Japan's inflation situation has always been different from that of the US and Europe.
From 1998 to 2012, Japan experienced a prolonged deflation that lasted for 15 years.
In 2013, the Bank of Japan decided to introduce a 2% inflation target and introduced the so-called Quantitative and Qualitative Monetary Easing (QQE) policy in the same year to achieve this inflation target as soon as possible.
Subsequently, the Bank of Japan strengthened QQE through various means, and in the following decade (2013-2023), Japan completely overcame deflation, but inflation has been fluctuating around 1%, with almost no increase in wage levels.
After the outbreak of the Russia-Ukraine conflict in 2022, the situation changed dramatically.
With the skyrocketing of commodity prices and the depreciation of the yen, Japan's consumer inflation (CPI) rose by about 3% year-on-year in 2023.
Subsequently, Japan's wage levels began to rise, and the average wage increase offered by Japanese companies in 2024 reached 5.10%, the largest increase in nearly 33 years, boosted by factors such as rising consumer prices and record-high corporate profits.
At present, Japan's job market is very tight, with the unemployment rate falling in June to 2.6%.
Against this backdrop, as there is hope to achieve the 2% inflation target sustainably and stably, the Bank of Japan has no need to continue implementing extremely expansionary monetary policy.
Therefore, in March of this year, the Bank of Japan initiated the normalization process of monetary policy, raising the benchmark interest rate from -0.1% to the 0%-0.1% range.
This adjustment is very small, indicating that the Bank of Japan is very cautious about gradually raising the policy interest rate in the coming years.
In July of this year, the Bank of Japan raised the policy interest rate from 0%-0.1% to 0.25%, also very cautiously.
Looking to the future, I believe that the Bank of Japan will continue to gradually advance the normalization process, cautiously raising the policy interest rate until it reaches the neutral interest rate level.
The level of the natural interest rate is difficult to determine, and my intuition is that Japan's actual natural interest rate may be around 0 or slightly below 0, which means that the Bank of Japan is trying to gradually approach the nominal neutral interest rate level, which may be in the range of 1%-2%, significantly lower than 2%, around 1.5% or even lower.
The Bank of Japan is groping to try to reach the neutral interest rate level, but it is not yet clear (what the specific number is).
They will continue to gradually raise the policy interest rate until the economic growth rate stabilizes above 1%, inflation stabilizes at about 2%, and the financial market remains stable, only then can they know the levels of the nominal neutral interest rate and the actual natural interest rate.
The lessons learned from Japan's experience in overcoming deflation, as mentioned earlier, from 1998 to 2012, Japanese prices continued to fall.
It can be affirmed that this 15-year deflation was relatively mild, as prices only fell by an average of 0.3% per year; however, the deflation lasted for 15 years, with 11 years of negative price growth, so Japan experienced a mild but prolonged deflation.
In 2013, after the Bank of Japan introduced the QQE policy, deflation was finally overcome, but the inflation rate continued to stay around 1%, with almost no increase in wages.
The stagnation of wage growth is the most difficult part to solve.
Even if deflation is mild, if it lasts for a long time, it may affect the wage determination process, or it may cause businesses and unions to form such a mindset: even if the economy grows, wage levels cannot be raised.
And this is the reality in Japan, not only during the deflation period but also between 2013 and 2023.
Therefore, the most important thing is the wage determination process.
Japan's experience shows that the wage determination process may be frozen by the memory of 15 years of deflation, leading to wages never rising even though prices have risen.
In fact, during the 15 years of deflation, Japanese wages fell by an average of 0.9% per year, close to 1%.
If the wage determination process had not become so rigid, then some mild deflation or low inflation might be acceptable; but if mild deflation or low inflation lasts for a long time and causes the wage determination process to become rigid or almost frozen, then the central bank had better take measures to avoid long-term deflation, even mild deflation is not acceptable.
