus) is now the focus of attention.
3. Expansion of "government bond expenses"
due to rising interest rates
The most concerning aspect of
this budget is the "government bond expenses" used to repay debt and
interest.
• Raising the assumed
interest rate: In response to the rise in market interest rates following the
Bank of Japan's policy revision, the government is moving toward raising the
"assumed interest rate" used in budget calculations (there is discussion
of raising it from 1.9% last year to the 2% range).
• Interest Payment Burden:
Of the massive ¥120 trillion budget, approximately ¥28 trillion to ¥30 trillion
could be allocated to bond service, putting a strain on the budget available
for new policies.
________________________________________
Summary: Current Fiscal Situation
The FY2026 budget will see both
record-high tax revenues and record-high expenditures running parallel.
Item FY2025 (Initial) FY2026
(Forecast)
General Account Total:
Approximately ¥115 trillion
Over ¥120 trillion
Tax Revenue: Approximately ¥70
trillion
75-77 trillion
New Bond Issuance: ¥35.4 trillion
Low- to mid-¥30 trillion
Nominal tax revenues are
increasing due to negative real interest rates and rising prices caused by the
weak yen. However, rising interest rates are beginning to directly impact
interest payment burdens. This structure in which increased revenues are being
consumed by interest payments is becoming another major risk factor for the
Japanese economy going forward.
Tomo Nakamaru
Former World Bank economist
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