Shortly after I wrote in my previous blog post about “avoiding a Lost 40 Years,” U.S. military strikes on Iran commenced. This is a deeply troubling development; depending on how things unfold, the economy could significantly deteriorate. The surge in crude oil prices is, of course, the primary concern, but there are also reports that at the Takaichi-Trump summit on March 19, Japan may be asked to dispatch naval vessels. This leaves the administration with a difficult choice: refusal could damage Japan-U.S. relations, while acceptance could be exploited as a political weapon domestically.
I have no intention of posing as an expert on diplomacy or national security. I can only say that I hope Ms. Takaichi handles the negotiations with the U.S. skillfully. Regarding oil prices, based on estimates from various research institutions, we need not worry excessively as long as prices remain around $100 per barrel. Prime Minister Takaichi will likely boldly propose a supplementary budget in the trillions of yen if necessary, and that should be sufficient. While she may not say it out loud, Ms. Takaichi surely understands the logic: government bonds can be issued as much as needed, and the primary balance is irrelevant.
Thinking of this, I am profoundly relieved that the Ishiba administration did not continue. He likely would have offered lackluster measures, claiming, “While citizens face hardships, we must also consider fiscal health.” Even in diplomacy with the U.S., Ms. Takaichi offers a greater sense of stability. Whether even she can navigate this perfectly is unknown to me, but she is likely a better choice than the Ishiba administration.
What concerns me more than the government, however, is the movement of the Bank of Japan (BOJ). Aiming to burst the asset bubble, the BOJ continued raising interest rates through 1990. On August 2 of that year, it raised the official discount rate to 6.0%; on that same day, Iraq invaded Kuwait, causing oil prices to skyrocket. At that time, the BOJ delayed its decision to cut rates, leading to a rapid economic cooling. A similar mistake occurred in 2000. Despite a sharp rise in oil prices, the BOJ ended its zero-interest-rate policy. A recession followed shortly after, and they were ultimately forced to return to zero rates. One must not respond to cost-push inflation with high interest rates.
And yet today, while a positive output gap and real wage growth have yet to take root, oil prices are soaring. Board members like Mr. Tamura and Mr. Takata seem eager to raise rates to curb cost-push inflation. Against the backdrop of a weakening yen, public opinion also seems to support a rate hike more than ever before. As I have stated repeatedly in past posts: this is the wrong order of operations. Even if inflation persists somewhat longer, we must not repeat these past mistakes. Why can they not wait just another three to six months? We must absolutely avoid inducing a recession that would force us back to zero interest rates once again.
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