Exclusive: Japan's Exit from Super-Easy Monetary Policy Challenging but Needed: Former ADB President

By Harry Wu, SFC, 21st Century Business Herald

On March 19, 2024, the Bank of Japan (BOJ) implemented a historic interest rate hike, raising the benchmark rate from -0.1% to 0-0.1%, the first rate hike since 2007, officially ending eight years of negative interest rates. However, even after bidding farewell to negative interest rates, the BOJ's exit from its super-easy monetary policy remains a long and arduous task, and the pace of rate hikes has now slowed.

In an interview with SFC at the 2025 Bund Summit, Takehiko Nakao, former President of the Asian Development Bank and former Vice Minister of Finance of Japan, and now President of the Center for International Economics and Strategy, stated that he understands the many uncertainties felt by the BOJ, but considering market reaction and its political implication too much would make normalizing monetary policy more difficult, leading to a weaker yen and making the exit from super-easy monetary policy even more challenging. Therefore, formulating and implementing a robust plan for normalizing monetary policy is crucial. This is a formidable challenge, but the BOJ should strive to achieve it, he added.

With widespread easy monetary and fiscal policies globally and the ongoing AI boom, concerns about asset bubbles have resurfaced. Nakao warns that Asian countries should be more cautious if real estate and stock prices rise rapidly. Rapid capital inflows should also be taken seriously. People should learn many lessons from history, especially regarding asset bubbles and capital inflows.

Specifically, he believes the financial market environment faces three major risks. First, increase spending and widening deficits has led many countries to excessive accumulation of government debt. The US deficit is huge, as is Japan's. While some European countries, including Germany, were previously cautious, they have now increased spending. Second, stock prices may be overvalued due to expectations of the benefits of the AI revolution. Third, there are risks associated with private debt, where non-bank institutions are engaging in extensive financial intermediation activities instead of banks, and regulation is inadequate.

SFC: You worked at the Japanese Ministry of Finance and witnessed firsthand the negotiations for the 1985 Plaza Accord and its aftermath. From an insider perspective, what were Japan's primary strategic considerations and miscalculations when it agreed to a significant appreciation of the yen? In hindsight, what combination of monetary and fiscal policies should have been more prudent to cushion the impact of the appreciation and avoid the rapid expansion and bursting of the asset bubble?

Takehiko Nakao: In 1985, Japan joined the Plaza Accord, and the yen appreciated sharply against the dollar from 240 to 150 in about a year. People worried that the sharp yen appreciation would weaken the competitiveness of the export industry. Then, Japan adopted very expansionary fiscal and monetary policies, which was one of the reasons for the bubble. Another reason was that the yen appreciation made Japan very wealthy, to the point that in the 1990s, Japan's GDP per capita (in dollar terms) was 30% higher than that of the United States. Therefore, Japanese people felt very rich, and consumption increased accordingly, reflecting the wealth effect of the strong yen. This is a strong point of my view which is not widely understood.

In hindsight, Japan should have adopted more cautious monetary and fiscal policies during the bubble economy period. And after the bubble burst in 1990, policies were not fast and proactive enough. At that time, the Japanese government and the Bank of Japan did not truly realize the serious negative impact of the bubble burst. Banks and corporations experienced shrinking of assets and declining profitability, while liabilities remained, creating a massive balance sheet mismatch and triggering severe negative economic effects, with land and stock prices falling. People felt they became poor—this is the so-called negative wealth effect.

Japan's policies just after the bust of the bubble should have been more expansionary, but a more cautious approach was taken. Subsequently, in the event, Japan injected funds into banks, providing liquidity, and implemented fiscal expansion policies. But consecutive fiscal expansions since then have not truly worked to make Japan strong.

Japan's monetary policy has been very loose since 2013, but due to the prolonged maintenance of extraordinary monetary policy, the yen became very cheap, and fiscal discipline was lost. Moreover, the Bank of Japan's total assets are currently equivalent to about 120% of Japan's GDP, making adjustments to monetary policy extremely difficult. In 2013, this proportion was only around 30%, about the same level with other central banks.

SFC: What gains and losses in Japan's development over the past four decades hold lessons for today? What are your expectations for future development?

Takehiko Nakao: Japan has enormous economic potential, possessing numerous monetizable technologies. Therefore, we need to focus more on making money out of them and further invest in technological research and development; Japan can do a lot. Now that we have escaped deflation, we should use fiscal and monetary policies wisely.

SFC: After exiting negative interest rate policy, the Bank of Japan's pace of interest rate hikes has slowed due to uncertainties stemming from US policy. Given the constraints of high government debt, how should the Bank of Japan balance monetary policy normalization, preventing runaway inflation, and maintaining stability in the government bond market?

Takehiko Nakao: I understand the many uncertainties felt by the Bank of Japan, but considering market reaction and its political implication too much would make normalizing monetary policy more difficult, leading to further weakening of yen and making the exit from super-easy monetary policy even more challenging. Therefore, formulating and implementing a robust plan for normalizing monetary policy is crucial. I believe this is a formidable challenge, but the BOJ should strive to achieve it.

SFC: Given the current escalation of global trade frictions, how do you think trade-dependent countries should strengthen regional cooperation to offset the risks of unilateralism? For example, the RCEP and the China–Japan–South Korea FTA. How should these mechanisms be reformed to make them more attractive?

Takehiko Nakao: Yes, I think, as you said, many countries are facing the challenge of shrinking trade due to the US unilaterally raising tariffs. Therefore, one way for these countries to address this challenge is through regional cooperation. You mentioned RCEP and the China–Japan–South Korea FTA, which is the right direction. We should strive to maintain trade cooperation between countries. Maintaining friendship and cooperation between countries is very important, rather than being overly cautious about geopolitical issues. The Asia-Pacific Economic Cooperation (APEC) provides a good opportunity for countries to engage in dialogue.

SFC: In areas such as AI, semiconductors, and green finance, what practical cooperation projects can China and Japan jointly undertake to address global challenges? What are your expectations for the future?

Takehiko Nakao: China and Japan can cooperate in many areas, including the technology sector. China has many scientists, and Japan has a deep-rooted technological tradition; there is much room for cooperation between the two sides.

SFC: I was impressed by many elderly workers in Japan. You have repeatedly mentioned that population aging is a trend in human societal development, and that AI will be needed to help solve it in the future. Regarding the application of AI technology to healthcare and bridging the labor gap, what do you think are the most pressing policy and investment bottlenecks that governments and businesses need to overcome? How can we avoid creating new inequalities in the urban-rural divide through technology applications?

Takehiko Nakao: Population decline and aging are major challenges facing the Japanese economy, but also humanity more fundamentally. The labor force is shrinking, and we need more funds to pay for healthcare and elderly care. AI, robotics, and other technologies can help address population decline and aging. These technologies can support not only production but also help the healthcare industry. For instance, robotics can provide support for elderly care, so there are many opportunities.

However, as you said, we should also pay attention to the increasing polarization in society. Some people who are ready to embrace AI and other technologies will benefit, but if ordinary people's jobs are replaced by AI and robots, we must consider how to help them. But at the same time, we must be reminded that the emergence of new technologies create new areas of demand; historical experience shows that new technologies increase income and new demand, and also often give people more leisure time.

SFC: Based on your experience at the Japanese Ministry of Finance and the Asian Development Bank, looking back on the Asian Financial Crisis, what warning signs do you think were most systematically ignored by the international community and regional countries before the crisis erupted? How can we draw on these lessons to build a more effective early warning system as we monitor the global economy today?

Takehiko Nakao: It's important to pay attention to the risk of bubbles. Asian countries should be more cautious if real estate and stock prices rise rapidly. Rapid capital inflows should also be taken seriously. Therefore, we should learn many lessons, especially regarding asset bubbles and capital inflows.

The financial market environment faces three major risks. First, increase spending and widening deficits has led many countries to excessive accumulation of government debt. The US deficit is huge, as is Japan's. While some European countries, including Germany, were previously cautious, they have now increased spending. Second, stock prices may be overvalued due to expectations of the benefits of the AI revolution. Third, there are risks associated with private debt, where non-bank institutions (funds) are engaging in extensive financial intermediation activities instead of banks, and regulation is inadequate.

SFC: You led the Asian Development Bank for many years and witnessed the evolving influence of multilateral institutions. Given the current paralysis of the World Trade Organization (WTO) dispute settlement mechanism and challenges to global trade rules, how do you believe multilateral institutions like the ADB should adjust their roles to play a substantive role in maintaining the free trade order and preventing the world from sliding into a "bloc economy"?

Takehiko Nakao: Of course, institutions like the ADB should play such a role, but the ADB is ultimately just a financial institution, and repairing the trend of global integration is not easy. Institutions such as the International Monetary Fund, the World Bank, the ADB, and the Asian Infrastructure Investment Bank should work together to maintain global economic integration.

SFC: Growth and inclusion are crucial for Asia. In your leadership of the ADB, how has this concept been concretely translated into project evaluation criteria, loan conditions, or institutional priorities? After you stepped down, what are the core operating principles or strategic focuses that you most hope the ADB will uphold?

Takehiko Nakao: The ADB's strategic goal is to continue supporting poorer countries and poorer people; therefore, investment in education and rural infrastructure is crucial, as is action to address climate change. Furthermore, supporting gender equality is also essential.

SFC: You have pointed out that US tariff policy is misleading, ignoring the US surplus in the service trade sector. What exactly is the purpose of US tariff policy? Can Trump achieve his goals?

Takehiko Nakao: I cannot tell what Trump's ultimate goals are. He may have many goals, such as trying to bring manufacturing capacity back to the US, increasing tariff revenue, and "punishing" other countries, because Trump claims that the US has been "exploited" by other countries. But in reality, attracting manufacturing capacity back to the US is very difficult because the US has always been heavily reliant on manufacturing from other countries. The weakness in manufacturing is also due to the US's strength in other sectors, such as information technology, resources like oil or shale gas, and financial services. 

I don't know if these goals can be achieved. US manufacturing is relatively weak, and the capital account surplus further limits its competitiveness. That's my observation.

SFC: The US dollar, as a key currency, has brought enormous "excessive privilege" to the US. What are your expectations for currency cooperation within the Asian region (such as the cooperation between the RMB and the Japanese yen in cross-border trade settlement)?

Takehiko Nakao: From 2011 to 2013, I served as the Vice Minister of Finance for International Affairs at the Ministry of Finance of Japan. At that time, I proactively proposed initiating direct trading between the RMB and the yen, rather than through the dollar. I believed that monetary and financial cooperation between the two countries was crucial. Later, when I served as President of the Asian Development Bank, I facilitated cooperation between the Asian Development Bank and the Asian Infrastructure Investment Bank, with financing developing countries’ projects together based on co-financing agreement.

The dollar's status as a key currency cannot be easily reversed; we may not be able to alter its use. However, if the US becomes more unilateral and excessively uses the dollar for sanctions, it will damage the dollar's credibility and status. This would make regional countries more likely to cooperate using their own currencies. If US policies become even more unpredictable and unilateral, people may stop using the dollar for savings and investment. In this scenario, the international payment system or the international monetary system could become fragmented, leading to serious damage to global trade and economy.