Comment on “Understanding the Normalization of the Japanese Economy”

Abstract

Ito (2025) provides a comprehensive overview of the recent developments of Japan's economy, focusing on various aspects of the transition toward normalization. It is particularly useful for understanding the economic trajectory during 2022–2024, a period marked by significant macroeconomic changes. My comments relate to: exchange rates, price pass-through, and the role of policies; anchoring inflation expectations; and productivity.

Ito (2025) brilliantly describes the transition of the Japanese economy from a long-stagnating “triple zero” equilibrium with a zero inflation rate, zero expected inflation and zero nominal wage growth prior to 2022, to a new “2-2-3” equilibrium with 2% inflation, 2% expected inflation and 3% nominal wage growth. As Ito notes, the initial shift from the triple-zero equilibrium was driven by cost-push inflation, largely a consequence of the 2022 Russian invasion of Ukraine. I agree that cost-push inflation played a critical role, although government policies aimed at overcoming deflation also contributed significantly. Seizing the opportunity presented by cost-push inflation, the Japanese government has actively promoted raising wages above inflation, as noted by Ito (2025), and has encouraged effective price pass-through, which drastically changed firms' price-setting behavior.

A historical comparison can be drawn with the period of rising oil prices in 2007 and early 2008, when input prices for firms surged, yet output prices saw only marginal increases. However, the current situation is markedly different, as both input and output prices have risen due to more effective price pass-through, as shown in the Tankan survey (Figure S1). Many firms have changed their price-setting behavior, supported by government policies aimed at enhancing price pass-through, especially in transactions between large firms and small and medium enterprises (SMEs). For instance, the Fair Trade Commission and the SME Agency have adopted a “name and shame” approach, disclosing the names of large firms that resist price negotiations with SMEs.

This resulted in a higher pass-through of the exchange rate to domestic consumer prices (Cabinet Office 2024), and the large-scale yen depreciation from 110 to 160 per US dollar during 2022–2024 has had a significant impact on inflation.

This higher pass-through raises an important question: should monetary policy with an inflation target respond to currency deprecations or appreciations? This question is closely related to the trilemma of international finance. In the 2022 episode, we saw some Asian inflation-targeting central banks follow the Fed's rate hikes and raise their interest rates several times to avoid rapid currency depreciations. This helped them contain inflationary pressures from depreciations and reduce large deviations from their inflation targets. The yen depreciation since 2022 has left an important lesson for the future conduct of monetary policy.

Wage-setting has also evolved since 2022, as described by Ito (2025). Labor shortages, combined with policy measures such as tax incentives and annual increases in the minimum wage—faster than in the past—also contributed to accelerated wage growth in 2023–2025 and are worth noting.

This shift toward a new equilibrium was not an automatic process. Government policies also played an essential role in shaping this outcome.

Ito (2025) refers to inflation expectations as an important variable for the shift from the “triple zero” to the new “2-2-3” equilibrium. Here a question arises: whose inflation expectations are relevant in this context? There are several types of inflation expectations, including inflation expected by consumers, firms, and market participants. As economic theory suggests, consumer inflation expectations are key for understanding consumption patterns. For research focused on business activities, the inflation expectations of firms are relevant.

Recent data indicate a clear upward shift in inflation expectations among both households and firms, as shown in Data S1. Inflation expected by firms used to stubbornly hover around 1%, but since mid-2022, firms' inflation expectations have stabilized slightly above 2% (Figure S2). Household inflation expectations have also changed. The weighted average of inflation expected by households is 5.8% in May 2025, a significant increase from the level of the pre-COVID-19 period, for example, 1.5% in 2018 (Figure S3). These shifts are rooted in reality. Prices for approximately 80% of the items in the consumer basket are now higher than they were a year ago. Households are well aware of these changes, though their expectations may be somewhat inflated due to the frequently purchased goods.

Further challenges to the normalization of monetary policy include anchoring the inflation expectations of economic agents, particularly firms and households.

Ito (2025) thoughtfully touches upon several policy ideas for boosting productivity. However, I would argue that the shift to the “2-2-3” equilibrium offers the strongest impetus for change. Ito rightly highlights the perils of the “triple-zero” equilibrium. The lack of relative price changes over the past quarter century has contributed to inefficient resource allocation, leading to low overall productivity.

Sluggish investment in the past was also caused by the “triple-zero” equilibrium. Under pressure to keep prices unchanged, firms cut all costs, including R&D investment for future growth. This continuous cost-cutting behavior resulted in a failure to enhance productivity.

The core of Japan's growth normalization lies in restoring prices and the market mechanism, which will boost productivity.