Japan wanted higher inflation. Now it’s here, and it hurts

TOKYO — As the rest of the world fought to keep inflation in check, one country welcomed it with open arms.

In the past few years, Japan saw a burst of inflation, spurred by pandemic supply chain snags and geopolitical shocks, as a way to shake the economy out of a decades-long cycle of weak growth and pressure from deflation. So while major central banks like the U.S. Federal Reserve raised interest rates to rein in prices, the Bank of Japan kept rates low as inflation accelerated.

The theory was that by sticking with rock-bottom rates, the central bank could harness the temporary spike in prices to foster the kind of inflation it had long sought: moderate, steady and supporting economic growth.

Businesses could cite their rising costs to justify price increases, leading to higher revenues that went toward higher wages for workers. With more money in their pockets, consumers could spend more, creating a positive economic cycle.

There have been some promising signs: Big Japanese firms like Toyota have reported large profits and pledged the biggest wage increases for workers in decades. In March, the Bank of Japan raised its policy rate for the first time in 17 years, concluding that the economy had achieved the “virtuous cycle” between wages and prices it had envisioned.

Ahead of a Bank of Japan meeting this week, there are a growing number of signs that everything is not going to plan.

The central bank’s commitment in recent years to keeping rates low has not only allowed inflation to run hotter. (It has been above policymakers’ 2% target for more than two years.) It has also prompted the yen to plunge, making imported food, fuel and other staples suddenly more expensive. Consumers have responded by cutting back sharply on spending.

Smaller businesses facing sluggish demand have found it hard to raise prices and salaries as the country’s policymakers had hoped. And it remains unclear whether the wage increases at big multinational companies are spilling over to Japan’s more domestically focused firms.

Some economists suggest that the weak consumption dragging on Japan’s economy is a response to the Bank of Japan’s low-rate stance, which has raised fears in consumers that inflation will continue to surpass wage increases for years to come. Analysts are roughly evenly split on whether Bank of Japan officials will raise rates or keep them steady Wednesday, when they are set to announce their decision.

“The BOJ hoped that temporary inflation could lead to long-lasting inflation by pushing up wages — giving inflation second legs. But I don’t see that’s the case,” said Takahide Kiuchi, executive economist at Nomura Research Institute and a former policy board member at Japan’s central bank.

He said “surprisingly weak” consumer spending and the falling yen “all have one root: mistakes of monetary policy made in Japan over several years.”

If the Bank of Japan had raised rates years earlier, Kiuchi said, “the yen would not have depreciated so much, consumer activity would have been more stable and the economy would likely be doing better.”

Recently, on a sweltering afternoon in northwestern Tokyo, Yumiko Umemura, a 49-year-old mother of two, stopped by a meat shop to buy a mix of ground beef and pork. Umemura said her grocery bills had gone up in recent years while her salary at a data-processing firm had remained the same — a squeeze on her family’s budget she expects to last for some time.

That has left her looking for ways to save, like buying 250 grams of meat instead of 300. “Shopping without excess, that’s how I’ve been cutting back,” she said.

Yoshimasa Yamamoto, the owner of the shop, said he was grappling with the combination of slowing sales and rising costs. Even locally sourced meat costs more, he said, because the feed for livestock is mostly imported.

Yamamoto said he would like to raise prices but feels he can’t because for decades his customers have known only stagnant prices.

“Customers are used to our prices, and if we raise them, they won’t buy,” he said. “People have already stopped buying as much anyway — how could we raise prices?”

These dynamics are starting to appear in Japan’s broader economy. Salaries, while ticking up, have failed to keep pace with prices, leading inflation-adjusted wages to fall for 26 consecutive months, through May. Consumer spending, adjusted for inflation, has fallen for four quarters in a row.

Japan’s economy has shrunk in two of the past three quarters, losing its spot as the world’s third largest to Germany’s. This month, Japan’s Cabinet Office cut its forecast for economic growth for the fiscal year through March 2025, to 0.9% from 1.3%, mostly because of a downgrade to consumer spending.

“Consumer demand is weak. The savings rate has fallen to zero. People are having to spend their income,” said Richard Katz, an economist and author of a recent book, “The Contest for Japan’s Economic Future.” “To presume companies will be able to pass on wages — the BOJ is seeing things through a prism that tells them what they want to see.”

One reason Japan has struggled to manage the effects of rising prices, some economists say, is that officials have had a hard time moving on from long-standing policies intended to encourage inflation when there was none. A reluctance to raise rates because it could dampen demand, they say, has given way to an acknowledgment that consumer spending is perhaps even more sensitive to fears of persistently high inflation.

The yen has recovered some of its value in recent weeks — partly because expectations for falling U.S. interest rates have made Japanese assets more attractive — but it remains far weaker than it was before the pandemic.

Hopes that the virtuous cycle of steadily rising inflation, wages and spending could still be in the cards are tied to the pay increases agreed during the spring labor negotiations known as the “shunto.”

The Bank of Japan’s March rate increase came just days after Japan’s largest federation of trade unions said negotiations between big Japanese companies and unionized employees had resulted in the biggest jump in pay in decades.

Shunto wage increases, which cover about 16% of the labor force, began in April and phased in through June, so economists are still monitoring their broader impact. The economic impact of last year’s shunto increases, also sizable, ended up being “a big disappointment,” Katz said.

“Signs point to this time being better,” he added. “But by how much? We don’t know yet.”

This article originally appeared in The New York Times.

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