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The Future of Japanese Economics

December 23, 2025
Sarah Kumar

Japan’s economy is going through a historic transformation as it emerges from three decades of deflation and stagnation. The economy is projected to grow 0.8 to 1 percent in 2025, and continue to grow 0.4 to 0. 6 percent in 2026, driven by sustained wage gains, strong business investments and high performance in goods exports and tourism. This marks a significant shift for an economy that has struggled with near-zero growth since the asset bubble collapse of the early 1990s.

The most impactful change has been the Bank of Japan’s monetary policy shift. The Bank of Japan (BOJ) raised benchmark rates by 25 basis points to 0.75 percent, their highest level since 1995, marking the end of an era of ultra-low interest rates. The BOJ only began raising it in 2024, the first hike in 17 years, after inflation stabilized above its target of about 2%. This marks a shift from the bank’s long-standing stimulus policies designed to combat deflation.

The causes of this policy shift are multifaceted. The Japanese yen has weakened against the US dollar and many other major currencies, so Japanese consumers and companies pay more now for imported food, fuel and other items. This weak yen has driven import costs higher, fueling inflation that has remained above the central bank’s 2% target. CPI inflation is estimated to average 2.2 percent in 2025, creating pressure on the BOJ to continue raising rates.

Another critical part has been wage growth, which is enabling what economists call a “virtuous cycle.” Wage growth reached the highest level in 33 years in 2024, providing workers with increased purchasing power. The outcome of the ongoing annual wage negotiations for FY2025, with a 3.8% base pay increase as of 2nd May, is stronger than last year. These wage gains are essential for sustaining domestic consumption and supporting the transition away from deflation.

However, challenges remain for consumers. Inflation has risen faster than wages, squeezing household budgets and raising costs for businesses. This has created a tough balancing act for policymakers, who need to support economic growth while managing the cost of living.

Not only that but Japan faces a significant structural challenge with its public finances. At the end of March 2025, the general gross debt of the Japanese Government was 1,324 trillion yen, which is 234.9% of the country’s gross domestic product, and is one of the highest among developed nations. This massive debt load creates vulnerability as interest rates rise.

The combination of an aging population and a decline in overall population has resulted in a shrinking workforce, a key factor in Japan’s prolonged economic stagnation. Due to a decreasing tax base and rising social security costs, this demographic issue worsens economic strains. The government has to maintain a balance between providing fiscal sustainability for future generations and promoting economic recovery through stimulation measures.