For three decades after the collapse of its bubble, Japan was synonymous with low inflation and in some instances, outright deflation. Despite massive fiscal packages and repeated rounds of monetary easing, consumer prices remained stagnant. Between 1995 and 2020, headline CPI growth averaged just 0.3%, and core inflation was often negative.
Why, then, has inflation reappeared since 2021?
The first explanation is imported cost-push inflation. A combination of energy price shocks and a sharp depreciation of the yen raised the price of imports. Food, fuel, and raw material costs passed through to consumer prices, pushing CPI to above 4% in 2023, the highest in four decades. We should note here that the two spikes observed in CPI inflation in 1997 and 2014 were caused by a rise in the VAT which is a one off jump in prices.
This imported shock is visible when tracking the yen against commodity prices adjusted for the currency. Japan’s reliance on imported food and energy means that the exchange rate acts as a pass-through channel: a weaker yen and a rise in energy prices immediately raises the domestic cost of consumer goods. But here lies the key development: while the GSCI/NEER index has dropped sharply since 2023, CPI has not followed it lower. This tells us that inflation is no longer just about imported energy or a weak currency. Something else is anchoring prices at higher levels.
That “something” is structural labour scarcity. The Tankan survey shows firms consistently reporting tight employment conditions, which have historically tracked closely with wage settlements. With unemployment near multi-decade lows, labour shortages are now forcing companies to adapt by raising compensation and adjusting prices.
At the same time, corporate pricing behaviour has shifted. The Tankan non manufacturing output price survey shows more firms expecting to raise prices than at any time since the 1980s. When compared with CPI, the alignment is clear: corporate price expectations are now reinforcing actual inflation trends.
The policy environment reinforces this. Japan has been in fiscal dominance since 2011. This was followed no more than a year later by a policy of financial repression adopted by the BoJ, keeping nominal rates below inflation. This ensures that government debt remains financeable, but it also guarantees that real interest rates stay negative, which sustains inflation by discouraging saving and eroding debt in real terms.
So where does this leave Japan’s inflation outlook? The most likely scenario is that inflation remains above its historical norm, closer to 3% than to zero, as long as the yen stays weak, labour scarcity continues, and the BoJ maintains its repressive stance. In short, Japan has entered a new equilibrium: moderate inflation, negative real rates, continued yen depreciation, and financial repression as the anchor of monetary policy.
Regards,
Andre Chelhot, CFA
Editor
The Macro Anchor