On August 11th, Japan’s central bank, the Bank of Japan (BOJ), announced its first interest rate hike in ten years. For seventeen months, the BOJ had lent money overnight to the banking system at a rate of zero; that is, no interest. Now, with the hike, it will charge an annualized rate of one quarter of one percent for such lending, which is still almost zero.

Before it happened, the IMF, the Japanese Ministry of Finance, the U.S. Treasury Dept., and most economists had warned that such a move would seriously threaten any recovery in the Japanese economy, and urged the BOJ not to do it.

The BOJ responded by suggesting that 1) it was independent and didn’t take orders from politicians, 2) the Japanese economy was recovering strongly enough to endure a hike in rates from artificially low levels, and 3) the economy needed to solve its problems in better ways, i.e. through restructuring rather than hoping for a permanent infusion of free or subsidized loans.

I agree that the zero interest rate policy was clearly artificial – why would a commercial bank loan money to another without charging interest? One bank’s vault is just as good as another’s, so what’s the economic incentive to loan its money without interest? There is none, which is why this interest rate was a creation of the government, through its central bank. From this point, interbank lending rates can remain low, (appropriate for Japan’s mild deflation) but should also reflect the economic realities of the lending market.

Although the BOJ said nothing to indicate that this small interest rate hike would be the precursor of other hikes down the road, some economists and politicians are freaking out. Paul Krugman at the New York Times suggested that the hike might be “the beginning of the end of an era” for the whole world, claiming that the move was so horrible that he wouldn’t be surprised if Japan collapsed and central banks around the world lost their independence. In addition, many economists immediately slashed their expectations of GDP growth, some by as much as one percent, saying that the move was too early considering past deflation in Japan.

I think it’s outrageous that the BOJ’s rate hike is getting all this attention, primarily because it obscures much more important issues. Clearly, Japanese politicians are hoping to lay blame for any future problems on the BOJ when in fact their government policies are a far greater threat to Japan’s economic recovery. For example, the government is generating record budget deficits primarily to finance non-economic public works construction projects, and injecting money into corporations whose failures would be politically unpalatable. To boot, in order to finance this wasteful government spending, politicians are now proposing a hike in consumption taxes and income taxes.

Meanwhile, initiatives for deregulating Japan’s bureaucratically-suppressed industries have slowed in the past year, and Japanese producers are still seriously restricted by structural problems in the political economy.

In the end, it seems that every day that leaders complain that Japan’s rates, the lowest in the world, are not low enough, is another day that should have been spent introducing and implementing supply-side incentives: lower and simpler taxes, less regulation, and economic restructuring. There ‘s little doubt that’s what it’s going to take for Japan to experience a lasting economic recovery.

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Andrew West

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.