For the past 25 years, Japan’s central bank and government have found common cause in trying to end deflationary pressures that have been seen as a drag on economic growth. Now that they are succeeding, the verdict is in: People don’t like it.
For the past 25 years, Japan’s central bank and government have found common cause in trying to end deflationary pressures that have been seen as a drag on economic growth. Now that they are succeeding, the verdict is in: People don’t like it.
Under standard economic theory, high levels of deficit spending coupled with ultra-low interest rates should almost inevitably lead to higher rates of inflation—usually a problematic outcome for most economies. But Japan has become the poster child for the risks of the opposite problem, persistent price and wage deflation.
Former U.S. Federal Reserve Chairman Ben Bernanke was a strong advocate of action by the Bank of Japan (BOJ). “Addressing the deflation problem would bring substantial real and psychological benefits to the Japanese economy, and ending deflation would make solving the other problems that Japan faces only that much easier,” he said in an address to the Japan Society of Monetary Economics in May 2003, when he was still just a member of the Fed board. At stake, he said, was not just the economic health of Japan “but also, to a significant degree, the prosperity of the rest of the world.” His worries of a similar deflationary trap in the United States were one of the reasons he would later propose as Fed chairman the massive quantitative easing, or QE, program following the 2007-08 global financial crisis.
To achieve this, the BOJ first tried ultra-low interest rates and, when that failed, zero interest rates and finally negative interest rates. In addition, there were various programs to encourage lending, including special funding to banks that lend to smaller companies with growth potential and to banks that increased their lending by a certain amount. The lending initiatives ran into two primary obstacles: Japanese banks only want to lend money to companies that don’t need it (big companies in Japan sit on massive cash holdings), and with such low rates, the cost of initiating and servicing the loans outweighed the profits in terms of interest payments.
The ultimate plan to defeat all this came from the affable Haruhiko Kuroda, appointed in 2013 by newly elected Prime Minister Shinzo Abe as the head of the BOJ. Kuroda, a former Finance Ministry official who was therefore an outsider within the central bank, threw caution to the wind. He would, he promised, create 2 percent inflation in two years by doubling the BOJ’s balance sheet.
Moving beyond the Fed’s QE, Japan would have QQE, adding in the idea of qualitative to quantitative easing, meaning that the bank would not buy just government bonds but also riskier assets. The result was indeed a massive expansion in the balance sheet, in effect monetizing the government’s steady diet of fiscal overspending equal to around 30 percent of the total budget each year. Even though the balance sheet more than quadrupled over Kuroda’s 10-year term, the idea of a “virtuous cycle” of higher wages driving higher prices remained elusive for almost all of his tenure, with the consumer price index stuck around zero.
This was to change but not because of any central bank policy. Instead, it was due mainly to the world’s recent No. 1 game-changer: COVID-19. With higher import costs and supply chain disruptions, higher prices, albeit at a modest level by global standards, became visible in virtually every sector of the economy. By January 2023, the consumer price index jumped to 4 percent, the highest level since 1981 and well over the 2 percent target set by the BOJ. Within this, hotel prices have surged, rising 63 percent as foreign tourists again pack central Tokyo and Kyoto. For Japanese shoppers, much of the impact has been in the form of “shrinkflation” as food producers try to hide the higher costs. A bag of coffee in central Tokyo can still be found for around $4—it’s just that the same package now holds 40 percent less coffee. No wonder major food packaging companies saw their earnings jump 33 percent last year.
As a result, stagnant wages finally have started to show signs of movement as a shrinking workforce, good economic growth, and skills shortages have bid up salaries. Wages in October 2023 were up 1.5 percent year-on-year, and union workers logged average increases of 3.6 percent in their spring round of labor negotiations.
So why isn’t everyone happy? The reality is that the two growth lines have resulted in a steady decline in real wages adjusted for inflation. According to government figures, real wages fell for 20 consecutive months up to November 2023, registering a 3 percent decline year-on-year.
“People are not stupid,” said Jesper Koll, a global ambassador for the Monex Group and one of Japan’s best-known economists. “The 30 years of deflation have come to an end, but are the Japanese people getting the kind of inflation they want?”
Indeed, while deflation has had policymakers gnashing their teeth as Japan became relatively poorer (some tech jobs pay better in Vietnam than in Japan today), it was good for salaried workers who saw their pay rise modestly while prices would fall around 1 percent annually. The new scenario is more complex. As workers in any inflationary economy can attest, wages almost always rise more slowly than retail prices. One BOJ official in the pre-Kuroda days in 2012 said privately that their surveys showed people preferred deflation even as the central bank was trying to stamp it out.
The sticker shock of rising prices has been an unwanted blow to Prime Minister Fumio Kishida, who is facing a crisis in confidence for no clear reason—except that people don’t seem to like his administration. Kishida and U.S. President Joe Biden could no doubt commiserate on that front.
Last fall, when the government’s approval ratings fell below the “danger zone” of 30 percent—the figure that often heralds a party search for a fresh face as prime minister—Kishida started handing out cash that the government didn’t have, offering subsidies to limit the impact of higher prices in energy and utilities. Even this backfired badly, raising allegations that he was trying to buy his way back to popularity.
“What people are frustrated with is that he increases spending all the time but has no program to pay for it. The Japanese people are rational with their money—they don’t go out on spending sprees,” Koll said.
Kishida, who took office in October 2021, now has support of just above 20 percent by most polls, with two-thirds of respondents saying they disapprove of his administration. This would normally make him ripe for removal by the party elders who effectively control the ruling Liberal Democratic Party (LDP). That has been the model ever since the party was founded in 1955 and helped the LDP to remain in power for all but six years since then.
But Kishida may well survive for a while. The latest in a string of scandals also involves other senior figures in the LDP over potentially illegal fundraising, which has had the effect of shrinking the pool of potential successors. There is also no clear replacement for Kishida who would satisfy both the more liberal and hawkish wings of the party, part of the reason he got the job in the first place.
Another open question is whether Kishida—or a successor—will get to actually see an end to the 25 years of deflationary pressures. The latest inflation figures show a softening in price increases, with core inflation (without fresh food prices) rising just 2.5 percent in November 2023, its lowest in 16 months. That may be good news for consumers, but it has some economists skeptical over whether the economy has really turned the corner toward self-sustaining wage-price increases or if the new figures point to a consumer slowdown that would lead to a downturn. The focus will be on this spring’s union wage negotiations, where both the workers and the government are hopeful that increases will finally put workers ahead of inflation, at least for now. The companies that would have to pay for this have shown less enthusiasm.
But some economists remain skeptical. “I would venture that the wage hike to come during next spring’s negotiations won’t quite reach the level expected,” Takahide Kiuchi, an economist at the Nomura Research Institute and a former BOJ board member, wrote in a November report. He said this may prompt the BOJ to hold off on any changes to its negative rates. Japan remains the only country to maintain ultra-low rates as other advanced economies have switched to tighter money policies as inflation surged.
At the same time, Kiuchi noted, delaying for too long means the bank’s balance sheet will continue to grow as it buys bonds to keep yields at zero or below. This will increase the risks to its own financial position if interest rates rise in the future, since the massive holdings would plummet in value. With the balance sheet now larger than Japan’s annual GDP, the implications could be severe, a polite way of saying that it would face insolvency. If that happened, the government would be forced to bail it out. But the government is already using the BOJ to pay for its own financial excesses.
It’s all enough to leave the average Japanese yearning for the good old days of deflation.
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