New inflation ends decades of deflation in Japan

The head of the Central Bank of Japan is a very patient person. When Haruhiko Kuroda became governor of the Bank of Japan (BOJ) nine years ago, he pledged to rid the world’s third-largest economy of the deflationary pressures that had helped slow growth since 1990. His aim was to inject enough money to create a 2% inflation rate that would increase wages and purchasing power.

As commodity price inflation sounds the alarm globally, he finally seems ready to hit his target. While the latest data is highly volatile, economists predict that Japan will finally start to see an inflation rate of 2% – and possibly more – in the coming months.

So far, the numbers remain tame by global standards. While the US consumer price index rose 8.5% in March from a year earlier, the highest rate of increase since 1981, Japan’s index rose just 1 .2%. But that includes a 52.7% drop in mobile phone charges after a government crackdown on the three-company cartel that virtually controls the sector.

The head of the Central Bank of Japan is a very patient person. When Haruhiko Kuroda became governor of the Bank of Japan (BOJ) nine years ago, he pledged to rid the world’s third-largest economy of the deflationary pressures that had helped slow growth since 1990. His aim was to inject enough money to create a 2% inflation rate that would increase wages and purchasing power.

As commodity price inflation sounds the alarm globally, he finally seems ready to hit his target. While the latest data is highly volatile, economists predict that Japan will finally start to see an inflation rate of 2% – and possibly more – in the coming months.

So far, the numbers remain tame by global standards. While the US consumer price index rose 8.5% in March from a year earlier, the highest rate of increase since 1981, Japan’s index rose just 1 .2%. But that includes a 52.7% drop in mobile phone charges after a government crackdown on the three-company cartel that virtually controls the sector.

Other numbers were mind-boggling by Japanese standards. Energy costs jumped 20.8%, the biggest increase since 1981, while cooking oil rose 34.7%. Another measure of inflation at the wholesale level, the business goods price index jumped 9.5% year-on-year in March, in part due to the dire situation in Ukraine.

Overall, economists believe that after smoothing out the various one-off factors, core inflation is now around the 2% target. Yet no one seems to be celebrating. In the face of the June elections, the government is scrambling to formulate subsidy programs for those most affected, while the Japanese yen is falling sharply in value. Kuroda, however, seems indifferent, calling the higher costs a short-term problem that won’t distract him from his goal.

For Japan, the costs of more than two decades of deflation are clear. The country remains prosperous, safe and comfortable, but what many Japanese have failed to notice is that the rest of the world has gotten richer in absolute terms, while their country has largely stayed put. According to OECD data, average annual wages have increased by only 3% over the past 30 years, compared to 47% in the United States. Prices followed a similar trajectory. Tokyo was for many years ranked as the most expensive city in the world, but today Japan’s capital is not even among the top 10 in most global rankings, with cost reductions, gradual declines in tariffs and greater import substitution contributing to lower prices. .

To get out of there, the central bank has, over the past nine years, flooded the markets with liquidity, an unprecedented program that has made it the buyer of almost all new public debt. And since government tax revenues only cover 60% of expenditures in an average year, there is a lot of debt to be redeemed.

This creates two big problems. The Japanese government is the most indebted country in the world, with total debt equal to approximately 190% of annual economic output. This funding diverted from government largesse has meanwhile quadrupled the BOJ’s balance sheet as its own holdings grew to 92% of annual GDP in 2020, according to World Bank data, compared to 22% in the United States. and 18% in 2020. Germany.

With all of this, Japan now seems to have the wrong kind of inflation. The idea behind Kuroda’s goal was to create a so-called demand-driven virtuous cycle in which higher paid workers go out and spend more, driving up demand, leading to new investment and then higher wages.

Instead, higher costs from abroad will drive up prices and cause consumers to buy fewer goods, not more. The problem is particularly severe in resource-poor Japan, where almost all raw materials and commodities are imported. This includes more than 60% of all food consumed and about 95% of its energy, mostly from oil imports. With generally tame global commodity markets over the past decade, this hasn’t been a major issue so far, but wheat and natural gas are in the crosshairs of Russia’s invasion of Ukraine. , and the problems should get worse.

None of this is lost on a government seeking a stronger mandate in June’s elections for Japan’s upper house of parliament. While the ruling Liberal Democratic Party is unlikely to lose control, the level of support in the second chamber is often seen as an indicator of voter sentiment on how things are going. To help cushion the blow of rising prices, the government would introduce a sweeping $48 billion grant package to help consumers and small businesses. The aid ranges from additional gasoline subsidies to low-interest loans and cash assistance, according to Nikkei.

Meanwhile, Japanese Prime Minister Fumio Kishida is using soaring prices to help promote his “new form of capitalism” designed to distribute the wealth of big business and affluent retirees who have held up well in the last decade of Abenomics. under the former prime minister. Minister Shinzo Abe.

“To deal with rising prices, we will deploy all possible policy measures to protect people’s livelihoods by allowing companies to pass on costs and creating an environment for them to raise workers’ wages,” he said. Kishida said during a parliamentary session in March.

Skeptics such as Credit Suisse economist and former BOJ official Hiromichi Shirakawa say asking companies to raise wages even as other costs rise is quite a difficult task. Japanese consumers have traditionally reduced their purchases whenever prices rise. This has made retailers wary of raising prices in the past, leading to the concept of “shrinkflation”, where smaller quantities hide higher unit costs.

Worsening the outlook was a sudden drop in the value of the Japanese yen, which will make imported goods even more expensive. The yen is approaching 130 to the US dollar, down 10% since the start of the year. This will only deepen the economic gap that Kishida is trying to narrow. Large corporations with large overseas interests will reap significantly higher profits when they return their money home, while the average worker will end up paying more at the checkout.

“As people’s attention shifts to higher imported inflation and a weaker yen, it will be necessary to reassess and weigh the pros and cons of not only short-term economic stimulus, but also the negative effects term of the ultra-loose monetary policy lockdown,” said Ryutaro Kono, chief economist for Japan at BNP Paribas and a respected BOJ watcher.

In the longer term, the biggest threat to the BOJ is an inflationary cycle spiraling out of control. “If the public were to be convinced that the BOJ’s policy stance is exacerbating the fall of the yen and pushing prices higher, the bank could become the villain that increasingly weighs on households,” the economist said. head of Deutsche Bank Tokyo, Kentaro Koyama, in a recent report. But raising interest rates, the traditional way to fight rising prices, would not only dampen an already weak economy, it would also lead to massive losses on the BOJ’s government debt holdings.

But Kuroda is undeterred and the central bank has maintained its bond-buying program in recent weeks despite concerns over debt levels and a falling yen. His goal, he always insisted, is to get Japan out of the “deflationary mentality”. With price increases like these, it could well be on the way to success.

The question is whether these new worries, combined with an aging Japanese society, shrinking workforce and slowing growth, will create a long-term and potentially irreversible slowdown. While the outlook is problematic, Japan has defied skeptics several times in the past. “Japan is the hardest economy in the world to understand,” Willem Buiter, then Citigroup chief economist, said at a 2010 event. “If this were physics, then gravity wouldn’t work. not in Japan.”