Japan no longer needs the aggressive fiscal stimulus and ultra-loose monetary policy that once defined its economic strategy, according to former Bank of Japan board member Asahi Noguchi, who expects the central bank to raise interest rates again in December.
Noguchi’s stance marks a significant shift in thinking from an economist who spent years advocating reflationary policies. He now argues that sustained inflation, stronger wage growth and a positive output gap have fundamentally changed the policy problem facing Japan.
“Underlying inflation is near the BOJ’s 2% target and wages are becoming embedded at levels consistent with 2% inflation. If so, it would be too risky to implement policies that boost demand,” Noguchi said in an interview with Reuters.
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The argument comes as Japan confronts a new combination of risks. Inflation is no longer the persistent undershooting problem that dominated policymaking for decades, while the weak yen has become a source of imported inflation. At the same time, aggressive government spending is putting pressure on the bond market and raising concerns about whether fiscal expansion could undermine private investment.
The BOJ has already accelerated monetary tightening. It raised its policy rate in June and again in September, taking the rate to 1.25%, its highest level in more than three decades. The central bank’s September meeting also showed some policymakers arguing that rates may need to move higher more quickly to prevent inflation from overshooting the 2% target.
Noguchi expects the BOJ to leave rates unchanged at its next meeting as diminishing expectations of a US rate hike in October reduce some of the immediate pressure on the yen. But he sees a good chance of another increase to 1.5% in December.
The former policymaker believes the eventual endpoint could be considerably higher, with the policy rate potentially reaching 1.75% or even 2%, depending on the Federal Reserve’s policy path and developments in the Middle East.
That does not mean he expects the BOJ to tighten aggressively. Noguchi cautioned that a 2% policy rate could shock households and companies that have operated for years under exceptionally cheap borrowing conditions.
“With so much uncertainty on how its rate hikes affect the economy, the BOJ probably wants to take things very slowly,” he said. “But market forces won’t let it do so.”
Weak Yen is Forcing The BOJ’s Hand
The yen has become a central constraint on the BOJ’s ability to normalize policy gradually. The currency has hovered around 158 to the dollar, close to the 160 level that markets regard as a potential trigger for Japanese intervention. A weaker yen raises the cost of imported energy and food, transmitting currency depreciation directly into household prices.
Noguchi argues that the BOJ is particularly concerned that a move below 160 could generate another wave of food inflation.
“It’s hard for the BOJ alone to move slowly when other central banks are shifting to a rate-hike mode amid global inflationary pressures,” he said.
The problem is that higher Japanese rates alone may not be enough to stabilize the currency if US rates remain high. The BOJ therefore faces a difficult trade-off: move too slowly and yen depreciation can intensify imported inflation; move too quickly and higher borrowing costs could weaken domestic demand.
Recent BOJ discussions show that this tension is already shaping policy debate. While some policymakers have argued for further tightening, government representatives have urged caution because of concerns about the effect of cumulative rate increases on consumption and growth.
The shift is notable for Noguchi himself. He joined the BOJ board in 2021 as an advocate of aggressive monetary easing and opposed the central bank’s decision to end negative interest rates in 2024, as well as its subsequent increase to 0.25%. He later voted in favor of two further rate increases.
His change in emphasis illustrates how Japan’s policy challenge has evolved. The question is no longer primarily how to generate inflation and wages. It is how to prevent inflation from becoming entrenched while avoiding an unnecessarily sharp economic slowdown.
“Japan doesn’t need policies to boost demand as expansionary fiscal policy would crowd out private investment, while too-low interest rates would cause yen falls,” Noguchi said. “In short, reflationary policies no longer have a role to play in Japan.”
Fiscal Expansion Collides With Rising Bond Yields
Noguchi’s warning extends beyond monetary policy to the government’s spending plans.
With Japan’s output gap now positive, he argues that another large fiscal expansion could compete with private-sector investment and push government bond yields higher. Investors have already sold Japanese government bonds amid concerns about the country’s fiscal trajectory, while the yen has also come under pressure.
Prime Minister Sanae Takaichi’s spending plans have added to those concerns. Takaichi has subsequently sought to reassure markets about fiscal discipline, while long-term Japanese government bond yields have continued to reflect investor concern about the scale of future government borrowing.
The tension is straightforward. Fiscal stimulus can support households and businesses in the short term, but if the economy is already operating with a positive output gap, additional demand could add to inflation rather than simply raise growth. At the same time, greater government borrowing can lift long-term yields, increasing financing costs for companies and potentially discouraging private investment.
Japan’s economic data does not point to an economy in free fall, although it does show signs of moderation.
The final S&P Global Japan Services PMI fell to 51.3 in September from 52.5 in August, below the preliminary 51.6 reading. New orders continued to rise for a 27th consecutive month, but the pace slowed, while new export business declined again. Employment increased for a 13th straight month and at its fastest rate since February.
The broader composite PMI, covering manufacturing and services, dropped to 52.3 from 53.5, its weakest reading since May.
The figures therefore do not eliminate the case for caution. Service-sector activity is still expanding, employment is increasing, and domestic demand continues to support sales, but growth is losing momentum.
Japan’s quarterly Tankan survey offers a similarly mixed picture. Manufacturer confidence reached an eight-year high in the July-September period, while sentiment among non-manufacturers deteriorated. That leaves the BOJ facing a fundamentally different policy environment from the one Noguchi helped shape earlier in his career.
For years, Japan’s central bank and government were trying to escape deflation, stimulate demand and persuade companies to raise wages. Now the risks are increasingly moving in the opposite direction: excessive fiscal demand, a weak currency, elevated import costs and inflation becoming embedded in wages and prices.
The BOJ’s difficult challenge is to normalize rates without destabilizing an economy conditioned for decades to ultra-low borrowing costs. For the government, the challenge is equally difficult: supporting households and long-term growth without convincing bond and currency markets that Japan is returning to an era of unchecked fiscal expansion.
Noguchi’s conclusion is therefore more than a call for another rate hike. It is seen as a signal of a broader reassessment of the economic framework that governed Japan for much of the past decade. The reflationary era may not have ended because policymakers achieved everything they wanted. It may be ending because the problem Japan now has to solve is fundamentally different.