Editorial: Japan's 2% inflation calls expansionary fiscal policy into question

The Bank of Japan has recently reported that the country's underlying inflation rate, which does not account for temporary fluctuations, has reached its 2% target after 13 years of effort following its establishment in 2013. This marks a significant milestone as the Japanese economy transitions from a prolonged period of deflation.

The inflation target was initially set by the second administration of former Prime Minister Shinzo Abe, who aimed for a quick exit from deflation. The Bank of Japan implemented extensive monetary easing measures, such as large-scale government bond purchases and a negative interest rate policy, but struggled to reach the target for years.

Recently, concerns have arisen regarding the declaration of an achievement in inflation at this point. The invasion of Ukraine by Russia in 2022 led to an increase in resource prices, and these high prices have persisted, putting pressure on household budgets. The situation worsened following the invasion, and the Bank of Japan ceased its unprecedented easing in the spring of 2024.

Its subsequent rate hikes were also slow due to concerns about cooling the economy too much and causing a return to deflation. However, since this summer, global inflationary pressures have grown, primarily driven by high crude oil prices due to unrest in the Middle East, as well as the depreciation of the yen, which has exacerbated the issue.

In Japan, price increases have become more pronounced. The central challenge now is to maintain inflation around the 2% target. To achieve this, the Bank of Japan must continue raising interest rates to curb price increases. Moving forward, Japan's economic recovery will also depend on the decisions made by the Japanese government.

Prime Minister Sanae Takaichi's administration, which faced criticism from U.S. President Donald Trump over the weak yen, has been less inclined to intervene in the Bank of Japan's monetary policy. However, restraint alone is not sufficient. The administration should reconsider its expansionary fiscal policy, including consumption tax cuts and gasoline subsidies, as they may counteract the effects of interest rate hikes and exacerbate inflation.

Now that the 2% inflation target has been achieved, the government should formally announce an exit from the deflationary era. The Takaichi administration might have avoided doing so, fearing that such a declaration would diminish the rationale for the expansionary fiscal policy that has become a cornerstone of its agenda. Nonetheless, for Japan to break the cycle of inflation and the weakening of the yen, the government and the Bank of Japan must coordinate their understanding of prices and adopt a suitable combination of fiscal and monetary policies.