The Bank of Japan's lifting of its zero-interest rate policy last week represents an end to an extraordinary policy that continued for five years and four months. With its decision, which marks a step toward normalization of the nation's monetary policy, the central bank has signaled that the Japanese economy has finally freed itself from the persistent effects of the burst of the economic bubble in the early 1990s, including a deflationary spiral. At the same time, the BOJ is taking an especially cautious approach in deciding future interest rates. This is welcome because the BOJ should strive to keep interest rates at a level that won't disrupt the economy.

The nine-member BOJ Policy Board, in a unanimous vote, increased the uncollateralized overnight call rate on short-term loans among banks from zero percent to 0.25 percent. The board voted 6-3 to raise the official discount rate, which the central bank charges ordinary banks for collateral-based borrowings, from 0.1 percent to 0.4 percent. This rate serves as the upper limit for short-term rates. To help prevent an increase in long-term interest rates, the BOJ will continue to buy national bonds worth 1.2 trillion yen every month on the market.

Behind the BOJ's decision was its assessment that the interest rate increases will not send the economy back into deflation as the Japanese economy continues to expand, and that continuation of the zero-interest rate policy would threaten to cause the economy to overheat. The BOJ thus defied opinion within the government that deflationary pressure remains and that the zero-interest rate policy should stay in place.