In my previous post, I stated that raising interest rates has a negative impact on employment and wages. Therefore, the critical question is whether the current economic environment justifies such a move. On the other hand, the public is calling for a stronger yen to curb inflation. While I understand this sentiment, as I mentioned previously, I believe a simple interest rate hike is a poor move.
Setting the general public aside, those who identify as “market participants” often call for rate hikes or predict their timing as a matter of course, without ever addressing the actual impact of inflation. Perhaps, as professionals, they feel there is no need to mention common-sense consensus every time. However, because a proper recognition of the current macroeconomic situation is far more important than the conclusion of “raising rates,” I insist that they address it explicitly.
I have argued that rather than focusing on inflation itself, we should aim for growth in real wages while taking inflation into account. Until early 2024, the Bank of Japan (BOJ) also seemed to emphasize real wages, but that focus has somehow vanished into thin air. What are your thoughts on this?
So, why are market participants so enamored with interest rate hikes? A certain number of them likely hold economic views entirely different from my own—those who, under the supremacy of inflation targeting, do nothing but track CPI data and remarks from key officials. I wish these individuals would show a bit more flexibility.
However, the majority are likely different. As Yoichi Takahashi has clearly pointed out for some time, the reason likely lies in the interest paid on BOJ current account balances. As of July 2025, the balance of current accounts subject to interest is 504 trillion yen; simply applying a policy rate of 0.5% results in 2.5 trillion yen per year. Since the BOJ pays this interest, it is entirely risk-free. Compared to the era of negative interest rates, this is a “heavenly” situation for them. Furthermore, rising rates may revitalize the short-term money market, which has long been stagnant, potentially increasing profit opportunities.
Rate hikes can also be a factor in increasing interest income from loans to the private sector—the core business of financial institutions. However, for the small and medium-sized enterprises (SMEs) that make up a significant portion of borrowers, higher rates increase the risk of bankruptcy. If business conditions are strong, interest income simply increases; if not, the rise in loan-loss provisions may outweigh the gains. To be honest, it is unclear which outcome we would see in the current economic environment. For reference, the June Tankan survey showed the Diffusion Index (DI) for SMEs at +1 for manufacturing (neither good nor bad) and +15 for non-manufacturing (fairly positive, perhaps due to the inbound tourism boom).
Stepping away from the perspective of financial institutions, rising interest rates sap the capacity of SMEs for capital investment and wage hikes. My view is that we should not rush to raise rates while real wages are still declining. While receiving risk-free money from the BOJ is undoubtedly a welcome prospect for those in the financial sector, I believe the true duty of financial institutions is to see the Japanese economy as a whole revitalize and SMEs grow steadily, and then receive interest as a share of that success.
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