The Bank of Japan officially adopted a 2 percent inflation target in January 2013 and has subsequently adopted an unconventional monetary easing policy (including large-scale asset purchases, a negative interest rate and yield curve control). As such tools have been in place for a long time, their effectiveness has increasingly become unclear. While they have helped lower long-term yields, depreciate exchange rates, and led to an appreciation of financial assets and real estate, their impact on inflation and inflation expectations have not been so successful.
Japan’s recent inflation, excluding all food and energy, remains around 0.1 percent. Adverse impacts of unconventional tools — such as market price distortion, declined banking sector profitability, adverse impacts on pension and insurance industries, quasi-fiscal policy, inequality — are increasingly becoming apparent.
Over the past five years, moreover, the BOJ has found it difficult to convince the public that inflation has to be raised by achieving the 2 percent target. Japan’s experience suggests that there is asymmetry between raising inflation to achieve the 2 percent inflation target and lowering inflation to achieve the 2 percent inflation target.
This is because nominal wage growth does not necessarily catch up with inflation since wage negotiations are often backward looking or based on past inflation. Indeed, higher inflation since 2013 — driven by oil prices and/or higher food prices caused by the yen’s depreciation and bad weather — resulted in a further decline of the real wage level despite a modest increase in the nominal wage level.
Achieving 2 percent inflation seems difficult in Japan since there is little public support for the target to begin with. This arises from the fact that households always perceive that prices of goods and services to have been high and expect they will be high — not only positive but well above actual consumer price index-based inflation.
This suggests that households retain an inflation mindset rather than the deflation mindset often claimed by the BOJ. (Indeed, the behavior of postponing consumption in anticipation of a price decline has also never been observed.) This reflects the fact that wages have been declining since the early 2000s and are hardly expected to rise in the future.
Another factor is that the elderly aged 65 and older already account for a third of the population and many of them are concerned about their retirement life due to insufficient pensions and financial assets. While some take irregular jobs to supplement their pensions, the low wages they receive have not allayed their concerns.
This is why households’ spending has been very sensitive to the prices of daily goods and services to an extent that firms find it very difficult to raise their prices steadily. A recent example is this year’s January-March quarter, when the contribution of consumption to real GDP growth turned negative due to higher food prices caused by bad weather.
What should the BOJ do? Some propose nominal wage targeting may be more effective to achieve the 2 percent inflation target since it is directly associated with workers’ income and thus may stimulate consumer spending.
However, wages are determined differently between regular and irregular workers and the latter already accounts for a third of total employment. Firms may feel uncomfortable to commit to such wage hikes due to the practical difficulty of implementing them given the complex wage settling structure as well as a high degree of uncertainty about the economy (due to the declining population and tougher competition).
Due to the nation’s severe labor shortage, the wage differences between regular and irregular workers are likely to shrink and wage growth may start to pick up more forcefully in the future. It may, however, take years to realize this since companies need time to change their business customs and find ways to improve their productivity to pay for higher wages.
There is a widespread view in Japan that the BOJ should lower its price stability target to around 1 percent or even abandon the target altogether. As very few believe that inflation will reach 2 percent stably in the foreseeable future, the central bank may eventually find that discussion of the appropriateness of the inflation target is inevitable.
As a first step, the BOJ could consider the adoption of the 1 percent upper and lower range (±1 percent) into the 2 percent target. The BOJ would then not need to abandon the target and lose credibility while the public may consider the 1 percent inflation to be acceptable. The flexibility also enables the BOJ to take steps toward normalization of monetary policy.
Sayuri Shirai is a professor of economics at Keio University and a former board member of the Bank of Japan. She is the author of “Mission Incomplete: Reflating Japan’s Economy.”