Japan May Escape Deflation After 30 Years... Bank of Korea Sees Possibility of Escape Declaration in Second Half

Tokyo city center, Japan (archival photo)

There is a prospect that the Japanese government may declare an escape from deflation (a decline in prices amid economic stagnation) after the second half of this year. Japan has been striving to overcome deflation for the past 30 years, and the likelihood of this becoming a reality this year is increasing.

According to the report titled "Review of the Possibility of the Japanese Government Declaring an Escape from Deflation" by the Bank of Korea's Tokyo office on the 6th, the Japanese government is currently deliberating whether to declare an escape from deflation.

As Japan's inflation rate has continuously exceeded the Bank of Japan's 2% inflation target since April 2022 and is expected to stabilize around 2% in the future, interest in whether the government will declare an escape from deflation is growing locally.

In March, the Bank of Japan lifted its negative interest rate policy and implemented an interest rate hike for the first time in 17 years, citing the visibility of achieving its price stability target.

The recent inflation situation in Japan is evaluated as showing many positive movements, including the highest wage increases in 30 years, active price pass-through, the spread of inflation approaching levels seen in the 1980s, and rising inflation expectations.

Going forward, it is recognized as essential to establish a virtuous cycle structure between wages and prices through real wage increases that enhance household purchasing power, expanded labor cost pass-through in the service sector, and additional wage hikes.

Private research institutions also assess that, considering recent trends in price indicators, wages, and changes in price-setting patterns, the possibility of a deflation escape declaration is higher than ever.

The timing of the Japanese government's deflation escape declaration is generally expected to be after the second half of this year, when real wages are anticipated to turn positive.

However, various risk factors related to the deflation escape declaration have also been raised.

For a virtuous cycle between wages and prices to be established, an improvement in household purchasing power is essential, but currently, the real wage growth rate representing Japanese household purchasing power remains negative. Considering that the point at which the real wage growth rate turned positive in the past was 5 to 10 quarters after the peak of inflation, it is expected locally that this will occur after the second half of 2024.

Mitsubishi UFJ Financial Group (MUFG) diagnosed that the Japanese government's deflation escape declaration would signify the normalization of macroeconomic policies conducted under deflation, and with a shift in economic perception, side effects from the normalization of economic policies could emerge as issues.

If the joint statement between the government and the Bank of Japan, based on ultra-loose monetary policy and active fiscal policy, is discarded, the Bank of Japan will be able to operate more flexible monetary policies, and efforts to normalize government finances could become visible. However, the suspension of the Bank of Japan's government bond purchases and reduction of its asset size, along with the resulting rise in market interest rates, could increase the government's interest expenses, which is evaluated as a significant future burden on the Japanese economy.