Japan is now about to implement the most ambitious and experimental challenge in its economic policy history: Abenomics. Abenomics will certainly have a major impact on Japan's economic environment from 2013 onward. In this column, we will examine its trajectory and dare to make specific predictions about its consequences. Let me begin with our conclusion: We predict that Abenomics will cause the dollar-yen exchange rate to fall to 110 yen by the end of 2013, and that the economy from 2014 onward may head toward stagflation (rising prices amid economic recession).

The basis for this prediction is as follows: First, the most important aspect of Japan's monetary policy adjustment is that US consent (tolerating the correction of the strong yen) has been obtained. Second, regarding the criticism of Japan's weak yen policy from European countries that has already emerged (so-called criticism of exporting recession), Japan's diplomatic capabilities are sufficient to counter this. Third, there is a high possibility that the 2% rise in the consumer price index will be due to increased import costs rather than expanded demand. As a result of these factors, Japan may fall into stagflation from 2014 onward.

Abenomics is a bold challenge that stakes the nation's fate, and we appreciate this attempt. However, for Abenomics as a policy to become better, several conditions need to be met. Currently, the US economy is on a recovery track, and long-term interest rates are also rising. As a result, an interest rate differential between Japan and the US may emerge, potentially supporting the yen's weakening trend. In other words, it is almost certain that as a result of Abenomics, the exchange rate will swing considerably toward yen depreciation.

Such correction of the strong yen would normally often become the target of criticism from other countries. In particular, considerable opposition has already emerged from countries with intense competition in the automotive industry, such as Germany. However, Japan's diplomatic capabilities function to a certain degree except with regard to the United States, and it is believed that such external pressure will not impede Abenomics.

However, it is questionable whether Abenomics will truly bring about a rise in the Consumer Price Index (CPI) as planned. Normally, for monetary easing to cause a CPI increase, it must work through several channels. Specifically, the improvement in performance of export-oriented companies due to yen depreciation must be distributed as wages, thereby stimulating consumption. Also, the supply of liquidity to markets causes stock and real estate prices to rise, creating an "asset effect" that induces consumption. However, our analysis suggests that this monetary easing may not produce either of these effects. Normally, if the exchange rate swings toward yen depreciation, the performance improvement of export companies would certainly progress. However, in present-day Japan, the possibility is low that this will immediately lead to increased employment or wage increases, and the asset effect is also unlikely to materialize. What happens as a result? There is a high possibility of "cost-push inflation" occurring, where the rate of nominal price increases exceeds the rate of nominal wage increases.

Should such cost-push inflation emerge, household real income would decline, and Japan may fall into serious stagflation. To prevent this, systems that prioritize allocating a certain percentage of profits to wages and new employment, or tax incentives for profit distribution policies, would be necessary. However, such mechanisms are unfortunately not built into Japan's current economy. Furthermore, while the "growth strategy" mentioned by Abenomics is certainly important, it is not something that can be realized in a short period.

Ultimately, unless corporate performance recovery due to yen depreciation creates profit distribution and accompanying wage increase cycles, and nominal wage rate increases exceed the inflation rate, Japan will fall into stagflation at some point. Naturally, we hope that such unfortunate circumstances do not arise. We expect that the behavioral principles of Japanese companies and Japanese employees will gradually change, creating a better economic environment.