After nearly three decades of what may be described as “chronic deflation,” Japan finally entered an inflationary phase in the spring of 2022. Prices and wages, which had remained virtually unchanged since the mid-1990s, began to rise. This year marks the fifth year of that transition. While the shift is historically significant, the more important question is whether Japan can complete the move toward a genuinely normal economic environment.

At first glance, this shift might appear to be the long-awaited success of Japan’s deflation-fighting policies. In reality, however, Japan’s exit from deflation did not unfold as policymakers had originally envisioned. Inflation was largely imported from abroad and only later interacted with domestic forces, including wage increases. Even so, Japan has undeniably moved closer to what former Prime Minister Fumio Kishida has called a “virtuous cycle of wages and prices.”

In a normal economy, prices rise moderately at around 2 percent, wages increase in line with prices, and the central bank’s policy interest rate settles at roughly the same level. In my view, Japan has been steadily moving toward this configuration since 2022, and the normalization process is likely to continue this year. The critical question, however, is whether Japan can complete this transition.

To assess how firmly inflation has taken hold, my colleagues and I examined detailed microdata. Using purchase history data from approximately 60,000 households, we calculated household-level inflation rates and measured the share of households experiencing inflation above the Bank of Japan’s 2 percent target. We conducted a similar analysis for firms, using scanner data on prices of all products sold by approximately 6,000 companies that manufacture and sell consumer goods, including food and other daily necessities.

The results are striking. As of the end of last year, 56.0 percent of households and 63.7 percent of firms were experiencing inflation above 2 percent. Inflation above the central bank’s target is no longer confined to specific sectors or income groups; it has spread throughout Japan’s economy. In this sense, inflation is no longer a temporary or transitory phenomenon but an embedded feature of everyday economic behavior.

Expectations tell a similar story. According to surveys we conducted late last year, more than 30 percent of households expect inflation of approximately 5-10 percent, and a non-negligible share anticipate inflation of 10-20 percent. Firms’ expectations are broadly aligned, with many also expecting inflation of roughly 5-10 percent to persist. This marks a sharp break from the era of chronic deflation, when households and businesses widely assumed that prices would remain flat indefinitely.

Yet the entrenchment of inflation has not translated into broad public approval. While large firms with pricing power have often maintained or even expanded profit margins, many small and medium-sized enterprises -- especially subcontractors unable to pass on higher costs -- are under severe pressure. For households, particularly those with lower incomes, inflation has meant a steady erosion of purchasing power.

Unsurprisingly, policymakers have responded by trying to suppress inflation directly. The supplementary budget enacted at the end of last year included price controls on energy, including electricity, gas, and gasoline. In the ongoing House of Representatives election, both the ruling and opposition parties have proposed temporary or permanent reductions in the consumption tax, particularly on food items, making inflation a central political issue.

These measures reflect a shared political diagnosis: Inflation is the problem. But that diagnosis is misguided. Returning Japan to the zero-inflation environment of chronic deflation would be neither feasible nor desirable. The true problem facing the Japanese economy today is not inflation per se but the persistent failure of wages to keep pace with rising prices.

International comparisons make this point clear. In a survey conducted last December among consumers in five advanced economies, including Japan, respondents were asked about both their price expectations and their expectations for their own wages, allowing us to infer expectations of future real wages.

In the United Kingdom, for example, 13 percent of respondents expect their real wages to rise, while 36 percent expect them to remain unchanged. Together, nearly half of workers hold an optimistic view of their real wage prospects. By contrast, 51 percent expect real wages to decline, resulting in a roughly even balance between optimism and pessimism. The United States, Canada, and Germany show similar patterns.

Japan, however, stands out sharply. Only 4 percent of respondents expect their real wages to rise, and even when combined with the 17 percent who expect them to remain unchanged, the total is just 21 percent. By contrast, a striking 78 percent expect their real wages to decline. This level of pessimism is exceptional and cannot be explained by current wage conditions alone. It reflects deeply entrenched expectations shaped by decades of wage stagnation.

To be sure, nominal wage growth has improved. Since the 2023 spring wage negotiations, known as Shunto, wage increases have been relatively strong by Japan’s historical standards. Nevertheless, most workers do not expect these gains to continue. Without confidence in sustained real wage growth, Japan’s inflationary transition risks remaining incomplete.

How, then, can this situation be improved? A review by the “Future-Oriented Shunto” Evaluation Committee of the Japanese Trade Union Confederation (Rengo), of which I was a member, concluded that labor unions must fundamentally rethink how they formulate wage demands. The committee put forward four recommendations.

First, wage increase targets should be based on expected future inflation rather than past outcomes. Traditionally, Shunto negotiations have referenced inflation in the most recent fiscal year. While this backward-looking approach posed few problems during the deflationary era, since inflation began accelerating in 2022, it has contributed to wage increases that lag behind prices. As a result, real wages have declined by up to 6 percent since 2022. In an inflationary environment, wage setting must be forward-looking. Using the Bank of Japan’s 2 percent inflation target as an explicit benchmark could help anchor negotiations.

Second, wage agreements should include a real-wage catch-up clause. Even well-informed inflation forecasts can be wrong. When unexpected inflation erodes real wages, there must be a pre-agreed mechanism for workers to recover those losses in subsequent negotiations. Without such a mechanism, uncertainty about future purchasing power will continue to undermine confidence.

Third, labor shortages should be explicitly reflected in wage targets. Japan faces a severe labor shortage, with labor demand exceeding supply. Under these conditions, real wages should　rise until equilibrium is restored. Estimates indicate that Japan’s “natural real wage” -- the level consistent with labor-market balance -- is at least 3 percent higher than the current level. Ignoring this gap only delays adjustment and prolongs economic strain.

Finally, workers’ medium- to long-term wage expectations must be stabilized through proactive communication. People plan their lives over years, not months. Clear, credible information about the future trajectory of wages is essential to restoring confidence and improving overall well-being. Labor unions, employers, and the government all have a role to play in shaping these expectations.

Japan’s experience offers a broader lesson. Escaping deflation is not merely about raising prices. Without a credible, sustained path to real wage growth, inflation may fuel social and political tensions rather than drive economic revival.

Tsutomu Watanabe

Tsutomu Watanabe is the founder and scientific advisor at Nowcast Inc. and professor emeritus of economics at the University of Tokyo. The views expressed here are the writer’s own. — Ed.