博客

Amid growing optimism that China has turned the page on its 2025 deflation crisis, new analysis warns the foundations of this recovery remain fragile, drawing stark parallels to Japan’s 30-year battle with entrenched deflationary pressures that continues to hobble growth today.

Official data from May shows China’s consumer price index climbing 1.2% year-on-year, while producer prices surged 3.9% driven by rising input costs for energy, semiconductors and industrial metals. Many economists have pointed to this uptick as the clearest evidence yet that the deflationary era is ending, giving way to a period of controlled reflation. But experts warn that surface-level inflation readings do not address deep structural imbalances that have kept deflationary sentiment alive, just as they did in Japan starting in the 1990s.

Two critical structural reforms stand between Beijing and a durable end to weak price pressures, neither of which the Chinese government has pursued with urgent action. The first is resolving the ongoing deep-seated housing market crisis, which increasingly mirrors the bad-loan spiral that dragged down Japan’s economy starting in the 1990s. With roughly 70% of Chinese household wealth tied directly to real estate, stabilizing property markets across the country’s 70 largest cities is a non-negotiable prerequisite to reviving consumer spending and sustaining annual GDP growth between 4.5% and 5%, analysts note. The second priority is building a robust, nationwide social safety net that would allow China’s 1.4 billion citizens to feel secure enough to increase consumption instead of maintaining high precautionary savings.

Japan’s decades-long experience serves as a critical cautionary tale for Chinese policymakers. Even as the Bank of Japan (BOJ) prepares to raise its benchmark interest rate to 1% next week – the farthest it has moved from the zero lower bound in more than 30 years – deep deflationary undercurrents still persist across the Japanese economy.

On paper, Japan appears to have finally escaped its decades-long low-price trap: the BOJ projects full-year 2026 inflation will hit 2.8%, a reading that seems to confirm reflation is taking hold. But beneath the headline data, real wage growth remains negative, with earnings consistently lagging rising prices, and weakening domestic demand as a direct result. This has created a slow-burn stagflation dynamic, and Tokyo has still failed to implement the structural reforms needed to close the gap between rising living costs and stagnant household incomes.

“For the Japanese economy to fully break free from its long-standing deflationary mindset, it’s imperative for the government and the central bank to align, articulate their risk assessments, maintain honest and transparent dialogue with financial markets, and resolutely execute bold, long-term growth investments,” said Toshihiro Nagahama, chief economist at the Dai-ichi Life Research Institute.

Nagahama argues that today’s global economy is being shaped by an unusually dense web of overlapping shocks: the ongoing war in Ukraine, widespread volatility across the Middle East, and historic turning points in central bank monetary policy across major advanced economies. The connecting thread across these shifts is clear: geopolitical developments are now driving global economic outcomes, rather than the reverse. With the potential for expanded conflict in Iran creating major uncertainty, Nagahama warns that governments cannot anchor economic strategies to optimistic best-case scenarios. Instead, they must plan for worst-case risks, including the possibility of multi-year disruptions to shipping through the Strait of Hormuz, a critical energy chokepoint whose closure would reshape global energy trade flows and inflation dynamics for years to come.

“While these shifts present a formidable trial for Japan, they also represent a historic opportunity,” Nagahama notes. “As the country sheds its decades-long deflationary mindset and restores nominal growth, these external shocks serve as a critical test for fully escaping the paradigm of contracting equilibrium.”

Yet Japan may not get the sweeping policy rethink it needs to escape this trap. Prime Minister Sanae Takaichi’s economic framework still relies heavily on the ultralow interest rates and weak yen policy that Tokyo has leaned on for nearly 30 years. That is why next week’s widely expected rate hike to 1% has already sparked pushback from Japanese political leaders who prefer the comfort of decades-old monetary policy over painful structural reform.

The timing of the BOJ’s June 16 rate-setting meeting is awkward: it will proceed without Governor Kazuo Ueda, who has been hospitalized with a liver infection. Even so, Nomura economist Mari Iwashita notes that Ueda’s absence is unlikely to change the final outcome of the vote. Still, Takaichi’s administration has publicly pressured the BOJ to hold off on tightening. Last year, she even dismissed the idea of rate hikes as “stupid,” despite growing evidence that Japan’s 27-year experiment with near-zero interest rates has backfired. Her government is the 14th Japanese administration since the late 1990s to double down on a weak-yen strategy designed to boost exports and lift headline GDP.

Far from reviving entrepreneurial and business confidence across Japan, this approach has dulled risk-taking incentives. Decades of near-free money reduced the urgency for policymakers to boost national competitiveness and for corporate leaders to pursue innovation, restructuring and calculated risk-taking. That long-running complacency is visible today: Japanese industry is watching uneasily as Chinese EV maker BYD upends the global electric vehicle market and Chinese AI firm DeepSeek reshapes the global artificial intelligence landscape – the same kind of disruptive innovation Japanese companies dominated back in the 1980s.

Since taking office in October, Takaichi has shown little interest in breaking from this long-standing script. Her “Sanaenomics” agenda is essentially a continuation of former Prime Minister Shinzo Abe’s Abenomics framework, built on the same reliance on ultralow rates and a deliberately undervalued yen. The core problem with this approach is that Japan’s current inflation is not the healthy, demand-driven growth that policymakers once hoped for. It is fueled by high import costs for energy, food and other essential goods – classic cost-push inflation, not the demand-led price gains that signal rising household and business confidence. In short, it is unhealthy inflation that erodes living standards rather than reflecting broad-based growth.

A strikingly similar dynamic is now unfolding in China. The gap between surging producer price inflation and muted consumer price growth is the widest it has been since June 2022. This divergence indicates that Chinese manufacturers are still struggling to pass higher input costs on to end consumers, leaving corporate profit margins under intense pressure. If this margin squeeze persists, it could have severe consequences for wage growth across the world’s second-largest $20 trillion economy, undermining household spending and weakening Beijing’s narrative of a successful end to deflation.

This trajectory explains why Eurasia Group CEO Ian Bremmer began 2026 warning that “China’s deflation trap” would not disappear as easily as many optimistic analysts predict. Bremmer argues that Chinese leader Xi Jinping continues to prioritize political control and technological supremacy over the consumption stimulus and structural reforms that could break the deflationary cycle. “Beijing has the means to prevent a full-blown crisis, but living standards will deteriorate, the fallout will spread abroad, and the world’s second-largest economy will remain stuck in a trap of its own making,” Bremmer said.

Five consecutive years of falling home prices have created “household wealth destruction on par with America’s 2008 crash, except it’s still accelerating,” Bremmer added. “Consumer confidence, investment, and domestic demand have cratered with it. Beijing bet big that high-tech manufacturing would fill the gap left by a contracting property sector. Instead, state-driven investment has created massive overcapacity, and weak domestic demand means there aren’t enough buyers to absorb the excess production.”

One clear outcome of Beijing’s policy priorities is that too many Chinese firms are competing for a shrinking pool of domestic demand, forcing widespread price cuts to stay in business. “Margins collapse, forcing even well-run firms to cut wages and jobs to stay afloat,” Bremmer notes. “Workers spend less. Demand weakens further, so firms cut prices again. Meanwhile, debts grow harder to service with each turn of the cycle. Banks and local governments keep zombie firms alive — rolling over loans, protecting local champions — which keeps overcapacity entrenched.”

Former U.S. President Donald Trump’s 2025 tariffs on Chinese goods made the situation even worse, closing off a critical export market and forcing Chinese firms to choose between cutting prices to find new buyers outside the U.S. or absorbing the extra costs of transshipping goods through third countries to access American consumers. Either choice further squeezes corporate margins, and today more than a quarter of all listed Chinese firms are unprofitable, the highest share in 25 years, creating a self-reinforcing debt-deflation cycle, Bremmer concludes.

The core takeaway from decades of Japanese experience and current Chinese trends is that deflationary pressures can persist long after headline inflation turns positive, quietly eroding consumer and business confidence over time. This dynamic is why global markets are increasingly pricing in the possibility of monetary easing from the People’s Bank of China (PBOC) in the coming months – a move that would likely weaken the yuan and widen China’s already large trade surplus.

As Council on Foreign Relations economist Brad Setser puts it: “Of course, no one explicitly says they would welcome a bigger surplus. But if an international institution’s policy advice is monetary easing — to fight deflation — and fiscal consolidation because of off-balance-sheet risks, plus more exchange-rate flexibility, it is effectively advocating for the country to export its way out of its domestic troubles.”

Beijing has so far been reluctant to allow sharp yuan depreciation, for three key strategic reasons. A stable or slowly appreciating currency reduces the risk of offshore debt defaults among heavily indebted Chinese property developers. It also supports Xi’s long-term ambition to position the yuan as a credible alternative reserve currency to the U.S. dollar. Finally, it helps manage trade tensions with the second Trump White House, which remains highly sensitive to any policy that appears to give Chinese exporters an unfair competitive advantage.

Regardless of how 2026 unfolds for the Chinese economy, hopes that Xi’s administration has successfully defeated deflation could be heading for a sharp correction. Japan’s decades-long experience proves that even when headline economic data suggests reflation is gaining traction, the deeply entrenched deflationary mindset among households and businesses is extremely difficult to reverse.