• Japan's labour market is undergoing changes due to a shrinking working-age population, causing firms to increase wages and service prices.
• The Bank of Japan's research shows that labour shortages are triggering changes in companies' wage-setting behaviour.
• Wage pressure is replacing raw material costs as the main driver of inflation, leading to a rise in service-sector prices.

The Bank of Japan is adjusting its policies in response to these changes, reflecting a broader global trend of central banks adapting to changing economic conditions.
Japan's labour market is witnessing significant structural changes due to a dwindling working-age population, according to research papers released by the Bank of Japan (BOJ). These changes are exerting pressure on firms to increase wages and service prices, supporting the central bank's argument for a steady rise in interest rates from near-zero levels.

The BOJ's research indicates that despite intensifying labour shortages since the mid-2010s, permanent workers' pay remained stagnant. This was largely due to the gap being filled by female and elderly workers taking on low-paid, part-time jobs. However, this trend is shifting as the pool of female and elderly workers dwindles, and the number of job hoppers rises.

An increase in pay for part-time jobs is also prompting firms to raise permanent workers' pay. The BOJ's research paper on Japan's labour market states, "Labour shortages are triggering changes in companies' wage-setting behaviour. Scope for additional labour supply is likely to gradually shrink, which is seen keeping upward pressure on wages."

Wage Pressure Replacing Raw Material Costs as Inflation Driver

This wage pressure is beginning to replace raw material costs as the main driver of inflation, according to another BOJ research paper on Japan's service-sector prices. The impact of these labour market changes is evident in various service sectors. Prices for services ranging from English lessons to tuition to massage have risen as labour costs continue to increase.

The BOJ notes, "With wage pressure heightening, companies' price-setting behaviour is changing and propping up service-sector prices, which had hovered around zero since the late 1990s". In response to these inflationary pressures, the BOJ ended negative interest rates in March and hiked short-term borrowing costs to 0.25% in July.

The central bank believes that a solid economic recovery will sustain inflation at its 2% target. BOJ Governor Kazuo Ueda has stated that the central bank will continue to raise interest rates if economic growth and inflation align with its projections.

Global Economic Trends and Lessons for Japan

These developments in Japan's labour market and monetary policy are reminiscent of similar situations in other economies. For instance, the eurozone experienced significant economic stagnation over 2023, although it proved more resilient than anticipated. High inflation and interest rates weighed on private consumption and corporate investment, and the construction sector cooled down noticeably. However, most service sectors performed better, and the economic outlook for 2024 looks sedate.

In contrast, India's economy outperformed numerous economies over the past year, with strong equity market performance, a robust foreign reserve cushion, and impressive growth dynamics. However, inflation remains a concern. Global headwinds have played to India's advantage, with geopolitical developments influencing trade relationships and disrupting supply chains. This has highlighted India's potential as an export hub and investment destination, particularly in the manufacturing and services sectors.

The BOJ's current stance on monetary policy and the structural changes in Japan's labour market reflect a broader global trend of central banks adjusting their policies in response to changing economic conditions. As Japan navigates these changes, the experiences of other economies may provide valuable insights and lessons.

In conclusion, the unique demographic challenges facing Japan, such as its rapidly ageing population and shrinking workforce, require tailored solutions that address the country's specific needs and circumstances. The BOJ's research and subsequent policy adjustments underscore the importance of adapting to these changes to ensure sustainable economic growth and stability.