Fukui's mission impossible: some now argue the Bank of Japan--with a would-be reformer at the helm--is the answer to Japan's economic malaise. Actually, the Central Bank is still part of the problem.

• Author: Nakamae, Tadashi
• Position: Japan

The gist of my last article for The International Economy was as follows: The capital investment bubble of the late 1980s created a glut of supply capacity in the Japanese economy. Protected by ultra-low interest rates, this excess of supply capacity has remained at around 30 percent since the bubble burst. Balance can be restored to the Japanese economy only through market-driven reduction of supply capacity. To this end, interest rates must rise substantially. But this will not happen until the decline of Japan's current account surplus, combined with capital flight from the household sector, triggers a significant depreciation of the yen.

This still represents in a nutshell my view of the Japan problem. I wrote last time of the tragic futility of attempts to solve the problem by boosting demand. In fact, government attempts to boost demand through fiscal expansion, and the Bank of Japan's attempts to boost demand through low interest rates, have not been merely futile; they have been decidedly counterproductive, because they have prevented the market from addressing the issue of supply-side reform.

Like central banks the world over, the BOJ is not given to radical new initiatives. Rather, it responds to events in predictable ways. In particular, the BOJ has shown itself capable of vigorous reaction to three stimuli, namely: (1) weakening of the economy; (2) decline of the stock market; and (3) perceived threat to the banking system. And successive reappearance of these stimuli has consistently elicited the same response from the BO J: lowering of the interest rate. Thus, as a result of the BOJ's plodding reactivity since the bursting of the capital investment bubble, the interest rate has seen a truly drastic decline, from 8 percent in the early 1990s to its current rate of zero percent.

Given that the BOJ has lowered the interest rate in order to revive economic growth, support the stock market, and help the banking system, let us consider whether lower interest rates have in fact brought benefit in each of these areas.

Lowering of the interest rate is the normal reaction of a central bank to a cyclical downturn in the economy. But even reducing the interest rate to zero has not caused Japan's economy to recover. Why not? Because Japan's ills are not cyclical; they are structural.

On the supply side, lower interest rates have made it possible for inefficient corporations to survive on meagre rates of return on capital. This has been the biggest obstacle to the structural...