According to the revised central bank law, monetary policy should achieve price stability. For a long time, it was unclear what that meant until the Bank of Japan (BoJ) introduced the inflation target of 2% in January 2013. Governor Haruhiko Kuroda was unable to achieve 2% in ten years. Ueda then took office with the promise of achieving it after all. However, this meant that he had to continue the monetary easing of his predecessor.

The maximum reached a year ago was 4.2% – much lower than in Europe and the US. In January, it was 2%. But if you exclude food and hotel costs, it was only 0.4%. So we cannot say that underlying inflation is at 2%. If there was a prospect of a „stable“ 2%, then monetary policy could be normalized. But in the second half of the year, inflation is expected to fall and be well below 2% in 2025. How can the BoJ justify normalization then? This is the biggest challenge for Ueda.

Correct. But that only works with the prospect of that 2% inflation. The most important thing in monetary policy is forward guidance, meaning communication about the central bank's future actions. In Japan, it has two elements: firstly, the BoJ will control the yield curve until the 2% „stable“ level is reached. If this is not the case, how can the BoJ stop controlling the yield curve? That would be inconsistent. Second, the monetary base is supposed to expand until core inflation exceeds 2%.

Understandable, they want to make money. But as a former member of the BoJ's management team, I would say that the most important thing for the BoJ is the consistency and credibility of its framework. From this perspective, they are not yet ready for normalization. I don't really see a way to achieve stable inflation of 2% in this country.

The pay rises will be implemented from April, but we won't get the relevant data until June. In April 2023, the spring negotiations resulted in an increase of 3.8%. But wages at small companies only rose by an average of 1.3% between April and November. So the BoJ had better wait until July. Let's not forget the second point, the ongoing review of the last 25 years of monetary policy. We don't know the outcome yet. If I were governor, I would deal with everything at the same time – present the review and draw the consequences.

In fact, Ueda's employees would like to get rid of the negative interest rate. The reason I see for this is that the negative interest rate in Japan has caused much greater damage than the ECB's negative interest rate. The ECB was consistent in its policy. The deposit rate was at −0.5% and the lending rate between −0.5% and −1%. But the Bank of Japan gave commercial banks a positive deposit rate during the pandemic. The portion of commercial banks' deposits subject to the negative interest rate of −0.1% also became smaller and smaller. Basically, the BoJ has negated its own policy. So the negative interest rate must disappear this year.

We will only see a minimal change. The negative interest rate will be abolished, and the deposit rate will rise to 0.1%. Logically, the zero percent target for the ten-year yield must be dropped then as well. The 1% will remain as a loose upper limit to prevent overshooting. Then the disruption on the financial market will be limited.

I think the BoJ will have to continue to buy a lot of government bonds and provide corresponding forward guidance as long as it continues to pursue its goal of expanding the monetary base. At some point, it should only buy enough bonds to keep its holdings at the same level. But this is problematic in that the government is currently taking on more debt. So the BoJ would have to discuss this with the government.

One option would be to make the inflation target more flexible and aim for a rate between 1% and 3%. This target would be reviewed every three years. Monetary policy could then be normalized without internal contradictions. But as long as we stick to 2%, there is the problem of inconsistency.

I know that many foreigners think this way. But the abolition of the negative interest rate is enough for now. In light of the weak state of Japan's economy, there is no room for rapid interest rate hikes.

The government has benefited from the fact that the central bank has kept interest rates low. In the meantime, the BoJ has bought 53% of government bonds (JGBs). Imagine if it had not done that. Then interest rates would be much higher. The best scenario would be for the BoJ to maintain the current level of JGB holdings. But that would be difficult. The government is currently increasing spending on children, climate protection, and defence, but is not raising taxes. So the central bank has to keep buying JGBs.

Definitely not forever. At the moment, foreigners only hold 12% of government bonds. Japanese insurers and pension funds are still buying JGBs. We don't have a debt crisis. But the current policy is not sustainable. In an ageing society, payments into pension funds are declining. The elderly will stop working and use up their savings. Then we will be more dependent on foreign capital. These investors will then ask us what kind of policy we are actually pursuing, which would be a potential trigger.

Not in the next ten years. Fortunately, we have no inflation in Japan and more than half of the debt is held by the Bank of Japan, so we can continue as we are for the time being. But that's not healthy. If other countries were to budget like this, their credit rating would have been downgraded long ago. But Japan is a special case. The BoJ can still push down long-term interest rates. But the pressure will increase. The situation is simply not normal. No country has ever tried this. So we don't know how long it will last.

Sayuri Shirai is a professor of economics at Keio Private University in Tokyo. Before that, she worked for the International Monetary Fund, among others. From April 2011 to March 2016, she was a member of the Policy Board of the Bank of Japan.