When I think about Japan’s economy as a Japanese citizen, I cannot help but feel disheartened. The problem is not a single failure, but a structure in which monetary policy, fiscal policy, and exchange rates are entangled all at once, leaving very little room to escape. To begin with, Japan is already clearly in an inflationary phase. Consumer prices, both headline and core, have been rising at around 3% year-on-year, a level that can no longer be dismissed as temporary or blamed solely on imported inflation. Under normal circumstances, a central bank would respond by raising policy rates, supporting the currency, and anchoring inflation expectations. Yet the Bank of Japan, burdened by years of ultra-low interest rates and massive holdings of government bonds, finds it extremely difficult to make that obvious choice.
In the latest move, the policy rate was raised from 0.5% to 0.75%. What followed, however, was not a stronger yen, but a weaker one. This is a highly symbolic outcome. The fact that the yen was sold even after a rate hike indicates that markets have concluded this level of tightening is insufficient to control either inflation or fiscal risks. With inflation hovering around 3%, a policy rate of 0.75% still implies deeply negative real interest rates, offering little incentive to hold yen. Moreover, investors appear convinced that the Bank of Japan, constrained by political and fiscal considerations, will remain reluctant to normalize policy decisively. As a result, the perception has taken hold that rate hikes will remain small, cautious, and perpetually delayed, and the yen continues to be sold accordingly.
This monetary instability is being exacerbated by the government’s fiscal stance. The Takaichi administration’s slogan of “responsible proactive fiscal policy” is presented as a strategy to balance growth and national security, but in practice it deepens reliance on deficit-financed government bonds. Most of the supplementary budget is funded through new bond issuance, and even defense spending, long protected by the postwar taboo against deficit financing, has now crossed that line. Expanding defense expenditures to more than 3% of GDP without a clearly secured and sustainable tax base represents, from the market’s perspective, a clear retreat from fiscal discipline.
That judgment is already visible in the government bond market. Yields on 10-year Japanese government bonds have risen at a pace rarely seen before, reaching the 2% range. For decades, JGBs were regarded as immovable safe assets. What we are witnessing now is the beginning of a repricing driven by doubts about fiscal sustainability itself. Rising yields mean higher debt-servicing costs, translating into trillions of yen in additional fiscal burden. If those interest payments are then financed through yet more bond issuance, confidence in the yen will deteriorate further, setting the stage for renewed currency depreciation and accelerating inflation.
What makes Japan’s inflation problem particularly serious is that the country is drifting toward what economists call fiscal dominance. Japan’s total government debt stands at roughly 250% of GDP, an extraordinary level even among advanced economies. For a country carrying debt of this magnitude, rising interest rates are no longer merely a tool of macroeconomic adjustment; they are a direct threat to fiscal stability itself. Raise rates decisively, and debt-servicing costs explode. Suppress rates, and the currency weakens while inflation accelerates. When a central bank is effectively forced to prioritize government solvency over price stability, fiscal dominance has already set in, and markets are increasingly viewing Japan through that lens.
The people most directly affected by this situation are those whose assets and incomes are almost entirely denominated in yen. Banknotes issued by the Bank of Japan are, at their core, pieces of paper sustained by trust in the state and society, a human-based monetary system. When that trust erodes, the real value of savings is quietly shaved away. Unless wages consistently keep pace with prices, living standards will inevitably decline. Inflation is a process in which wealth erodes even without anyone explicitly taking it, and the burden falls disproportionately on those who hold only cash and yen deposits.
And yet, public sentiment is buoyed by the symbolism of Japan’s first female prime minister, with some people enthusiastically engaging in what they call “サナ活(Sana-katsu)”, a form of political fandom. Many of these supporters are ordinary citizens whose entire livelihoods depend on the credibility of the yen, and who have no way to escape shifts in currency or bond markets. A weaker yen raises the cost of imports, pushing food, energy, and daily necessities ever higher. Rising interest rates increase the burden of mortgages and loans, while a slowing economy places downward pressure on employment and wages. To hold only yen-denominated assets is to bear the full force of these structural changes.
Around the Takaichi administration, reflationists often repeat the claim that “because Japan issues debt in its own currency, fiscal collapse is impossible.” On an accounting level, this may sound persuasive. Japan issues government bonds in yen, and the BOJ can supply yen without limit. In that narrow sense, a formal default, an inability to repay principal and interest in nominal terms, is indeed unlikely. What this argument fatally overlooks, however, is that the central bank can create currency symbols, not economic value.
The yen functions as money only because it is supported by social trust, the belief that this piece of paper will continue to purchase goods and services in the future. As long as that trust holds, unlimited issuance may appear harmless. But trust is not unconditional. When money creation becomes excessive, inflation accelerates, and everyday life becomes unsustainable, people begin to avoid holding that currency altogether. A situation in which prices keep rising, wages fail to catch up, savings lose real value, and even basic necessities become difficult to afford constitutes a very real collapse from the perspective of ordinary people, even without any formal declaration of default.
Ultimately, the phrase “there will be no fiscal collapse” protects the state’s appearance, not the lives of its citizens. An economy in which ordinary people can no longer sustain their livelihoods cannot be called healthy, no matter how carefully its books are balanced. Currency is nothing more, and nothing less, than a network of human trust. When that trust breaks, collapse has already occurred.
Japan’s economy now stands at a critical juncture. This is not a question of right versus left, nor an ideological debate. It is a concrete and unavoidable issue for everyone whose life is denominated in yen. The Takaichi cabinet enjoys approval ratings near 70%, and many people hope its economic policies will succeed. But markets are relentlessly honest.
