Inflation continues to soar on a global scale. According to the World Economic Outlook by the IMF (International Monetary Fund) (July 2022), the global CPI inflation rate rose from a 3.2% year-on-year increase in 2020 to a 4.7% year-on-year increase in 2021, and in 2022 it’s forecasted to rise sharply to an 8.3% increase over last year. While Japan’s current CPI inflation rate is relatively low compared to the rates in Western nations at just over 2% year-on-year, with wage inflation at a standstill, these price increases could potentially end up doing serious damage to consumer spending. Will the world ultimately enter a new inflation era, or maybe even a period of “stagflation” beset by both economic downturns and skyrocketing prices?

Rising prices are becoming a major problem for Japan too

In Japan’s consumer price statistics compiled for June, the core CPI (composite index excluding fresh food) was up 2.2% over the same month the year prior, which was slightly higher than the 2.1% rise seen in May. This figure has surpassed the Bank of Japan’s 2.0% inflation target for three months in a row. In terms of the future outlook for the year-on-year change in the core CPI, based on what’s happening with the current yen-to-dollar rate and crude oil prices, it’s expected to rise by slightly less than 3.0% as of the end of this year, but if the yen continues to weaken and crude oil prices keep on rising going forward, this rise will exceed 3.0% within the year.
The core CPI excluding food (non-perishables) and energy—which are heavily influenced by overseas conditions— is up 1.0% from a year ago. This is arguably low relative to the rise in consumer prices in the US in June, which was +9.1% year-on-year, or up 5.9% for the core index excluding food and energy. Nevertheless, compared to the annual rise in US hourly wages of around 5%, in Japan wage increases appear to be trending at just around 0.5%. The failure of wage increases to keep pace with rising prices is thus also happening in Japan, and high prices could potentially deal a major blow to consumer spending.
As long as consumers believe that the soaring prices of food and energy (which are heavily affected by conditions abroad) will be temporary, consumer spending won’t be too badly shaken, but if more people start to believe that these rising prices will go on for a long while, or that the depreciation of the yen will continue to send the prices of all imported goods upward for some time, then it’s possible that consumer behavior will go on the defensive. The Japanese economy is currently facing just such a serious risk.

Monetary policy also has a role to play in combatting high prices

Calls within the government ruling party have been mounting to draw up a supplementary budget this fall in order to combat the huge price increases we’re seeing. As I’ve repeatedly remarked before, I think it’s important not only to provide benefits and other aid for a wide range of individuals, but also to offer intensive pinpointed support that’s focused specifically on low-income earners and micro-scale enterprises which are heavily impacted by skyrocketing prices. The impact on Japanese households from these ongoing price increases is not uniform. In the food and energy-related sectors where rising prices are currently most conspicuous, daily necessities are being most heavily affected, with these making up a greater proportion of people’s overall spending the lower their income levels are. From this perspective, soaring prices are dealing a severe blow to low-income earners especially.
It's also hoped that the government will take aggressive measures to raise labor productivity and the potential growth rate by enhancing its growth policies. Consequently, if more individuals come to expect that wages will begin to rise going forward, the hit from rising prices on consumer spending will be lessened. That would help to structurally enhance Japan’s economic resilience against rising prices.
Furthermore, preventing fears over protracted steep price increases from growing is also important from the standpoint of maintaining economic stability. That’s surely an area where monetary policy ought to play a role. I hope to see the Bank of Japan redouble its commitment to stabilizing prices, at some future point by normalizing its monetary policy as a whole, but for the time being by enacting more flexible policy measures that would allow long-term interest rates to rise to some extent. If that can ease people’s concerns over just how long the unfortunate depreciation of the yen and rising prices will continue under the government’s rigid monetary policy, then it could very well contribute to stabilizing the Japanese economy.

Soaring prices stemming from both COVID-19 and the war in Ukraine

While more than a few people may be under the impression that these steep price increases kicked off with Russia’s invasion of Ukraine this past February, prices started to rise about a year earlier than that. That is conceivably because of the effects of the COVID-19 pandemic. The fact is that the soaring prices we’re seeing now were brought about by both COVID-19 and the war in Ukraine.
The ways in which COVID-19 affected prices are rather complicated, but I think the most influential one among them was probably how it led consumer behavior to change on an individual level. To reduce the risk of spreading infection, people cut back on their spending on services involving contact with others, like eating out and taking trips, while also spending more on goods like furniture, household electronics, automobiles, and homes. The increased demand for these goods led their prices to climb, and this led to more raw materials and electric power invested to increase production, which in turn pushed up raw material and energy prices. The rise in prices is playing a role by encouraging us to transition to a new industrial structure for the post-COVID world.
However, once this transition in productive resources to these newly in-demand fields runs its course, these steep price rises can be expected to calm down. From this perspective, I believe the rise in prices caused by COVID-19 won’t last very long.

Will sacrificing the economy bring back price stability?

Meanwhile, the sharp rise in energy and food-related prices following the Russian invasion of Ukraine—which in some sense have been triggered by the sanctions placed on Russia by advanced nations—is the typical sort of cost-push inflation rooted in supply-side factors. Once these supply constraints are eliminated, these soaring prices can be expected to calm down relatively rapidly. However, the sanctions against Russia are in fact expected to be protracted, and with foreign energy-related companies pulling out of the country, Russian energy production is projected to follow a downward trend going forward. For that reason, it seems that increasing the supply would offer little chance of bringing these steep price rises to an end.
On the other hand, it’s also conceivable that if there’s a demand-side change, that is, if the global economy slows down and we see energy and food-related demand weaken, then these steeply rising prices could abate. To respond to these historic price surges, the FRB (US Federal Reserve Board) has been pursuing a drastic monetary tightening policy since this March. The FRB has taken a strong stance prioritizing the recovery of price stability over the economy. This policy stance has also spread to other countries, and recently even in the Eurozone, which is facing severe energy shortages and fiscal problems in Southern Europe, the ECB (European Central Bank) decided in July to enact a wide-ranging hike in policy interest rates that exceeded any forecasts.
Foreign exchange rates also have something to do with how the US’ dramatic monetary tightening stance has spilled over to other nations. I believe many countries other than Japan would like to somehow avoid weakening their own currencies which would only encourage prices to go higher. In such a situation, if the US enacts a dramatic monetary tightening, the dollar will continue to appreciate, and other countries will be compelled to weaken their currencies in relation to it. In order to avoid that scenario, many countries are now locked in competition, flocking to tighten their own monetary supplies drastically, raising the value of their currencies, and putting pricing pressures on other countries. This competitive currency roundup and interest rate hiking has never been experienced before, and it could very well deal a major blow to the world economy. When the IMF announced its latest World Economic Outlook, it warned that “the world may soon be teetering on the edge of a global recession”.
As we head into next year, I think we’ll likely see countries paying the price of an economic recession in order to bring energy and food-related prices down, thereby allowing the world to gain back its price stability. If that happens, we can prevent the historic high prices we’re seeing now from becoming entrenched, and the world will avoid entering a new era of inflation, or an era of stagflation where economic downturns and soaring prices go hand in hand.