South-Westerns' Economic News Summaries
In Japan, Cheap Money is a Thing of the Past
Topic International Finance
Key Words

Loose Money and Short Term Interest Rates

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Reference ID: A143047551 and A142990053
News Story

The Bank of Japan, the nation's central bank, announced that it will end its loose money policy followed in recent years. Rather, the bank will use increased interest rates to guide the future of the now-healthy Japanese economy. The main message in the announcement was to declare victory over an extended stretch of economic stagnation previously experienced by the Japanese economy.

"The Japanese economy is improving steadily," Toshihiko Fukui, the governor of the Bank of Japan, said, according to a Reuters report, "with prices having turned positive and expected to stay positive. This trend is strengthening."

The central bank's decision was seen as a first step toward an eventual rise in short-term interest rates in Japan from near zero and seemed to reflect the bank's confidence that deflation was under control. The question remains as to how smoothly they can pull back from making the easy money available.

"These are uncharted waters for a central bank," R. Glenn Hubbard, dean of Columbia University Business School and a central banking expert, said. "Exiting with minimal disruptions will be a difficult exercise."

By tightening credit, the Japanese central bank will end one of the biggest financial free rides in modern history. The loose money policy has had the unintended side effect of turning Japan into a huge pot of basically free money for the rest of the world. With an overnight call rate of about 0.001 percent global investors have borrowed cheaply in Japan to invest elsewhere and Japanese investors, from retirees to megabanks have bought foreign stocks and bonds in search of higher returns.

The fear now is that this flow of funds could reverse as interest rates begin to rise and Japanese investors could start selling their foreign stocks and bonds and return to domestic investments. "There is a risk of people overreacting," said Richard Jerran, a Tokyo-based economist for Macquarie Securities. "The five-year free ride comes to and end, or at least that's the fear.

"It probably won't happen, but there's always the possibility of unexpected consequences," said Atsushi Nakajima, chief economist at the research arm of Mizuho Financial, which is based in Tokyo.


Discuss how the loose money policy served to promote economic growth.

2. How will higher interest rates in Japan impact investment in other countries?
Source Martin Fackler, "Japan Ends Loose Money Policy", The New York Times Online, March 9, 2006 and Martin Fackler, "Japan Central Bank Declares an End to the Economic Blahs," The New York Times Online, March 10, 2006.
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