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Japan sees new phase in long struggle against deflation

Indicators show improvement, but pay raises needed to prevent backslide

Prime Minister Shinzo Abe, far left, has fought to keep Japan from returning to deflation.

TOKYO -- Japan has entered a new phase in defeating deflation, the Cabinet Office said Thursday, but weak inflation points to the continued need to stoke wage growth  -- a challenge around which Prime Minster Shinzo Abe is trying to rally cash-rich companies.

All four of the indicators the Abe government uses to measure progress away from the "D-word" read positive for the July-September quarter, the Cabinet Office reported at a meeting of the the Council on Economic and Fiscal Policy. It marked the first such alignment in 25 years.

The consumer price index and the GDP deflator, which measure broad movements in prices, both improved over the year-earlier quarter. So did unit labor costs, which reflect wage trends. The GDP gap pointed to a wider surplus of aggregate demand.

Feeling richer yet?

The Cabinet Office identified wage growth as an area where further progress is needed. Japanese businesses remain cautious about raising base pay, despite record profits. Labor's share of earnings at major corporations is at a roughly 46-year low, according to Ministry of Finance data. Abe urged corporate leaders in October to raise pay 3% next spring in order to help spur a virtuous cycle of consumption.

Moreover, businesses are pessimistic about the future amid headwinds like a shrinking population. A Cabinet Office survey in January showed listed companies forecasting a real economic growth rate of just 1% a year over the next five years -- one of the lowest views on record.

Boosting the economy's growth potential through investment in human resources is also key in fighting deflation. the Cabinet Office reckons. Abe's government has pushed for a shift toward pay based on results rather than hours worked, which could help raise individual earnings power, as could importing more foreign talent.

Many economists predict the current economic expansion will last beyond January 2019 to become Japan's longest in postwar history, but the question remains whether an environment conducive to faster wage growth can be created while the momentum away from deflation lasts.

History of deflation

Japan's government first diagnosed the country as suffering from deflation in the postwar era in March 2001. This followed a period of contraction in the economy brought about by shocks like the the bursting of the asset-price bubble in the early 1990s, the 1997 Asian financial crisis and a consumption tax hike.

The Bank of Japan embarked on quantitative easing, a policy of increasing the money supply to stimulate inflation. A global economic recovery helped ease downward pressure on prices, but the 2008 financial crisis and the ensuing worldwide drop in demand plunged Japan back into deflation.

In April 2013, the BOJ, under current Gov. Haruhiko Kuroda, massively scaled up its easing program, helping weaken a strong yen. This, coupled with fiscal stimulus by the Abe government, has supported a long economic recovery. By the end of 2016, the deflationary output gap had been filled. Meanwhile, a labor shortage has brought more seniors and women into the work force, contributing to a modest increase in household incomes that has help nudged prices toward a normal level.


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