Inflation and Fiscal Balance

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:
https://www.rieti.go.jp/en/columns/a01_0700.html

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