Economic Outlook for the New Year 2023

15 February 2023

Japanese version: 1 January 2023

Akihiro Morishige
Center for Policy and the Economy


  • As the crisis in Ukraine spurs on global turbulence, we are entering into an era of Great Volatility
  • In 2023, the global economy will slow with all eyes on how the U.S. economy and policy implementation in China play out 
  • The Japanese economy stands at a decisive crossroads for achieving a positive cycle—upgrading human capital will make the difference

Review of the global economy in 2022

Russia’s invasion of Ukraine in February sent shivers down the world’s back. In a Japanese article one year ago, we outlined three factors that we saw would spur on global turbulence—a trend that is only gaining steam.

1. Volatility in world order

Though China’s emergence as a superpower means that American hegemony is coming to an end, each has a GDP that accounts for only about 20 percent of the world’s total. Meanwhile, the imposition of sanctions on Russia has strengthened solidarity among Western countries, especially the U.S., Japan, Australia, and those in Europe. However, the sanctions’ effectiveness has been diluted by China, India, and other non-Western–aligned countries’ increasing their imports of Russian energy. When the UN voted on censuring Russia in March 2022, a number of countries from the Global South abstained from voting, resulting in consensus from essentially less than half the world’s population. This made evident the complicated web of political influence behind international society consisting of three blocks: Western-aligned countries, China and Russia, and those countries caught between the two.

2. Focus on sustainability

The crisis in Ukraine has motivated many countries to hasten their shift to renewable energy in the long term as a means to ensure stable domestic energy supply. But it is also forcing a rethink of the process for transitioning. In Europe, governments are considering restarting coal-fired power plants as well as building new nuclear plants and extending the operating life of existing ones. Renewable energy comes with its own challenges too; countries run by authoritarian regimes hold a majority of the sources for materials required to fabricate equipment including storage batteries. All this makes urgent the need to find a way to achieve both carbon neutrality and national security.

3. Recalibrating capitalism

The need to rectify mounting inequality has been an ongoing issue since before the pandemic. Sights have turned to corporations to put excessive pursuit of profit behind them and build sustainable relationships with diverse stakeholders. In the U.S. and Europe, more companies are focusing on good workforce relations to retain talent amid serious labor shortages brought by the pandemic. Companies must also rethink the future of their businesses in facing economic sanctions and supply-chain disruption stemming from geopolitical conflicts due to the crisis in Ukraine.

Historically high inflation has taken hold as result of these trends surfacing in the economic domain. Economies face this situation because of upward pressure on prices attributable to greater costs for resources and food, the expense of decoupling from Russia, and rising wages; these run in tangent to a jump in demand coming off of the covid pandemic. Though both supply and demand on a global level recovered progressively during 2022, high inflation and monetary tightening in mainly the U.S. and European economies put a damper on economic growth worldwide.

With economic conditions and price fluctuations like none since the 1970s, the world is inching towards an era of extreme uncertainty—an era of Great Volatility1 (Figure 1).
[Figure 1] Fluctuation in real GDP and CPI, 1960–2020 (U.S., UK, and Japan averages)
Fluctuation in real GDP and CPI, 1960–2020 (U.S., UK, and Japan averages)
Source: Mitsubishi Research Institute, Inc. based on CEIC and IMF data

Outlook for global economy in 2023

Given the economic consequences of financial tightening mainly in the U.S. and Europe, growth in the first half of 2023 is likely to be slow. We anticipate a gradual return to growth in the year’s second half as inflationary and other pressures ease. We believe global growth will fall to the upper 1% range, which is below the potential growth rate.

These forecasts must be viewed as having a degree of variability as they have been formed amid the extreme uncertainty currently enveloping the world. We have identified three factors worthy of particular attention: 1) inflation in the U.S. and Europe, 2) economic conditions in the U.S., and 3) policy implementation in China. Depending on the directions they head in, global economic growth could well take another turn for the worse.

Factor 1: Inflation in the U.S. and Europe

The U.S. and European economies look set to fly low in 2023 with growth close to 0%* and output gap likely to see an easing of inflationary pressures. There are, however, other factors: rises in consumer inflation expectations and inflationary pressures that accompany acceleration of the three 2022 trends. Keeping inflation down to the 2% level central banks in the US and Europe aim for is no easy task.

Particularly in Europe, governments are moving ahead with plans extending into 2024 to lower dependance on Russian energy.2 This has forced them to procure LNG at high prices due to anticipated worldwide supply bottlenecks. These high energy prices are fueling cost-push inflationary pressure.

In the US, inflationary pressure attributable to domestic conditions bears watching: Households have ample savings from generous stimulus programs during the pandemic, and we forecast a high rate of wage inflation amid structural labor shortages due to workers on the edge of retirement deciding to leave the workforce early. These could conspire to stymie easing of inflationary pressures.

*As of 16 November 2022, we estimate real 2023 GDP will rise 0.4% YoY in the US and fall 0.2% YoY in Europe (average for Germany, France, UK, Italy, and Spain). We assume terminal rates for policy interest rates for suppressing inflation at 5% for the FRB and 3.5% for the ECB (deposit facility rate for the Euro zone)

Factor 2: Economic conditions in the U.S.

In the U.S., the Fed is expected to continue raising interest rates through the first half of 2023 amid strong domestic inflationary pressures. Already, interest rates on residential mortgage loans have jumped from 3% a year ago to 7%, and housing investment has turned around to decline 25% YoY. The effects of higher rates will likely reach purchases of cars and durable goods next. According to estimates published by the New York Federal Reserve Bank, the probability of a recession in the U.S. in the next 12 months is on the rise and was 38% as of November 2022.*

The Fed has two policy targets: maximum employment and price stability. It would like to start cutting rates once inflation is on track to settle down, but a premature easing would undermine public confidence in the institution if inflation flared up again. It will likely tread cautiously concerning rate cuts given the lessons learned from the 1970s oil crises. It remains to be seen if the US economy will be able to hold up in the interim.

*Estimated from the term spread between ten-year and three-month Treasury bonds. Source: Federal Reserve Bank of New York

Factor 3: Policy implementation in China

New leadership elected after the 2022 Chinese Communist Party Central Congress will formally take office at the National People’s Congress in March 2023. With Premier Li Keqiang and others stepping down, the focus will be on policy implementation in a political system where power is increasingly concentrated in the hands of President Xi Jinping.

In the short term, efforts will be centered on revitalizing the domestic economy, which has slumped under a deteriorating property market and policies to mitigate covid. However, the relaxation of regulations could result in worsening side-effects such as increased bad debts in the real estate sector and an exacerbated pandemic. The Chinese government is likely to enact policies aimed at striking a balance between such side-effects and economic growth.

Outlook for Japanese Economy in 2023

Despite sub-par prospects for export growth due to a slowing global economy, we expect the Japanese economy to recover to growth in the mid 1% range, driven mainly by domestic demand.

Factors that should help boost growth include an expected recovery in out-of-home spending post-pandemic, the economic stimulus package passed in December 20223, and a rebound in inbound traveler demand*.

Corporate capital expenditure should also see solid growth. Target areas include decarbonization, digital transformation, and bolstering supply chain resilience. The output gap has improved and is likely to shift to positive output in the second half of 2023.

Over 2023, we are likely to see both upward and downward pressure on prices. Recent inflationary pressures from a weak yen and high resource prices are likely to moderate through the latter half of 2023 as the U.S. rate-rise cycle pauses and prices on global markets lower once the world economy slows down.

Meanwhile, prices in Japan have long been characterized by upward price rigidity, but moves to raise prices are emerging on numerous fronts. Cost pass-through has been less prevalent in Japan than in the U.S. and Europe, but there are signs of change emerging.

According to Tokyo Shoko Research4, companies that are passing through at least 50% of input cost increases accounted for 40% of the overall total as of December 2022, up from 20% in February 2022. Corporate expectations for inflation five years down the line are also rising5, making the environment more conducive to price hikes.

Concurrently, the proportion of companies increasing wages has also reached a historical high6. The aim is to recruit and maintain workforces amid a labor shortage. While real wage growth has been negative YoY recently, it should turn positive in the second half of 2023.

*We anticipate contributions to real 2023 GDP of +0.4ppt attributable to economic policies and +0.2ppt attributable to expanding inbound demand

Fortifying human capital to achieve positive cycle

Cost pass-through and wage hikes present the Japanese economy with an opportunity to break free from its “lost 30 years” of stagnant prices and wages. Companies have been forced to secure profits by cutting costs for the last three decades. However, prices and wages have already begun to rise, and Japan can achieve a sustainable positive cycle by the addition of productivity gains through the creation of added value. The year 2023 is an opportune and crucial time to realize this positive cycle, as wages and consumption are expected to grow even as prices do too (Figure 2).
[Figure 2] Prices, output gap, and labor shortages (Japan)
Prices, output gap, and labor shortages (Japan)
Source: Forecasts by Mitsubishi Research Institute, Inc.; historical data from Cabinet Office, Ministry of Internal Affairs and Communications, and BoJ
One key to bringing this about is enhancing human capital. Improving productivity entails two pillars: digital transformation, or DX, which is using digitalization in business settings; and green transformation, or GX, which is decarbonizing society. These require workers who are skilled in the use of digital technologies and the redeployment of human resources to growth sectors related to decarbonization. If human resources are mobilized and organizations become more diverse, synergies from the integration of knowledge and collaboration should follow.

It will be vital to reform wage structures to fairly evaluate the innovative personnel who create new value. Employees will be more motivated to improve their skills if the irrational differences in the wages and benefits of permanent and non-permanent employees are eliminated and wage structures realigned to reflect job duties and responsibilities.

If wages and prices rise in an orderly manner—in a positive cycle—changing the current monetary policy comes onto the radar. A crucial element in such a case would be moving fiscal policy to a sound footing. If prices rise steadily, increases to short and long-term interest rate targets are in prospect. With government bond yields to be determined by the market, obtaining market confidence in government finances is vital in order to avoid a spike in interest rates due to loosened financial order.

This is the year of the rabbit in the Chinese zodiac, signifying dawn in terms of time of day and April, or the beginning of a new cycle, in terms of months of the year. We hope to see harbingers of the Japanese economy breaking free from its three lost decades and moving ahead on the way to recovery.

Works Cited:

1"Monetary policy and the Great Volatility," speech by Isabel Schnabel, Member of the Executive Board of the ECB, at the 2022 Jackson Hole Economic Policy Symposium (Jackson Hole, Wyoming) (Accessed: 3 February 2023)

2Germany aims to reduce its dependence on Russian energy (March 2022 energy security progress report). (Accessed: 3 February 2023)

3Second Supplementary Budget for FY2022 (¥28.9 trillion)

4Survey on procurement difficulties and costs increases, Tokyo Shoko Research, Ltd., December 2022

5BoJ Tankan

6Survey on Wage Increase, 2022,” Ministry of Health, Labour and Welfare of Japan, 2022