RIETI Report October 7, 2022

Inflation and Fiscal Balance

Dear Readers,
Welcome to RIETI Report.
This bi-weekly newsletter will keep you updated with the recent columns, event information and research results by RIETI fellows and other leading economists in Japan and around the world.

In this edition, we present topics related to inflation and fiscal balance. The current global inflation apparently has aspects of both “cost-push inflation” and an “inflation spiral.” In fear of hyperinflation, governments around the world are trying to slow down economic activity via rapid monetary tightening. However, the situation in Japan is that its economy is experiencing cost-push inflation. Faculty Fellow Keiichiro Kobayashi says that inflation may work to improve the fiscal balance if it remains mild. He explains the importance of maintaining confidence in fiscal balance and need for a long-term path to fiscal consolidation.

We hope you will enjoy it. If you have any feedback, we would love to hear from you (news-info@rieti.go.jp).
Editors of RIETI Report (Facebook: @en.RIETI / Twitter: @RIETIenglish / URL: https://www.rieti.go.jp/en/)

This month's featured article

Inflation and Fiscal Balance

KOBAYASHI KeiichiroProgram Director and Faculty Fellow, RIETI

Global Inflation and Inflation in Japan

The current global inflation apparently has aspects of both “cost-push inflation,” which is attributable to supply-side factors such as the worldwide supply chain disruptions due to the COVID-19 crisis and constraints on resources and energy due to the Ukraine situation, and an “inflation spiral,” in which a wage upsurge caused by a labor shortage and general price increases mutually amplify each other. If such a self-perpetuating inflation spiral accelerates, eventually, the kind of hyperinflation that frequently strikes developing countries could be triggered due to the loss of public confidence in currencies. Therefore, governments around the world are trying to hold down the ongoing inflation by slowing down economic activity through rapid monetary tightening.

The situation in Japan is not an inflation spiral but the economy is in a cost-push inflation phase in which inflationary pressures are gaining additional momentum from the yen’s depreciation due to the widening of the interest rate differential vis-a-vis the United States and Europe.

Prospects for Inflation and Fiscal Balance in Japan

In Japan, the cost-push inflation has had a direct impact on such industries as food and energy as well as low-income families, whereas a demand shortage continues at the macroeconomic level. Therefore, it would not be appropriate at this moment to cool down demand through monetary tightening. The necessary course of action is to mitigate the adverse effects of the cost increase through subsidies for specific industries and redistribution for low-income families. In short, the government should implement targeted fiscal measures, and in that case, a temporary deterioration of the fiscal balance may be inevitable.

However, as will be explained below, inflation may work to improve the fiscal balance if it remains mild.

To read the full text:

Related article

“Business Investment and Wage Growth are the Keys to Overcoming Inflation and Fiscal Balance Deterioration”
NAKAJIMA Atsushi (Consulting Fellow, RIETI)

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