South-Western College Publishing - Economics  
Like a Bird or a Plane, Japanese Interest Rates Rise Above Zero
Topic International Finance
Key Words Interest Rates, Stagnation, and Deflation
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Reference ID: A148162807,A148032634

News Story The Bank of Japan, the Japanese central bank, increased its benchmark target for overnight lending from zero to 0.25 percent in response to a rebounding economy. Japan, one of the largest economies in the world (second only to the United States), has finally recovered from an economy characterized by stagnation.

Japan economy watchers generally applauded the move, saying that such a small increase will not likely have any great impact on the economy, but does send a strong signal that the central bank is watching the economy closely and that the bank will act on price movements. "In real terms, this is very incremental," said Jason Rogers, an Asian banking analyst in Barclay's Singapore office. "But it is important symbolically because it means that Japan's economy is starting to function normally again."

The rate increase came as recent economic data indicated that consumer and wholesale prices were rising, after years of stagnant economic activity and falling prices--or deflation. Increasing domestic consumption has led to the rising prices.. "Consumption is finally coming back to life," said Dai-Ichi Life Research Institute's chief economist Naoki Iizuka, "Japan doesn't have to rely on exports anymore."

During the long years of Japan's economic downturn, consumers spent cautiously as wages and prices tumbled. With lower wages, workers couldn't buy as much, and with prices constantly falling, they kept waiting to get a lower price. The result: low consumption and high saving rates. For the economy to continue its rise, and to "function normally" again, Japanese consumers will have spend more freely and more often.

Analysts' main worry is the frugality that has been built into the Japanese consumer's mindset over years of deflation and stagnation in the economy. Japanese consumers in their 20's and 30's have known only deflation and stagnation. "You're talking about an entire generation," said Lehman Brothers Tokyo economist Paul Sheard. "Everyone in Japan has been living so long in the deflationary environment that this behavior is in the neurons of their brains."

Most economists agree that the Bank of Japan wants to show that it is up to the task of leading the Japanese economy into a new era of growth. "The Bank of Japan wants to show that it can be effective," said Akio Makabe, a professor specializing in central bank policy at Shinshu University in Matsumoto, Japan. The measure of whether the Bank is correct in increasing interest rates may well be determined by whether Japanese consumers continue to spend. The bank will keep a close watch on that trend.

Discussion Questions:
1. How has deflation affected the Japanese consumer?
2. What do you think the Bank of Japan is trying to achieve by raising interest rates?
3. Using any source available, compare the savings rate in Japan and the United States and discuss the consequences of having either too high or too low a rate?
Multiple Choice/True False Questions:
1. Continual decreases in prices has caused Japanese consumers to:
  1. save less.
  2. save more.
  3. consume and save less.
  4. buy more durable goods.
2. For years, the Japanese economy has been characterized by:
  1. a large growing economy.
  2. rampant inflation.
  3. falling prices.
  4. high interest rates
Source Martin Fackler, "Central Bank Raises Rates in Japan", The New York Times Online, July 14, 2006. Martin Fackler, "Japan Looks to Its Savers to Consume", The New York Times Online, July 11, 2006.
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