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[Article] Hysteresis and Sluggish Growth in Wages and Prices: The Case Study of Japan

Article contributed to the 30th Villa Mondragone International Economic Seminar "Yearning for Inclusive Growth and Development, Good Jobs and Sustainability"

Makoto Sakurai
Member of the Policy Board
June 25, 2018

Abstract

Despite the recent strong economic recovery, growth in wages and prices has been sluggish across the globe. Japan has come to face this issue ahead of any others. The policy authorities of each economy could learn something from the case study of Japan. This article will examine some factors that have restrained growth in wages and prices in Japan, and discuss the desired policy responses to address this issue.

In relation to the theme of this session - inequality, wages, and growth - factors responsible for this curb on growth in wages and prices can be divided primarily into two categories. One is "hysteresis" brought about by past serious economic downturns. Serious economic downturns have left persistent damage to the supply side of the economy through various channels, including an increase in the number of "discouraged workers" and "involuntary non-regular employees," a slowdown in (human) capital accumulation, and the inefficient business processes that took root under excessive competition. This damage has created the slack that is easing the upward pressure on prices that has come from an expansion in demand. Besides this hysteresis, the second category includes factors of a more structural nature that reduce upward pressure on wages amid an increase in labor demand. These factors include: an increase in labor participation of women and the elderly, whose wages are relatively low; firms' and households' anxiety for the future; and technological innovation in the IT industry, such as robotic process automation (RPA) and artificial intelligence (AI).

If the supply-demand conditions continue to tighten, the factors in the former category will eventually mitigate with hysteresis reversing. Moreover, the reversal of hysteresis is a desirable change, in that it can enrich people's lives. To bring this about, the Bank is expected to continue to maintain the adequate level of tightening of supply-demand conditions, thereby supporting the reversal of hysteresis. Given that it could take some time to reverse hysteresis, the Bank needs to conduct monetary policy while closely monitoring the economic and financial conditions so that no severe distortion will be created under the prolonged accommodative financial condition. Meanwhile, factors in the latter category need to be addressed in a more structural way. Monetary policy and structural policy must nonetheless address the issue interactively, since these factors are somewhat related to each other.

This article consists of three sections. Sections I and II are assessments of the factors responsible for sluggish growth in wages and prices, jointly written by Makoto Sakurai and Masahiko Kataoka. Section III is a personal assessment by Makoto Sakurai of the current situation and what policy responses should be made.