The Japanese Inflation Mystery: After Decades of Deflation, Tokyo Faces a New Economic Reality

A Tuesday afternoon stroll through a mid-range supermarket in Tokyo will reveal something that would have seemed nearly impossible ten years ago. The price stickers are evolving. Not dramatically, not all at once, but enough for regular customers to pause, double-check the numbers, and then discreetly put the merchandise back on the shelf. It’s a brief moment that would hardly stand out anywhere else in the world. It feels seismic in Japan.

Japan lived in an unpopular economic experiment for about thirty years. Wages hardly changed, prices remained unchanged, and a generation of consumers grew up believing that the cost of goods would be about the same the following year. For the majority of their adult lives, Japanese people under 40 have never truly experienced true inflation. Everything has been influenced by this psychological reality, including how businesses set wages, how families save money, and how much they charge for their goods. In Japan, deflation was more than just an economic issue. It developed into a sort of cultural reflex.

This is the result of a feedback loop whose dysfunction is almost elegant. Customers postpone purchases because they anticipate that prices will decrease or remain unchanged. Businesses maintain wages in order to preserve margins while observing a decline in demand. Employees with flat pay are frugal with their spending. Thus, prices remain unchanged once more. For twenty-five years, round and round. The average Japanese annual wage increased steadily until 1997, when it reached $38,395, and then virtually stopped, according to OECD data. The amount was $38,515 by 2020. Wage growth has been almost nonexistent for twenty years, almost to the dollar.

Then something changed. Inflation started to slowly but steadily increase in late 2021. A portion of the pressures came from outside sources, such as rising commodity prices worldwide, supply chains still entangled from the pandemic, and the consequences of Russia’s invasion of Ukraine driving up food and energy prices globally. Japan was not exempt. However, Japan has responded to these pressures in an intriguingly different way than the other G7 members. Japan was quietly sitting at about 3%, while the United States, Germany, and the United Kingdom reported inflation above 8%, 7%, and 10%, respectively. The difference is so great that it begs the question, “Is Japan’s situation a success story, or simply a different kind of problem?”

The Japanese government controls prices differently than the majority of Western economies, which contributes to the solution. Because utility companies typically lock in long-term supply contracts that protect them from short-term commodity spikes, gas and electricity regulations restrict how quickly these companies can pass costs on to consumers. Every six months, a government agency that oversees wheat imports sets resale prices. These are not the results of a free market. They are intentional structural decisions that soften the edges of inflation, which has a certain irony in a nation that has always been afraid of deflation.

Additionally, Japan recovered from the pandemic more slowly than its peers, which was more significant than first thought. Tokyo gradually eased restrictions, delaying the kind of demand spike that caused inflation in North America and Europe to spike. There’s a feeling that Japan’s prudence, which at the time frequently irritated both tourists and business executives, unintentionally acted as a buffer against inflation. On paper, it’s difficult to dispute the results, but it’s possible that the government didn’t fully anticipate that outcome.

However, something more structurally challenging is taking place beneath these protective layers. Even as inflation increases the cost of living, domestic demand in Japan is still low, and wages have not increased significantly. In Japan, over one-third of workers are employed on a contract or part-time basis. Historically, unions have placed a higher priority on job security than wage increases. Additionally, the population is declining—by about 300,000 in a recent year—due to an aging population that prefers to save money rather than spend it, particularly when interest rates are low. For six years, the Bank of Japan kept interest rates below zero. Theoretically, that ought to promote spending. In general, it didn’t.

At least rhetorically, former prime minister Fumio Kishida recognized the urgency. He promised pay increases for welfare workers, such as nurses and caregivers, and pushed companies whose profits had returned to pre-pandemic levels to raise wages by at least 3%. To be honest, it’s still unclear if those calls resulted in actual change. Policy announcements in Tokyo have a long history of encountering reality somewhere between the press conference and the paycheck, and Japan’s employment culture is extremely resistant to quick change.

Perhaps the most unexpected development is that an increasing number of Japanese businesses have begun to raise prices, which is a minor revolution in and of itself given decades of deflationary thinking. Nearly two-thirds of the nearly 1,900 businesses surveyed had either raised prices or planned to do so, a statistic that would have seemed nearly unimaginable five years ago. It’s more than a statistic. It implies that, somewhere within the inflexible machinery of Japan’s price expectations, something is truly loosening.

As this develops, it’s difficult to avoid the impression that Japan is experiencing one of those infrequent economic turning points where the established norms are disintegrating and no one is completely certain of what will happen next. The nation battled to avoid deflation for a generation. The general public’s response to the price increase has been more akin to discomfort than joy, which may not come as a surprise. There was more to the Japanese Inflation Mystery than just statistics. The story revolved around a society that had become so accustomed to a particular economic reality that the remedy felt nearly as bizarre as the illness.