The reasons for this were two-fold. There was a rise in commodity prices due to both the recovery of the global economy from the COVID-19 pandemic, and the supply shock stemming from Russia’s invasion of Ukraine. The other reason was the depreciation of the yen that resulted from the United States and Europe pursuing monetary tightening policies while Japan maintained a loose monetary policy.

The worsening terms of trade have affected Japan’s national income. This loss of income was equivalent to 4.6 per cent of real gross national income (GNI). Since the contribution of real GDP growth to the real GNI growth rate during this period was 8.8 per cent, more than half of the contribution made by real GDP growth was undermined by trading loss.

At the same time, part of the trading loss was offset by the increase in net income received from abroad. The rise in interest rates abroad and the depreciation of the yen helped to push up real GNI by 3 per cent during the period.

But the burden of trading loss has weighed heavily on the Japanese economy, whose recovery from the COVID-19 pandemic has been slow compared to other economies. In particular, private consumption has been greatly discouraged by the rise in inflation, which saw the headline consumer price index (CPI) peak at 4.3 per cent in January 2023. The level of private consumption achieved in the first quarter of 2020 did not recover until the first quarter of 2023.

Business investment has also remained low due to uncertainty surrounding future growth prospects. As a result of weak domestic demand, the core CPI, which excludes food and energy, stayed below 2 per cent during the period. As 2 per cent is the Bank of Japan’s CPI target, it was unable to change its monetary policy position even when the economy faced a headline inflation rate that exceeded four per cent.

Instead, the government took control of fiscal policy to alleviate the impact of the rise in commodity prices, especially energy prices. Subsidies were provided to wholesale oil companies from January 2022 and to electricity and city-gas companies from January 2023 so that they could cap their retail prices. While the policies to counter price increases could have been more targeted and consistent with efforts to reduce energy consumption and greenhouse gas emissions, price cap policies were chosen as emergency measures.

To deal with the depreciation of the yen, the government also intervened in the foreign exchange market to support the yen. The interventions that took place in late 2022 were the first interventions to support the yen since June 1998.

While these costly actions were taken to shield Japan from external shocks, it was not until commodity prices finally peaked in the third quarter of 2022 that the terms of trade gradually started to improve. Accumulated trade gains from then up until the second quarter of 2023 amounted to 1.7 per cent of real GNI as of the third quarter of 2022. This also led the headline CPI inflation rate to slow down to 3.2 per cent in August 2023.

The short-term situation seems to have improved, but a few concerns remain. Anticipation that Japan’s monetary policy will continue to diverge from that of other economies caused the yen to start depreciating again in May 2023, which has offset some of the positive impact of the fall in commodity prices.

If the world economy regains its growth momentum, or if some external shock occurs, trends in the commodities market can easily be reversed and prices could rise again. The Japanese economy — which is greatly dependent on trade and vulnerable to changes in the global economy — will be easily affected by these developments. The long overdue work of reforming Japan’s economy to strengthen its resilience is yet to happen.

Jun Saito is Senior Research Fellow at the Japan Center for Economic Research.