BOJ’s ultra-loose monetary policy nears crossroads

An era of inflation has begun all over the world. The U.S. consumer price index jumped 8.5% in March from a year earlier, reaching a 40-year high.

Back in the latter half of the 1970s, when the United States entered a period of high inflation in the wake of the second oil crisis, then-Federal Reserve Chair Paul Volcker resolutely responded by sharply raising the policy rate — the federal funds rate. Despite criticism for causing stock market plunges and other economic woes, the U.S. central bank let the benchmark for most interest rates go up to an unprecedented high of 22%, successfully taming inflation.

This time around, the Fed has already begun pushing up the federal funds rate. Yet, the outlook remains uncertain with stock prices fluctuating disturbingly. Inflation, alongside unemployment rates, is one of the issues of greatest concern to the U.S. public. Coping with rising consumer prices is therefore a crucial challenge for the administration of President Joe Biden ahead of the midterm elections set for November.

In Europe, too, consumer prices have risen. French President Emmanuel Macron won re-election by defeating rival Marine Le Pen in the presidential election runoff on April 24. Household purchasing power was at the heart of the election. Gasoline prices in France soared 30% over the past year. As a result, wage increases have failed to catch up with consumer price surges, fueling discontent over household finances.

In April, inflation in Russia stood at 17.8% year-on-year, reflecting economic sanctions imposed by the international community in response to its invasion of Ukraine in February. In Russia, prices of used vehicles and smartphones, for example, were already up more than 30% from the corresponding month in 2021, while sugar prices were up 42% in Siberia. It is the Russian people who are being forced to pay the price for the reckless war.

Inflation has spread globally now that the prices of crude oil and other natural resources have risen sharply as the easing of the COVID-19 pandemic has allowed economic activities to resume across the world. This situation has been exacerbated by supply chain disruptions caused by the invasion of Ukraine. Ukraine is one of the world’s largest crop-producing countries, and its continued export problems have sharply driven up the prices of wheat while increasing upward pressure on the cost of other foods.

Japan is not necessarily immune to these global trends. Japan’s corporate goods price index, a measure of prices that companies charge each other for resources and materials, was up 10% in April from 12 months before, registering the fastest year-on-year rise in 41 years.

The prices of internationally traded resources are set in U.S. dollars. So, the weaker the yen is, the higher the yen-denominated prices. For example, the costs of commodities, including petroleum and coal products and construction steel, have risen sharply.

Unique expectations?

Of course, what matters most to us is the consumer price index, which measures changes in the prices of goods and services that we purchase for our everyday life. The prices of things around us, such as instant noodles, cooking oil and mayonnaise, have begun rising.

On May 20, the Internal Affairs and Communications Ministry said Japan’s core consumer price index, excluding fresh foods, for April was up 2.1% from a year earlier, exceeding the Bank of Japan’s price stability target of 2%. Global inflationary pressure is now affecting Japanese consumers as well.

Japanese inflation rates are much lower than in the United States and Europe. While moves to raise retail prices are gathering momentum to some extent, the increase in raw material prices has not been sufficiently transmitted to consumer prices yet. Why are businesses cautious about hiking retail prices?

Economists say that people in Japan, unlike other advanced countries, commonly take it for granted that “consumer prices do not change.” Against this backdrop, when one store raises prices, Japanese consumers regard it as an exception and are willing to take the time and effort to go to other stores. Store owners are fully aware of this tendency, so they have no choice but to be cautious about raising prices.

That said, this social norm that “consumer prices do not change” is not embedded in the DNA of the Japanese people. When the first oil crisis broke out in the early 1970s, Japan experienced “crazy inflation” with its consumer price index repeating year-on-year jumps of more than 20%, the worst among advanced countries.

So, why has the idea that prices do not change been commonly accepted in Japanese society of late? It’s common for people, regardless of which part of the world they live in, to want goods at the cheapest possible prices. The question here is: to what extent are people serious about looking for cheaper goods?

Time is money. Whether a consumer actually expends the time and effort to go to another store in search of cheaper goods depends on their financial well-being, and the truth is likely that the financial well-being of the average Japanese is now so low that rather than having a common belief that prices will not change, they have no choice but to look for goods that are as cheap as possible.

According to monthly labor statistics surveys compiled by the Health, Labor and Welfare Ministry, there has been almost no increase in workers’ average gross salary, including tax and social security premiums, in Japan for 30 years, since the collapse of the bubble economy. This phenomenon is not seen in any other advanced country. Consumers in Japan have no choice but to be more sensitive to prices than those in other advanced countries.

Businesses in Japan are fully aware of these circumstances, so they are cautious about raising retail prices. Japan is the only place in the world where you see corporate representatives apologetically lowering their heads when announcing price hikes.

Nevertheless, consumer prices also go up in Japan. The administration of Prime Minister Fumio Kishida is advocating “a new form of capitalism” to trigger “a virtuous cycle of growth and distribution.” Inflation would have a negative impact on both growth and distribution.

Burden on the vulnerable

Inflation refers to an across-the-board increase in the prices of goods and services. But, in reality, all prices don’t rise by the same margin. Inflation causes the elderly and economically vulnerable, such as families in poverty, to bear heavy burdens whenever and wherever they live.

How will inflation affect the Japanese economy? It should first be noted that the cause of Japan’s prolonged deflation — which has often been said to be peculiar to the country — is wage deflation. In this year’s shunto spring labor offensive wage negotiations, the country’s major corporations agreed to raise monthly wages by more than 2%. Given that regular employees of top businesses account for only a fraction of the labor force, the current inflation rate of about 2% means that there is a decrease in many workers’ real wages.

Household wealth includes certain assets that are vulnerable to inflation. Household financial assets in Japan stood at ¥2 quadrillion as of the end of 2021 — it was the first time that the total value had surpassed that threshold. However, cash and deposits, both of which would decline in value in the event of higher prices, account for 54% of the accumulation, compared to 13% in the United States. On the other hand, the combined share of equities and investment trust assets, both of which are known to be inflation-resistant, stood at a mere 15% in Japan, versus 51% in the United States,

With wages and household income barely increasing, consumption, which accounts for about 60% of the country’s gross domestic product, hardly grows. This phenomenon can be referred to as a chronic disease in Japan. Inflation reduces household purchasing power, pushes down consumption and nips economic growth in the bud. Although Japan’s inflation rate remains lower than other advanced countries, its economy is far less resilient to inflation.

Many countries in the world, including the United States, have begun applying measures to eradicate inflation. Monetary tightening along the standard central bank playbook runs the risk of a recession. An economic slowdown in the United States is most likely to adversely affect the world economy, while its multiple interest rate hikes will certainly spur rapid capital outflows from emerging market economies, raising the probability of debt issues.

The foreign exchange market weighs on interest rate differentials between Japan and abroad, keeping the yen weaker. The depreciation of the yen aggravates inflation further through higher import prices. Nonetheless, the Bank of Japan remains too stubborn to alter its policy of keeping interest rates at ultra-low levels. To what extent can ultra-low interest rates be effective in revitalizing the Japanese economy, which remains too anemic to help increase wages and lacks innovation?

The arrival of an era of inflation heralds a paradigm shift in the world economy. The Bank of Japan’s ultra-loose monetary policy is approaching a crossroads.

Hiroshi Yoshikawa

Hiroshi Yoshikawa is a professor emeritus at the University of Tokyo. He was the president of Rissho University from 2019 to March this year, and serves as the chair of the Cabinet Office’s study panel on diffusion indexes for business conditions.