This article is based on ideas originally published by VoxEU – Centre for Economic Policy Research (CEPR) and has been independently rewritten and extended by The Economy editorial team. While inspired by the original analysis, the content presented here reflects a broader interpretation and additional commentary. The views expressed do not necessarily represent those of VoxEU or CEPR.
This article was independently developed by The Economy editorial team and draws on original analysis published by East Asia Forum. The content has been substantially rewritten, expanded, and reframed for broader context and relevance. All views expressed are solely those of the author and do not represent the official position of East Asia Forum or its contributors.
This article is based on ideas originally published by VoxEU – Centre for Economic Policy Research (CEPR) and has been independently rewritten and extended by The Economy editorial team. While inspired by the original analysis, the content presented here reflects a broader interpretation and additional commentary. The views expressed do not necessarily represent those of VoxEU or CEPR.
The most revealing number in first‑quarter 2025 was not a blockbuster yield or a spectacular default. It was 3.1 basis points—the average bid‑ask spread recorded across forty‑one sovereign and supranational bonds issued as fully tokenised instruments on permissioned ledgers. Their matched conventional twins traded at 6.6 basis points, more than double the friction. That 3.5-basis-point delta may look microscopic, yet every basis point saved on a standard USD 100 million ten-year bond removes roughly USD 100,000 in intermediation costs.
CXMT and YMTC Expand Production Rapidly to Capture Market Share Will Rising DDR4 Prices Provide Additional Tailwinds? Chinese Firms Also Eye High-Value Products Like DDR5 and HBM
The influence of Chinese memory semiconductor companies—Changxin Memory Technologies (CXMT) and Yangtze Memory Technologies Co. (YMTC)—in the global market is strengthening. This is the result of a significant increase in market share built upon rapidly expanded production volumes over the past few years. Market analysts forecast that the presence of Chinese firms will soon become visible in advanced memory markets such as Double Data Rate (DDR) 5 and High Bandwidth Memory (HBM).
According to a recent report by market research firm Omdia on July 21, CXMT's DRAM production capacity (in terms of wafer input) reached 720,000 wafers in the third quarter of this year, a 70% increase compared to the same period last year (420,000 wafers). On an annual basis, CXMT’s DRAM wafer production is expected to rise from 1.62 million last year to 2.73 million this year. Considering that CXMT's average monthly DRAM production stood at only 100,000 wafers as recently as the first quarter of last year, this growth is remarkable.
Its market share is also rapidly expanding. According to data from Chinese consulting firm Qianzhan, CXMT's DRAM market share, which remained below 1% in 2020, grew to 5% last year. Another market research firm, TrendForce, predicts that CXMT's DRAM market share could reach 12% by the end of this year. Dan Hutcheson, Vice Chair of semiconductor research firm TechInsights, told the Financial Times (FT) that “CXMT’s market share is still low but its rapid growth is creating a ‘snowball effect,’” adding, “This mirrors how Korea displaced Japan in the memory sector.”
In the NAND flash market, YMTC is continuing its volume expansion strategy. While major players such as Samsung Electronics, SK Hynix, Kioxia, and Micron have maintained a production cut stance, YMTC has drastically increased output at its second plant in Wuhan since the first quarter of last year. YMTC’s NAND output from its Wuhan Line 2 reached 130,000 wafers in the second quarter of this year, more than doubling from 60,000 during the same period last year. YMTC’s total NAND production also rose by 42% year-over-year.
There are growing expectations that Chinese memory firms’ growth trajectories will steepen. This is largely due to the soaring prices of DDR4, a general-purpose (legacy) DRAM product and CXMT’s flagship offering. According to TrendForce, the price of 16-gigabyte (Gb) DDR4 jumped from an average of $5.60 on May 23 to $11.50 on June 20—more than doubling in just four weeks. TrendForce forecasts that DDR4 prices could surge by over 40% in the third quarter of this year.
Prices of general-purpose DRAM had previously plummeted due to oversupply driven by Chinese output and weak downstream demand, but began rebounding sharply in April. As Samsung, SK Hynix, and Micron successively decided to halt DDR4 production, PC and IT equipment manufacturers began stockpiling inventories out of concern over potential tariff hikes under the Donald Trump administration. As a result, the year-on-year export growth rate of general-purpose DRAM, which dropped to 15.7% in February, exceeded 20% for four consecutive months: 27.8% in March, 38.0% in April, 36.0% in May, and 25.5% from June 1 to 20.
If this trend continues, changes in DDR4 production plans by Chinese memory firms appear likely. A market insider commented, “CXMT has formulated plans to gradually cease DDR4 production for server and PC applications by mid-next year,” but added, “If DDR4 prices continue to rise, the actual cessation date may be postponed.” The insider further noted, “SK Hynix and Samsung Electronics are also reportedly suspending their plans to phase out DDR4 production.”
The fact that Chinese companies are intensifying efforts in advanced memory product development is also noteworthy. CXMT has successfully mass-produced DDR5 DRAM, moving beyond DDR4. While market evaluations, such as those from TechInsights, have generally estimated that Chinese technology lags Korea’s by 3–4 years, some analyses suggest that CXMT’s DDR5 performance shows little difference compared to Korean counterparts. In fact, CXMT’s DDR5 product yield is reportedly above 80%.
The pursuit of HBM (High Bandwidth Memory) is also gaining momentum. CXMT has recently completed development of HBM3 (fourth-generation HBM) samples and has finished testing with multiple Chinese AI hardware startups. Chinese tech firms such as Cambricon, Biren Technology, and Iluvatar CoreX are rumored to have signed pilot agreements with CXMT. The company plans to begin supplying HBM3 samples within the year and commence full-scale product sales to customers by early 2026.
The market’s current leading product, HBM3E (fifth-generation), is scheduled to launch in 2027. If CXMT’s plan materializes, the technological gap between it and SK Hynix/Samsung Electronics could narrow to within two to three years. HBM3E is currently almost exclusively supplied by SK Hynix. Samsung has yet to begin deliveries as quality validation with major client Nvidia has been delayed.
Battle for Sovereignty in Treasury Yields and Currency Circulation Dollar-Backed Banking Ambitions Emerge "Trust vs. Innovation"—Profitability Under Scrutiny
With the Trump administration enacting legislation that provides a regulatory path for stablecoins, dollar-backed coin issuance has now entered the legal mainstream. Crypto firms such as Ripple and Circle are moving aggressively toward banking operations. In response, traditional financial institutions are pushing back against these firms’ treasury-based revenue structures while exploring stablecoin issuance of their own to defend market leadership. Although concerns over the profitability and trustworthiness of crypto-based models persist, the growing confrontation is beginning to signal a potential overhaul of the U.S. financial system.
According to crypto-focused media outlet CoinGape on July 20 (local time), the American Bankers Association (ABA) and Independent Community Bankers of America (ICBA) recently sent a joint letter to the Office of the Comptroller of the Currency (OCC), requesting that bank license approvals for crypto companies like Ripple and Circle be postponed. The associations argue that these firms lack transparency and fail to provide consumers with sufficient information to assess their business models and associated risks.
The Trump administration’s official endorsement of stablecoin integration has been seen as a major turning point in the financial sector. The newly passed legislation allows the issuance of coins backed by dollar-denominated assets and enables these coins to generate returns through the purchase of U.S. Treasury securities. This effectively authorizes crypto firms to engage in "dollar-based asset management," a role traditionally reserved for banks, particularly with regard to bond investments and income generation.
Following the bill's passage, expectations have grown that crypto companies will rapidly advance into banking services. If crypto-backed assets are converted into U.S. Treasuries and begin yielding stable returns, the issuers will effectively function as quasi-financial institutions deriving revenue from sovereign debt. This marks a shift in the role of stablecoins from simple payment tools to fully fledged asset management instruments.
Use cases for stablecoins are also expanding at a rapid pace. In regions such as Latin America and other emerging markets—where confidence in local currencies is weak—stablecoins are increasingly functioning as "digital dollars." Due to limited access to USD and underdeveloped financial infrastructure, stablecoins, with their low fees and real-time transfer capabilities, are gaining traction as tools for everyday commerce and remittances. This development positions crypto issuers as emerging players in global liquidity management, thereby intensifying competitive pressure on traditional banks.
Ultimately, the banking sector’s resistance can be interpreted not merely as a fight over market share but as a broader contest for systemic control. The model of replacing dollar circulation through stablecoins and earning interest on U.S. Treasuries directly undermines the revenue foundation of the existing banking system. As the Trump administration signals a long-term pivot toward a stablecoin-centric financial architecture, observers see a full-scale showdown between banks and crypto firms as inevitable.
In what appears to be a move to accelerate this confrontation, Ripple has applied to the OCC for a national banking charter—aiming to operate under the same regulatory regime as traditional banks. Ripple Labs CEO Brad Garlinghouse announced via social media on July 3, “Ripple has submitted an application for a national bank charter with the OCC,” adding that this step would serve as a “unique benchmark” for the broader market.
Should Ripple secure the national banking license, it would be subject to federal regulatory oversight—a significant elevation from state-based licensing structures previously used for stablecoin operations. Ripple had already launched its RippleUSD (RLUSD) stablecoin in December of last year, signaling its commitment to a regulation-centered strategy. Circle is also pursuing a banking license, laying the groundwork to offer services akin to those of traditional banks, including anti-money laundering protocols and deposit insurance.
Meanwhile, several major U.S. banks are beginning to develop their own stablecoin initiatives. Jamie Dimon, CEO of JPMorgan Chase—one of the largest banks in the country—recently stated in an interview, “We are involved in both JPMorgan deposit coins and stablecoins.” The bank is reportedly piloting an internal deposit-token dubbed “JPMD,” with plans for external deployment in the future. Additionally, JPMorgan is said to be considering a collaborative stablecoin project alongside Bank of America, Citigroup, and Wells Fargo.
Some banks are also exploring connections with central bank digital currencies (CBDCs), using internally issued coins as testbeds. Leveraging their established infrastructure and regulatory expertise, these institutions aim to quickly build trust within the stablecoin market. This shift indicates that banks are moving beyond viewing stablecoins solely as risk factors and are now positioning them as potential revenue generators and payment solutions.
However, questions remain regarding the long-term viability and profitability of stablecoins. By design, stablecoins must maintain a fixed value, limiting volatility and making it difficult to generate revenue organically. While Treasury yields offer a potential income source, returns remain constrained by issuance volume and prevailing interest rates. As such, it remains uncertain whether coin issuers can create stable, long-term profit streams comparable to those of traditional banks.
Trust issues also persist. For stablecoins to function as currencies, both technical stability and public confidence are essential. Yet, major collapses like the Luna incident continue to cast a long shadow over the market. Luna’s algorithmic stablecoin TerraUSD (UST) was designed to maintain a $1 peg by automatically minting and burning its native coin, Luna, without any underlying collateral.
In May 2022, Terra’s peg failed, triggering an exponential minting of Luna tokens. The result was a catastrophic price collapse, erasing nearly $50 billion in combined market value in just a few days. Countless investors suffered massive losses, and the event led to a widespread erosion of trust in the stablecoin system as a whole. The incident underscores the argument that technical innovation alone cannot replace the social role of banks.
$177 Billion Invested in World’s Largest Hydropower Project Harnessing High-Altitude Terrain for Maximum Energy Efficiency India and Bangladesh React with Strong Protests over 'Survival Threat'
China has launched the world’s largest hydropower project in the Tibet region with a total investment of approximately $177 billion. The dam construction project, which had been delayed for more than a decade, is now finally underway. The issue is that the river in question flows into Bangladesh and merges with India. Downstream countries like India express concerns that the Chinese hydropower project may cause environmental degradation and fear that China could weaponize water.
According to state-run Xinhua News Agency on the 21st, Chinese authorities held a groundbreaking ceremony on the 19th for the “Lower Yarlung Tsangpo River Hydropower Project” in Linzhi, Tibet Autonomous Region, attended by Premier Li Qiang. The project is being carried out by Power Construction Corporation of China (POWER CHINA) and is scheduled for completion in 2033.
Facing increasing pressure to reduce greenhouse gas emissions, China aims to decrease reliance on coal-fired power plants while effectively addressing the electricity shortfall stemming from the expansion of electric vehicles and artificial intelligence (AI) industries. At the same time, this project—the largest single hydropower initiative in history—is expected to contribute to the development and economic revitalization of underdeveloped western regions, including the Tibet Autonomous Region. Chinese authorities have stated that the project will generate an annual income of about $2.8 billion for Tibet.
China had announced its intention to build hydropower dams on the Yarlung Tsangpo River more than a decade ago. Originating at an altitude of over 3,000 meters in the Tibetan Plateau, the Yarlung Tsangpo River is fed primarily by glacial meltwater from the Himalayas and stretches 2,840 km in length. It also boasts the world’s largest canyon, more than 5,000 meters deep. One segment of this river falls over 2,000 meters in just 50 km, offering immense potential for hydropower generation.
The Yarlung Tsangpo River is deemed an optimal site for hydropower under China’s "East Data, West Computing" initiative, which seeks to transfer data from the east to be processed in the west. Since launching the strategy in 2022, China has begun operating the Yajiang-1 supercomputing center on the Tibetan Plateau as of last month, aiming to build a sustainable high-performance computing hub.
Located in Shannan city in the Tibet Autonomous Region, the initial phase of the center will deploy more than 256 advanced computing servers capable of delivering a total of 2,000 petaflops (200 quadrillion floating-point operations per second). Jointly developed by Tibet Yarlung Tsangpo Computing Technology Company and local governments, the facility is designed to pioneer the "high-altitude digital economy."
As the first step in extending the East Data, West Computing strategy into Tibet, Yajiang-1 maximizes the region’s unique environmental conditions for sustainable operations. The high altitude naturally provides cooler temperatures, reducing the need for artificial cooling, while abundant solar, hydro, and wind resources lower operational costs. According to a report from the Shannan Investment Promotion Bureau, the center addresses the global challenge of balancing computing demands and environmental protection at an altitude of 3,600 meters by employing an innovative system combining solar power, waste heat recovery, and high-efficiency cooling.
This integrated approach maintains a power usage effectiveness (PUE) rating of under 1.3, achieving 40% higher energy efficiency than conventional data centers. Once the 2,000-petaflop Yajiang-1 reaches full capacity, it will handle 4 million hours of AI training annually for China’s eastern region—saving 320 million kWh of electricity and reducing carbon emissions by 280,000 tons per year. The investment bureau also reports that the on-site solar panels, covering 25,000 m², generate 48 GWh of clean power annually, while recovered server waste heat is used to warm nearby buildings, cutting coal consumption by 12,000 tons per year.
The key issue is that the Yarlung Tsangpo River flows downstream into northeastern India and Bangladesh. Originating in the Qinghai-Tibet Plateau, it is a critical transboundary river in South Asia, eventually emptying into the Bay of Bengal. Accordingly, downstream countries like India and Bangladesh have formally demanded that China safeguard their interests, raising concerns that massive upstream dam construction could worsen monsoon flooding, intensify dry-season droughts, threaten water and food security, and damage ecosystems. The dam project requires boring at least four 20-km tunnels through the 7,782-meter-high Namcha Barwa Mountain, which may alter the river’s flow, heightening risks of water shortages, flooding, and landslides in India and Bangladesh.
Similar issues have already emerged on the Mekong River, which originates in Tibet and flows through Yunnan Province into Southeast Asia. Over the past decade, China has built numerous dams on the Mekong’s upper reaches, and neighboring countries like Thailand, Myanmar, and Laos have suffered from water shortages. Dam construction has also triggered nutrient depletion, obstructed fish migration, and led to vegetation loss downstream, disrupting the entire ecosystem. Fishermen in countries relying on the Yarlung Tsangpo River for their livelihoods are expected to suffer comparable consequences.
Above all, neighboring countries fear China may weaponize water by building multiple dams on the upper Yarlung Tsangpo. Although China claims it will coordinate with neighbors, there is no mechanism to enforce such cooperation, inevitably escalating tensions. India, which has long clashed with China, continues to protest vehemently against the dam project. The Indian Ministry of External Affairs previously warned it would “closely monitor the situation and take necessary steps to protect our interests” after China approved the project.
Some observers even speculate that the long-standing border dispute, temporarily defused late last year, could re-emerge. China and India fought a war over border issues in 1962, and in June 2020, a bloody skirmish broke out in the Galwan Valley in western Himalayas. Moreover, the two nations are currently engaged in another diplomatic standoff over the successor to the Dalai Lama, who has taken refuge in India. Given this already fraught relationship, the dam construction could become the catalyst for a deeper rift.
Ukraine’s drones pierced Moscow’s illusion of safety. Russia now faces mounting costs just to defend its cities. Zelenskyy’s “simple drone army” may have won Ukraine more than just airspace; it won support.
KYIV — The impact of a Ukrainian drone strike that temporarily closed Moscow’s Vnukovo Airport is reverberating far beyond the airspace over the Russian capital. What initially appeared to be a symbolic disruption has, in the space of a few days, evolved into a geopolitical accelerant, altering perceptions of Ukraine’s tactical capabilities, escalating Russia's operational costs, and influencing the calculus of foreign military aid.
The drone strike, confirmed by both Ukrainian and Russian sources, resulted in the closure of air traffic in and out of one of Russia’s busiest airports. While the Russian Ministry of Defense labeled it a minor provocation, the consequences were far more revealing. It demonstrated that Ukraine, despite its strained resources, retains the ability to strike the Russian heartland with precision and coordination.
The fact that Vnukovo Airport had to temporarily suspend flights, forcing reroutes and civilian panic, exposed vulnerabilities that President Putin has worked hard to shield from public view. In contrast to prior isolated strikes or sabotage acts, this drone incursion was part of a coordinated effort also targeting Odesa, a Ukrainian port city that Russian forces have repeatedly shelled.
But whereas Ukraine absorbed yet another attack on its southern coast, the psychological and operational blow in Moscow was visibly deeper. For a regime built on the perception of domestic control and invulnerability, the symbolism of a compromised capital, even if for just a few hours, is costly. Russia has now been forced to intensify security protocols across multiple urban and industrial targets, stretching its already complex wartime logistics.
For President Volodymyr Zelenskyy, the attack carried strategic weight beyond military metrics. In a speech weeks prior, he vowed to take the war to Russia’s decision-making centers. While analysts questioned whether such a plan could materialize without Western-supplied long-range missiles, Ukraine’s drone program, cobbled together through local ingenuity and modest international help, has now delivered proof.
Unlike the conventional militaries of NATO states, Ukraine’s wartime R&D has been defined by urgency, improvisation, and decentralization. Drones repurposed from commercial technology, adapted with local targeting systems and launched under conditions of extreme secrecy, have formed the backbone of Kyiv’s evolving strategy.
These are not the high-flying Reapers or Bayraktars that dominated early-war headlines. Instead, Ukraine’s latest wave of drones represents a shift toward scale and simplicity, an army of small, often disposable UAVs capable of slipping past radar, sowing disruption, and broadcasting a single, powerful message: Russia cannot shield itself completely.
This democratization of offensive power may prove as disruptive as any battlefield victory. With minimal cost and limited exposure to human casualties, Ukraine has found a pressure point. As the Kremlin redirects more resources to internal air defenses, it risks weakening frontline units or exposing critical economic infrastructure to new threats.
The drone attack’s ripple effects were not confined to Eastern Europe. In Washington, where the debate over Ukraine aid continues to polarize political factions, the strike gave new urgency to calls for expanded support. Just days after the incident, U.S. President Donald Trump confirmed plans to deliver a multi-billion-dollar arms package, including up to 17 additional Patriot missile systems and potentially long-range Tomahawk missiles.
The timing was more than coincidental. While official briefings avoided linking the drone strike with Trump’s decision, behind closed doors, U.S. defense officials acknowledged that Ukraine’s demonstration of offensive reach helped tip the internal debate. Kyiv had not only survived but was shaping the battlefield, and doing so independently of NATO’s more cumbersome systems.
Ukrainian defense officials have welcomed the announcement with guarded optimism. While Patriots would immediately boost air defense capabilities around urban centers and energy infrastructure, integrating more advanced long-range systems will require upgrades to Ukraine’s existing platforms and legal adjustments related to export regulations. Nonetheless, Kyiv views the move as a strategic endorsement: the U.S. is not merely helping Ukraine endure; it is now assisting Ukraine in its efforts to win.
For Russia, the attack has introduced a new layer of war fatigue. The physical damage to Moscow’s infrastructure may be minimal. Still, the psychological toll and the prospect of repeated, targeted drone incursions raise the long-term cost of the conflict: more personnel, more anti-air defenses, more economic disruption.
Maintaining a protective shield over cities like Moscow and Saint Petersburg, as well as key military-industrial sites, will come at a high price. These are costs Russia had managed to avoid for most of the war by containing combat within Ukraine’s borders. No longer. Now, with each successful Ukrainian incursion, the pressure on Putin’s regime mounts, not just to retaliate, but to justify the war’s ongoing cost to an increasingly wary population.
And that, perhaps, is Ukraine’s most potent weapon: not destruction, but disruption. The ability to force Russia into defensive postures, to stretch its command structure thin, and to pierce the illusion of homeland security.
As NATO allies assess the evolving shape of the conflict, the drone strike underscores an important truth: the war is not static, and neither is Ukraine’s capacity to adapt. Zelenskyy’s “simple drone army” has reset the expectations of what asymmetric warfare can achieve in a 21st-century conflict.
The international community must now contend with new questions: Will these attacks accelerate peace negotiations or provoke harsher retaliation? Will expanded Western support embolden Ukraine to push deeper into Russian-held territory? And will Moscow's newfound vulnerability change the trajectory of the war, or entrench it further?
Whatever the answers, one thing is clear: Ukraine’s tactical ingenuity, on full display in the skies above Moscow, has reshaped the strategic landscape. And for a Kremlin that once believed distance equaled safety, that may be the most dangerous realization yet.
Rising debt and yields are tying the Bank of Japan’s hands. Inflation is climbing, but policy tools are running out. Without serious reform, Japan’s economic stability is at risk.
Japan’s deepening fiscal woes and rising bond yields are limiting the Bank of Japan’s ability to raise interest rates. Inflation is up, but policy options are narrowing. Without reform, economic stability remains at risk.
TOKYO — The fallout from Japan’s recent Upper House election signals more than a shift in the political wind; it is the latest marker of a government caught in deepening economic quicksand. As the ruling Liberal Democratic Party and Komeito coalition lose their grip on legislative control, markets are beginning to reprice not just political risk, but also the fundamental question of Japan’s fiscal credibility.
For years, Japan’s public debt has been the elephant in the room: vast, looming, yet ignored mainly due to the domestic ownership of government bonds and the Bank of Japan’s long-standing ultra-loose monetary policy. But recent events have begun to pierce that veil of complacency. Prime Minister Shigeru Ishiba’s alarmist warnings about the fiscal position being “worse than Greece” may have once been dismissed as campaign rhetoric, an electoral tactic to counter opposition calls for temporary consumption-tax relief. Still, now they are beginning to sound like a premature confession.
As the election dust settles and the coalition faces legislative gridlock, Japan's ability to enact needed fiscal reforms is now in serious doubt. Investors, who were once content with paltry returns on Japanese Government Bonds (JGBs), are now facing a potential storm. The political paralysis raises red flags about any credible path toward fiscal consolidation. Without the ability to rein in spending or increase revenues through unpopular measures, such as tax hikes, the deficit is poised to deepen.
It is in this context that Ishiba's campaign warnings are gaining new significance. While critics derided his comparisons to the Greek debt crisis as exaggerated, the market's muted reaction may not last for long. The deterioration of government balance sheets is becoming harder to ignore. Fitch Ratings recently flagged Japan’s fiscal policy as the primary risk to its sovereign credit rating, underscoring that even a nation with the world's third-largest economy is not immune to the consequences of unchecked debt growth.
Moreover, the government's reluctance to consider corporate tax increases, even as it resists calls for easing the consumption tax, signals a broader unwillingness to redistribute fiscal burdens. What was once labelled prudent policy restraint now appears increasingly like political stasis. The situation is exacerbated by a rapidly aging population and stagnant productivity, leaving few levers to pull without incurring economic or political backlash.
The international financial community is taking notice. While the domestic ownership of JGBs has historically shielded Japan from the volatility seen in countries like Greece or Italy, globalization and interconnected capital markets mean no country is truly insulated. The fear is not that Japan will default, but that the rising cost of servicing its debt could trigger a broader loss of confidence. That concern alone is enough to push bond yields upward—a development that is already underway.
JGB yields have begun to creep higher in recent months, with the 10-year benchmark now hovering well above the 1 percent mark for the first time in years. The move, while moderate by global standards, represents a sea change for a nation that has lived in a world of near-zero rates for decades. As yields rise, so too does the burden on government finances, creating a vicious cycle that could further undermine fiscal stability.
Compounding the issue is the Bank of Japan’s precarious position. For years, the BoJ has served as both buyer and backstop for the government's borrowing spree, keeping interest rates low through aggressive bond purchases and yield curve control. But the monetary authority now finds itself in a tightening vise: it must balance the need to manage inflation and wage growth with the imperative of maintaining financial stability.
Japan is finally experiencing inflation consistently above the 2 percent target, with wages rising at their fastest pace in over three decades. Consumer demand is showing signs of recovery, and inflation expectations are rising among households. On paper, this should be the perfect time for the BoJ to normalize policy. But the reality is more complicated.
Any move to raise interest rates could exacerbate the upward pressure on bond yields, increasing the government’s debt servicing costs and potentially triggering financial instability. The BoJ has already signaled its caution, keeping its policy rate at a modest 0.5 percent and slowing the reduction of its bond purchase program. It appears increasingly constrained, not by macroeconomic fundamentals, but by the very fiscal imbalances the Ishiba administration has failed to resolve.
This hesitation in monetary policy reflects a broader anxiety: Japan’s so-called normalization may be built on shaky ground. Despite positive indicators, structural weaknesses remain. Household demand is still fragile, and export-driven growth remains vulnerable to global trade disruptions. The moment the BoJ signals a clear shift away from accommodative policy, it risks pulling the rug from under a nascent recovery.
Investors understand this paradox all too well. The rise in JGB yields is not just a response to inflation; it is also a pricing-in of risk, a recognition that Japan’s fiscal trajectory may be unsustainable without significant reform. The BoJ’s limited room to maneuver is part of that calculus. Markets are asking whether the central bank can truly normalize without triggering a fiscal crisis, and the answer, increasingly, appears to be no.
Thus, Japan finds itself caught between a rock and a hard place. The government’s fiscal hands are tied by political gridlock and demographic decline, while the BoJ is constrained by the very debt dynamics it once helped to enable. Both pillars of economic policy, fiscal and monetary, are now leaning on each other for support, and neither appears strong enough to stand alone.
If Japan is to navigate this treacherous terrain, it will need more than central bank finesse or electoral slogans. Structural reforms, credible fiscal consolidation plans, and a willingness to engage in honest public discourse about the nation’s economic future are essential. Without them, the current path leads not to normalization, but to a new normal of fragile stability and growing risk.
Ultimately, what began as an election centered on taxes and inflation has revealed the deeper fault lines within Japan’s economy. The international financial community is watching closely. If bond yields continue to climb and the BoJ remains cornered, the next crisis in Japan may not come with a crash, but with a long, slow erosion of confidence—and that could be even more difficult to reverse.
This article is based on ideas originally published by VoxEU – Centre for Economic Policy Research (CEPR) and has been independently rewritten and extended by The Economy editorial team. While inspired by the original analysis, the content presented here reflects a broader interpretation and additional commentary. The views expressed do not necessarily represent those of VoxEU or CEPR.
