Odd Lots · Thursday, August 6, 2026
Brad Setser explains the Bank of Japan's cautious approach to raising interest rates, despite inflation exceeding targets. Reasons include a desire not to prematurely end the fight against deflation, potential concerns about banking system funding costs, and a possible consideration of the government's overall debt servicing expenses.
“That is a very obvious question. For whatever reason, the Bank of Japan has been very slow to raise rates. So the short term policy rates about one percent. Inflation is clearly above that. They're different measures. Inflation has been above that for a long time. The stated reasons for the hesitation, as you know, the Bank of Japan has worked for so long to get inflation back to two. They don't want to prematurely cut off this shift in behavior to kind of they don't want to fall back into the zero rate, zero inflation economy.”
“I think there's also probably a few technical reasons that I'm sure that you Hada wanted the yield curve to steepen, and it has a lot before short term rates went up, and you know, short term rates affect the cost of all the yend deposits, so it's they impact the liability side of the banking system. The banks have a lot of low yielding assets on their balance sheet. So does the Bank of Japan, so there may be some concern about pushing up the cost of funding on the banking side too fast.”