Japan at a Crossroads in Its 25-Year Struggle Against Deflation

By Leika Kihara

TOKYO – Japan may be reaching a critical juncture in its 25-year struggle against deflation, as indications of rising prices and wages become more widespread, according to the government. This signals growing confidence that the economy is close to overcoming a prolonged period of stagnation.

This optimistic outlook aligns with the perspective of the Bank of Japan (BOJ), which has noted changes in how corporations set prices and wages. Such shifts may set the stage for a gradual reduction of the extensive fiscal and monetary support that the country has relied upon.

The government stated in its annual economic white paper, "Japan has seen price and wage increases broaden since the spring of 2022. These developments suggest the economy is reaching a turning point in its long battle with deflation." Furthermore, they emphasized that "we shouldn’t overlook the possibility that an opportunity to exit deflation might be emerging," especially as inflation rises and public concerns about persistent price declines ease.

However, the report did not claim that the risk of deflation has been completely eliminated, highlighting a "still moderate pace" of price increases in the services sector. It pointed out that service prices are critical in understanding inflation trends since they more accurately reflect domestic demand and wage conditions compared to goods prices. In the previous year’s report, the government noted that inflation remained modest except for certain food and energy items.

The shift in the government’s tone regarding deflation risks highlights changing priorities, driven by rising commodity prices and a tighter job market, which contribute to increased inflation and growing public anxiety over living costs.

Japan’s core inflation reached a four-decade high of 4.2% in January and consistently stayed above the BOJ’s 2% target for 16 months through July, with many companies passing on higher raw material costs to consumers. This year, businesses have offered their highest wage increases in three decades, reinforcing arguments for a shift away from years of ultra-loose monetary policies.

Despite these developments, the government has refrained from officially declaring an end to deflation, stating that this requires not only underlying price increases but also clear evidence that the nation will not revert to periods of price declines.

The report stressed the need to eradicate the persistent deflationary mindset affecting households and businesses, urging closer collaboration between the government and the BOJ to achieve sustained wage growth.

Since declaring Japan to be in a state of deflation in 2001, the government has prioritized ending price declines. This focus has resulted in substantial fiscal spending aimed at supporting the economy, maintaining pressure on the central bank to uphold its ultra-loose monetary policy.