On the internet, there seems to be an overwhelming number of voices calling for interest rate hikes. While everyone is free to demand what they wish, I worry whether people truly understand the significant downsides of such a move.
The policy rate is the overnight lending rate in the interbank market, which stands at 0.5% as of this writing. Raising this rate exerts upward pressure on all other interest rates (whether they actually rise is a separate issue). The most widely anticipated effect among the public is likely the containment of inflation via a stronger yen, which would lower import prices. Indeed, that effect would likely be substantial. Additionally, people expect interest income to increase as deposit rates rise. Some may even hope for a drop in housing prices as mortgage rates climb, but for those who already own a home, this is nothing less than the erosion of their asset value. Furthermore, for prospective buyers, the increased burden of mortgage interest payments makes it questionable whether there is any macroeconomic benefit at all.
Now, who exactly pays for that increase in interest? Naturally, it is the borrowers. In essence, the nature of a rate hike is a transfer of funds from borrowers to lenders—a zero-sum game where one person’s gain is another’s loss. As interest rates rise, the number of people refinancing or taking out new loans decreases. From a monetary perspective, as I mentioned in a previous post, this means a reduction in the money supply within the economy. From the perspective of the real economy, it dampens all domestic final demand that involves borrowing, namely capital investment, residential investment, and durable goods consumption (with automobiles being a prime example). While lowering import prices through a stronger yen sounds like a good anti-inflation measure, the resulting increase in imports of goods and services only serves to reduce GDP. A stronger yen is, of course, also a factor in decreasing exports. Beyond that, downward pressure would be applied not only to the aforementioned housing prices but also to stock prices and foreign-currency-denominated assets, likely triggering a “negative wealth effect.”
In short, a rate hike clearly has a significant negative impact on employment and wages. When, then, is a rate hike actually necessary? It is when the economy is overheating and labor shortages are severe, or when a current account deficit has increased substantially. Some argue that Japan’s labor shortage is dire, but I do not share that view. I believe there is currently no justification for cooling down the economy through rate hikes.
Who stands to benefit if a rate hike is implemented under these conditions? It would be civil servants and pensioners who have already finished paying off their mortgages. This is because they are not borrowers, they are highly resilient to deteriorating employment and wage conditions, and they generally hold significant savings. Middle-aged and older employees at large corporations could be said to be in a similar position if their mortgages are cleared, as firing them is difficult and wages possess “downward rigidity.” On the other hand, it would be a blow to many in the working generation, particularly the economically vulnerable whose employment and income are unstable. It goes without saying that it would also hit mortgage holders and small to medium-sized enterprises (SMEs), who are the primary borrowers of money.
I am, of course, aware that the depreciation of the yen due to low interest rates has brought about major adverse effects, not just inflation but also issues like over-tourism. However, I want people to understand that it is not as simple as saying, “Abenomics’ monetary easing only brought about a weak yen and inflation, therefore a rate hike is the correct answer.” My opinion is that we should combat inflation through other means first, rather than relying on an exchange rate increase triggered by a simple rate hike. It goes without saying that lowering the consumption tax rate is a powerful option. We should raise interest rates only once the growth of real wages is firmly on track—and that stage should not be in the too-distant future. If we are to rush a rate hike, it is all the more necessary to accompany it with large-scale fiscal stimulus.
In reality, however, while the Secretary-General of the ruling party speaks of “defending the consumption tax to the end,” the Bank of Japan (BOJ) seems intent on raising rates as if to say, “As long as we protect the 2% inflation target, that’s enough, right?” Political dynamics are fluid, so the future is uncertain, but if a government led by fiscal hawks is born, a “Lost 40 Years” seems almost certain.
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