Over the past year, in addition to the COVID-19 Crisis, the world economy has experienced a major event: the invasion of Ukraine by Russia. This triggered a spike in energy and food prices and accelerated global inflation. Businesses braced themselves for heightened geopolitical risks. Taking these events into account and looking back at history from a slightly longer perspective, it appears that the mechanism that has supported global economic expansion for more than 30-years since the collapse of the Berlin Wall and the end of the Cold War has reached a turning point. From this perspective, I will focus on three issues: economic and financial crises, rising inflation, and the risk of fragmentation of the global economy. These events seem to have occurred in succession with a certain causal relationship.

Regarding the first issue, economic and financial crisis, Japan was the first country to suffer a major crisis since the end of the Cold War. In the 1990s, the Japanese financial authorities focused on avoiding the spread of the crisis overseas, even though they were severely criticized both at home and abroad for doing too little too late in responding to the crisis. Ten years later, countries cooperated in dealing with the international financial crisis, which became serious with the collapse of Lehman Brothers, but efforts were unable to prevent the crisis from spreading worldwide in a globalized world. In response to the pandemic that broke out in 2020, major countries quickly and on a large scale launched a variety of policy measures, both monetary and fiscal, based on the lesson learned from past crises: Do not be stingy with policies and do not be too late. This is evidenced by the fact that the balance sheet of the U.S. Fed has ballooned to 2.4 times its pre-pandemic level. There is no doubt that these measures have prevented the situation from escalating into a financial crisis and have averted a major economic downturn.

On the other hand, the massive and prolonged implementation of crisis response measures may have sown the seeds of new problems. Global high inflation is one example, and the second issue I would like to mention. Supply factors such as the logistical disruptions caused by the COVID-19 Crisis, combined with demand-side effects such as the recovery in consumption following the lifting of restrictions on behavior, caused prices to soar, particularly in Europe and the United States. We cannot rule out the possibility that large-scale monetary and fiscal support had an impact as one factor that amplified the surge. Central banks in Europe and the U.S. had previously maintained an accommodative monetary policy stance that dared to allow prices to exceed their targets for fear of Japanization, in which deflationary sentiment takes hold under low inflation. However, they have rapidly shifted their policies in the direction of tighter monetary policy. A breakdown of price increases in the U.S. shows that wages have continued to rise and service prices have remained high. To ensure that prices are brought down to the 2% target, the Fed may continue to tighten for a longer period of time than the market has factored in. Conversely, it will be difficult to return price growth to 2% otherwise. In this sense, a U.S. recession seems inevitable in 2023, but the U.S. economy is robust. That is, the balance sheets of both households and companies are generally healthy, and what is different from the time of the international financial crisis above all is that the financial sector has not been heavily damaged, and its ability to support economic recovery has been maintained. Therefore, even if the economy were to fall into a recession, it would be able to recover relatively quickly. This is a positive factor for the global economy going forward.

The third issue is the geopolitical risk that casts a shadow over the global economy, particularly the outcome of the war in Ukraine. Major Western countries, including Japan, have imposed severe economic sanctions against Russia. These include a freeze on Russia's foreign assets, including US dollars, the exclusion of major Russian banks from SWIFT, the international interbank communication system, and a ban on insuring Russian crude oil sold above a certain price for marine transportation. The use of the reserve currency, the US dollar, SWIFT, and marine insurance have been public goods that have facilitated globalization and are available to any company, regardless of the political system. If access to these systems is blocked by sanctions, it is inevitable that alternative mechanisms will be established, as the impact of such measures will be substantial. Many domestic and international business leaders are increasingly concerned that the weaponization of economic sanctions will increase the risk of global economic fragmentation. In addition, the Friend-shoring Supply Chains concept advocated by the U.S. government, in which supply chains are completed in friendly countries with shared values, is causing companies to shift their focus from conventional efficiency to stability and resilience in preparation for any contingency. This means a shift from just in time, which Japanese companies have pursued until now, to just in case. Companies will be forced to incur additional costs such as supply chain restructuring, double investments, and inventory buildup. Inflationary pressures will increase accordingly. Basic principles such as cost efficiency and free market access, which have promoted globalization and supported the international economic order for almost three decades since the end of the Cold War, appear to be under pressure to change due to heightened geopolitical risks.

As we have seen above, the process of globalization has accelerated the speed at which financial crises propagate, and the scale of each country's policy response has grown enormously. Inevitably, the amplitude of economic fluctuations has also increased. In 2022, the war in Ukraine triggered heightened geopolitical risks, raising awareness of the risk of a fragmentation of the global economy. With both the international economic order and monetary policy reaching a turning point, the environment surrounding the global economy has become more uncertain than ever before. Although this has become a difficult environment for corporate management, we must be willing to find a way to take advantage of the opportunities lurking in the midst of uncertainty. In terms of economic measures, from the perspective of removing uncertainty for international business, it will be necessary, at a minimum, to establish rules based on multilateral agreements to ensure that economic sanctions are not used as weapons in a disorderly manner. For the Japanese economy, it will be even more important to increase the potential growth rate, which is currently estimated to be in the lower zero percent range, from the perspective of increasing resilience to external shocks. Growth potential can be raised through capital accumulation and technological innovation. In this regard, decarbonization is a good growth strategy to compensate for Japan's lack of growth factors in the long run, as it will be driven by massive investment and new technologies. The chartless voyage of the Japanese economy will continue this year, but I believe there is light on the horizon.