The BOJ is at the Entrance of a New Crisis, Not an "Exit"

 

The BOJ’s Persistence with "Ultra-Negative Real Interest Rates" Invites a Return to 1970s Stagflation

～ The Taylor Principle and the Risks in the Strait of Hormuz ～

Japan’s monetary policy currently stands at a historic crossroads. While the Bank of Japan (BOJ) ended its negative interest rate policy in 2024, declaring a return to a "world with interest rates," I cannot help but feel that the stance of both the government and the BOJ remains "too little, too late." To me, it looks like an extremely dangerous gamble.

By visualizing the data from the "List of Japan's Macroeconomic and Price Indicators (2020–2025)," I want to discuss the serious risks ahead, incorporating the fundamental principles of Mankiw’s macroeconomics and the lessons of the 1970s oil shocks.

First, let’s examine the underlying data.

Table: Trends in Japan's Key Price, Exchange Rate, and Interest Rate Indicators (2020–2025)

Year	Core CPI (%)	Domestic PPI (%)	GDP Deflator (%)	WTI Change (%)	USD/JPY Change (%)	Policy Rate (%)
2020	-0.2	-1.2	0.9	-31.0	-4.4 (Appreciation)	-0.10
2021	-0.2	4.6	-0.2	+72.9	+10.1 (Depreciation)	-0.10
2022	2.3	9.7	0.3	+38.9	+20.1 (Depreciation)	-0.10
2023	3.1	4.1	3.8	-17.7	+8.2 (Depreciation)	-0.10
2024	2.8	2.4	3.6	-2.4	+1.9 (Depreciation)	0.15
2025	2.5	2.2	3.1	-14.4	-0.5 (Flat/Apprec.)	0.58

Looking at this table, the pattern is clear: the explosive rise in WTI crude oil and the USD/JPY rate in 2021-2022 pushed the Producer Price Index (PPI) up to 9.7%. With a time lag, this has driven Core CPI and the GDP Deflator (an indicator of domestic factors) into the upper 3% range.

Yet, meanwhile, the BOJ’s policy rate remained stuck at -0.1% until the end of 2023 and averaged a mere 0.58% in 2025. This massive disconnect is the source of my intense sense of unease—the feeling that the BOJ is an outlier in the global economic landscape.

Furthermore, as of last weekend, WTI crude oil prices in 2026 have already skyrocketed by +71.5% year-to-date.

1. A Direct Challenge to "Mankiw’s Textbook" and the Taylor Principle

In basic macroeconomics, such as Mankiw’s textbook, a golden rule for balancing price stability with sustainable growth is the importance of maintaining the real policy interest rate (nominal rate minus inflation) in positive territory.

This is known as the "Taylor Principle." It dictates that when inflation rises, the central bank must raise nominal interest rates by more than the increase in inflation. This raises the real interest rate, thereby cooling the economy and suppressing inflation.

What is the reality in Japan? Since 2023, Core CPI has hovered around 3%, and the GDP Deflator hit 3.8% in 2023. Against this, the nominal policy rate was -0.1%. In other words, the real policy rate was left in an abnormally deep negative zone of $-3\%$ to $-4\%$.

Even with rate hikes in 2024 and 2025, if CPI remains above 2.5% while average annual rates are 0.15% or 0.58%, the real rate remains near $-2\%$. The "accommodative state" hasn't been resolved at all. The BOJ is the only major central bank to leave real rates so deeply negative during such a clear inflationary phase. It is no exaggeration to call this a direct challenge to the economic common sense of the Taylor Principle.

2. Promoting "Wage Hikes" and "Fiscal Stimulus" Simultaneously: A 1970s Deja Vu

More dangerous still is that while maintaining these "ultra-negative real rates," the Japanese government continues with "massive fiscal stimulus" and is actively stoking "inflation-driven wage hikes."

The government/BOJ scenario is likely: "If wage hikes exceed price increases and real wages turn positive, a virtuous cycle will be born." From a macroeconomic perspective, however, this is extremely risky.

Stimulating demand through both fiscal policy and wages while real interest rates are deeply negative only serves to further heighten inflation expectations. Once the expectation that "prices will rise" takes root, companies rush to pass on costs, and workers demand even higher wages. This is precisely the mechanism of the "wage-price inflation spiral" that ravaged the West in the 1970s.

Unless the BOJ shows a clear will to "anchor" these expectations by raising real interest rates, we risk falling into an inflationary abyss rather than a virtuous cycle. This leads to stagflation—where deep recession and high inflation coexist—the polar opposite of the government’s ideal.

 

3. The Closure of the Strait of Hormuz and the Reality of a Third Oil Shock

This domestic vulnerability is exacerbated by sudden changes in the external environment. The ongoing threat of the closure of the Strait of Hormuz is one of the most serious risks to Japan’s energy security.

We just witnessed the sudden surge in oil prices following the attack by Iran in late February. If the Strait is completely closed and crude oil prices skyrocket to $150 or $200—a "Third Oil Shock"—Japan's PPI will explode far beyond the 9.7% seen in 2022.

In such a scenario, it is somewhat understandable that the BOJ might hesitate to raise rates out of concern for the economy (as seen in the March meeting where rates were held at 0.75%). However, the greatest lesson from the 1970s is that "if you ease up on suppressing inflation, inflation expectations become uncontrollable, resulting in even deeper stagflation."

Back then, Western central banks failed to raise rates sufficiently because they prioritized economic growth. Ultimately, it took the brutal "shock therapy" of Paul Volcker (then Fed Chair)—raising real interest rates to nearly +10%—to kill inflation at the cost of a severe depression.

Conclusion: The BOJ is at the Entrance of a New Crisis, Not an "Exit"

The Japanese economy is currently exposed to double inflationary pressures: the "inflation stoking" caused by leaving real rates deeply negative, and the "external shock" of a potential Third Oil Shock.

If the government is going to push for wage hikes, the BOJ has a duty to raise interest rates even further to return real rates to positive territory based on the Taylor Principle and anchor inflation expectations.

Otherwise, we risk a repeat of the long, painful stagflation the West experienced in the 70s. The BOJ cannot afford to keep "hesitating" as it did in March 2026. Persisting with negative real interest rates is a dangerous act that may lead the Japanese economy into an "irreversible inflationary spiral."